Carry structures in Australia, USA and Europe

A reader writes:  "Do Australian private equity funds have different carry terms to US or European funds?"

A subject near and dear to my heart!  "Carry" or "carried interest" refers to the share of investment profits paid to the manager of a private equity fund.  I've posted about carry before (Who Keeps the Carried Interest?).

The most generous carry regime can be found in the US market, where limited partners typically allow GPs the discretion to pay themselves carry as soon as a fund starts generating profitable exits.  While popular with fund managers, this trusting "deal by deal" approach is not without risk.  Imagine a situation where a fund's first exit is a blockbuster, and the manager receives a large carry payment.  He buys a Ferrari.  Then things change.  It's April 2008.  The market tanks and the remainder of the deals in the portfolio turn out to be over-leveraged dogs.  It takes a few years, but these investments are eventually sold at a substantial loss. 

What happens in this painful situation?  Theoretically it's simple:  the manager is expected to repay all the carry he "incorrectly" received on the first deal  . . . this is the dreaded "clawback" provision. 

Needless to say, clawback can be difficult to enforce, especially in situations where staff have left the firm or suffered major financial setbacks-- like getting divorced or buying shares in 2008.  Some funds require a portion of carry payments to be placed in escrow to increase the likelihood that a clawback can be honoured.  With the recent collapse in equity and debt markets, you can be sure that clawback provisions are about to become front page news again.

In Europe clawback doesn't usually feature.  Instead, the GPs must wait far longer to pay themselves carry.  European fund managers can typically only distribute carry once all cash drawn down from their limited partners has been returned.  Sometimes the Europeans prohibit the payment of carry before the end of the fund's investment period, typically the first five years.  In a few draconian cases the manager must first repay any cash that will ever be drawn down from a particular fund (ie, committed capital) before carry can be distributed.

In Australia our fund terms tend to be conservative.  This in part reflects the dominant position held by a small group of limited partners in years gone by (you know who you are).  As a result, our carry structures follow the European model.  We must repay all drawn down capital before paying carry.

As always, however, supply and demand governs.  A group of "top decile" performers is emerging and they are no doubt already pressing for more generous carry distribution terms.

Comments

[S Hunting]

Do any Aussie private equity firms get more than 20% carry?

[PEguy]

I work for one of the industry super funds. We are a major investor in alternative assets, including PE. In fact we were one of the first Australian super funds to support the private equity and VC market.

I can tell you with pretty much 100% certainty that there is no Australian firm getting over 20% carry. I think I have seen every IM to come out in the past five years.

To your comment about a few Australian LPs setting tough terms -- I assume you mean industry funds like mine, IFS, Wilshire, etc. While I agree that supply/demand plays a rrole, so there is a degree of truth in what you say, it also should be said that we were investing in a unproven sector in a new geography. As private equity has proven itself in Oz, terms have pretty much reverted to US/European norms/means. (Not intended to be defensive, but that's what I genuinely believe).

PEGuy