General Partner Clawback

 
 
 

What is Carried Interest?

Carried Interest – also known as promote – is the disproportionate share of profits allocated to the General Partner in a fund or partnership. Carried Interest is usually paid to the General Partner after certain performance metrics are met. A common structure allocates 100% of distributions to Limited Partners until a certain return threshold has been met, usually around 8% IRR. This return threshold is commonly known as Preferred Return. After the Preferred Return has been met, General Partners will start to receive Carried Interest from each distribution. 

What is Clawback?

Due to the nature of the these Carried Interest calculations, it is possible that a General Partner can be paid too much Carried Interest. Carried Interest may be calculated at an earlier point in time can later change if more capital is called, or certain assets perform worse than expected and do not generate enough distributions. If the General Partner overpays themselves Carried Interest, a Clawback clause forces the General Partner to return the portion of overpaid Carried Interest to the Limited Partners. Clawback calculations are commonly triggered by the final liquidation of the fund or partnership. This is to ensure that there is no more activity that would further change the Carried Interest calculation, and thus necessitate another Clawback event. 


Clawback Provision in Action

Take a Fund with the following distribution terms:

  1. 100% to the Limited Partners until an 8% Preferred Return and return of contributed capital

  2. 100% to the General Partner until General Partner has received 20% of profits 

  3. Thereafter, 80% to the Limited Partners and 20% to the General Partner

Note: Distributions received by the General Partner under sections ii) and iii) are the “Carried Interest” 

Given the above terms, imagine a scenario where the Limited Partners in a fund have already met their preferred return thresholds and the General Partner has received enough distributions to reach 20% of profits. If the fund makes another distribution, the distribution will allocate according to section iii), so 80% will go to the Limited Partners and 20% will go to the General Partner as Carried Interest. 

If the fund then calls capital from investors after making distributions in the 80/20 tier, and makes no further distributions, the Limited Partners have no longer received all their Preferred Return and received all their contributed capital back. In this scenario, the General Partner has received over 20% of profits, and thus overpaid themselves Carried Interest. A Clawback clause in the Limited Partnership Agreement would force the General Partner to return the overpaid portion of the Carried Interest. 

Other Clawback Considerations:

Carried Interest Escrow: A portion of Carried Interest can be required to be placed in escrow by the General Partner until the final liquidation of the fund or partnership. This is to ensure that the General Partner still has the Carried Interest proceeds, if they need to be clawed back.

Clawback Guarantor: Equity owning members of the General Partnership entity can be held liable for the un-returned Clawback Carried Interest of other General Partnership members. Generally, liability of the guarantors is capped at the amount of Carried Interest they have received.

 
 
 
 

About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions regarding discounted cashflows or if he can help you with your modeling needs.

 
Eric Bergin