Carried interest, commonly known as "the carry," is a share of the profits earned by a venture capital or private equity firm that is given to the firm's investment professionals as compensation. This form of compensation is based on the performance of the investments made by the firm, and is intended to align the interests of the investment professionals with those of the firm's investors.
In the context of startups and venture capital, carried interest is often used as a way to incentivize investment professionals to seek out and invest in high-growth, innovative companies. By providing investment professionals with a share of the profits earned from successful investments, venture capital firms are able to attract and retain top talent who are motivated to identify and invest in the most promising startups.
The carried interest model is also advantageous for venture capital firms because it allows them to share some of the risk associated with investing in startups. If a startup is successful and generates significant returns for the firm, the investment professionals who worked on the deal will share in those returns through the carried interest. However, if the startup fails and the firm loses money, the investment professionals will also share in those losses.
Despite its potential advantages, carried interest has come under scrutiny in recent years due to concerns about fairness and equity. Critics argue that carried interest disproportionately benefits investment professionals at the expense of the investors who provide the capital for the firm's investments. There have also been calls for carried interest to be taxed at a higher rate, as it is currently treated as a capital gain rather than income.
Despite these criticisms, carried interest remains a popular form of compensation in the venture capital and private equity industries. As long as it continues to incentivize investment professionals to seek out and invest in promising startups, it is likely to remain a key component of the venture capital ecosystem.