Syndicated Investment: The Tale of Carried Interest

Our first post in our Syndicate Investment series, The Evolution of Syndicated Investment, defined a syndicate as a group of investors who pool their resources to invest in various ventures as a unit. Carried interest affects the way in which profits from investments are allocated among members of a syndicate, and is a crucial aspect of syndicate investment. Let us take you through the ins and outs!

Syndicates: Leads and Backers

Syndicates provide an informed marketplace where investors, or leads, share their deals with other accredited investors, or backers. Besides capital, leads lend their expertise and business acumen to fledgling businesses, and facilitate pools of capital. In return, leads are rewarded with a higher share of the profits compared with the other investors, the backers, in the syndicate.

What is Carry?

Carry, short for ‘carried interest’, is a share of the profit of an investment that is paid to the leads of the investment. The investors in a syndicate will forfeit an agreed portion of their collective profits to the lead investor. Carry is the mechanism that allows leads to be rewarded for their efforts.

AngelList provides an example of how carry works:

Sara decides to invest in a startup and asks for a $250k allocation in the company. She personally takes $50K of the allocation and decides to syndicate the rest. She shares the deal with investors and specifies that she is charging a 20% carry on the remaining $200k of her allocation. Sara’s capital and her co-investor’s capital is pooled into a $250K fund which invests in the startup.

Sara’s co-investors pay carry for her access, governance and value-add. She sourced the deal and used her judgment to select the investment. She manages the fund and provides oversight for her co-investors’ capital. And she provides ongoing value-add to the startup.

Carried interest has garnered significant attention in the past few years due to the tax loophole it’s afforded. Managers of hedge funds, and private equity and venture capitalist firms usually earn a “2-and-20” fee structure: 2% of the investments, and an additional 20% incentive fee of whatever additional gains they realise over benchmarks, deemed “carried interest”. Through a quirk in the tax code, the carried interest is allowed to be taxed at a rate around 20% less than income.

Proponents of the system argue that it provides incentives for investment, which ultimately translates into a thriving early-stage business sector, innovation and job creation. It also creates responsible investment by aligning the interests of lead investors with those of the companies.

How Much Carry?

AngelList’s model allows leads to choose the percentage of profits for the investment prior to gathering backers. Carry of 0% might suit leads who are new, and don’t have a proven track record, whereas those with a strong reputation, and impressive business knowledge and network could ask for a carry of 40%.

Why is Carry Important?

Syndicates are part of a wave of new tools for capital-hungry companies, contributing to innovation, economic growth and job creation. Carry provides the incentives for investors to become leads and form syndicates, providing powerful avenues for early-stage companies to access capital.

Carry aligns leads’ interests with those of the companies’. Once a syndicate is established, carry motivates leads to actively engage with and help companies by extending their expertise and leveraging their network.

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