Understand both the award and the fund documents
A short award notice may not tell the whole story. The agreements that govern the fund or business may contain the provisions that determine payment, restrictions, and what happens when employment ends.
This overview is particularly relevant to senior investment professionals and executives with material carried-interest, profits-interest, or fund-compensation arrangements.
What we help you understand
- How your share of investment profits is calculated and paid
- Whether payment can be reduced, taken back, or lost after you leave
- What tax treatment is expected and what steps may be required
- Which fund documents contain the terms that matter to you
Key questions about carried interest
Does the interest qualify as a profits interest? Where and how does it fit in the waterfall? Are there clawbacks, and how do they operate? What happens on termination? What restrictive covenants, forfeiture provisions, and transfer restrictions apply?
Profits-interest treatment and tax
Where an arrangement is intended to qualify as a profits interest, the relevant documents should be structured and reviewed with that intended treatment in mind. A defect in the arrangement can create significant and unexpected tax issues. The analysis should consider both the grant terms and the underlying entity documents.
Waterfall economics
A carried-interest award has to be understood within the applicable waterfall, which is the order in which fund profits are allocated and paid. The executive should know when the carry participates, what preferred returns, return-of-capital provisions, catch-ups, hurdles, or allocations come first, and how the award is affected by fund performance and timing.
Clawbacks
The documents should explain whether the executive can be required to return previously distributed carry, what events trigger a clawback, how the amount is calculated, whether tax distributions are addressed, and how long the obligation lasts.
Termination, forfeiture and restrictions
Carried-interest arrangements frequently provide different outcomes for resignation, termination without Cause, termination for Cause, retirement, disability, death, or a breach of restrictive covenants. The executive should understand whether carry is vested, forfeited, reduced, repurchased, or subject to continuing restrictions after employment ends.
Document review
The review should ordinarily include the award documents and, where applicable, the relevant LLC and LP agreements, the management-company agreements, waterfall provisions, side letters, clawback provisions, and restrictive-covenant provisions. Important rights and obligations may be hidden in documents the executive has not been given initially.
Frequently asked questions
What is the most important question about carried interest?
There is no single question. The executive needs to understand whether the interest receives the intended tax treatment, how it participates in the waterfall, whether it is subject to clawback, what happens at termination, and what restrictions or forfeiture provisions apply.
Why should the underlying fund documents be reviewed?
The economic and legal terms of carried interest are frequently contained in the partnership and LLC agreements, not just the employment offer or award notice. A review limited to the offer letter may miss the provisions that matter most.
What is a clawback or forfeiture provision, and why does it matter?
A clawback or forfeiture provision can require a fund professional to return previously distributed carried interest, or lose unpaid carried interest, based on later fund performance, losses, valuation changes, or other calculations. It can also be triggered by a breach of restrictive covenants or specified competitive conduct. In some arrangements, the clawback or forfeiture provision itself conditions continued entitlement on avoiding defined conduct, even if the documents do not contain a separately labeled restrictive covenant. The documents should identify the trigger, calculation, duration, treatment after termination, and tax consequences of any required repayment or forfeiture.
What are tax distributions, and why do they matter?
A partnership or LLC may allocate taxable income to an executive before the executive receives enough cash to pay the resulting tax. A tax-distribution provision is intended to provide cash to help cover that liability. The documents should address how the amount is calculated, whether it is an advance against future distributions, whether it must be repaid, how it interacts with clawbacks, and what happens after termination.
What happens to carried interest when a fund professional leaves?
That depends on the award documents and the underlying partnership or LLC agreements. Vesting, forfeiture, good-leaver or bad-leaver treatment, clawbacks, payment timing, and restrictive covenants should be analyzed before an executive accepts the arrangement or makes a decision that could trigger departure provisions.