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Chapter 5 of 5 · 9 min

The GP commitment

Carry rewards the upside and ignores the downside. The GP's own money in the fund is the LPs' counterweight.

By the end of this chapter you can
  • Calculate the GP's carry and the return on its own commitment
  • Compare the commitment with the carry it expects
  • Size the commitment an LP's skin-in-the-game test requires
  • Show what the GP loses when the fund returns less than its money
1

The intuition

You hire a friend to bet your money at the races for 20% of any winnings. If they lose, they lose nothing. Why would they not back long shots? Now ask them to put some of their own savings in the same bets. They still get their 20% when they win, but they feel it when they lose.

Carry is that 20% of winnings: an option with no downside. The GP commitment is the GP's own money invested in the fund alongside the LPs, historically 1% of the fund and now often 2–5%. It earns what any LP earns, and it falls when the fund falls.

The key idea

Carry = 20% × fund profit. The commitment earns the LP net multiple, 1 + 80% × (gross − 1). In a good fund carry dwarfs the commitment; in a bad fund the commitment is all that moves.

2

Why it works

  • The conventions here: carry is a flat 20% of all fund profit (the hurdle is cleared and the catch-up complete). The GP's own money earns exactly what an LP earns after carry. Fees are left out.
  • The commitment earns the net multiple, not the gross: the GP pays carry to itself on its own money, like everyone else.
  • In a good outcome carry dominates. A few million of commitment sits beside tens or hundreds of millions of carry. The share of the GP's gain that comes from carry depends only on the commitment percentage, not on how well the fund does.
  • In a bad outcome there is no profit, so no carry, and the commitment loses money like any LP's.
  • Beyond the check: partners often fund the commitment personally, sometimes through a fee waiver. The bigger alignment is reputation: a GP with a lost fund rarely raises another.
A $1,000M fund; 2% GP commitment; 2.5x gross; 20% carry
Commitment: 2% × 1,00020
Carry: 20% × 1,000 × 1.5300
Net multiple: 1 + 80% × 1.52.20x
Commitment grows to: 20 × 2.2044, a gain of 24
Share of the GP's gain from carry: 300 ÷ 32492.6%
Commitment for 25% of expected carry: 25% × 20% × 1.57.5% of the fund

If the fund returns 0.8x instead, carry is nothing and the commitment loses 4.

3

The formulas

GP commitment = commitment % × fund size

The GP's own money.

Carry = carry rate × fund × (gross − 1)

A share of profit, no money down.

Net multiple = 1 + (1 − carry rate) × (gross − 1)

What every investor earns, the GP included.

GP total = carry + commitment × net multiple

Both sources of GP economics.

Commitment % for a share of carry = share × carry rate × (gross − 1)

The skin-in-the-game test, backwards.

Downside loss = commitment × (1 − multiple), with no carry

Below 1x only the commitment moves.

4

Worked example

Carry on the fund's profit, then the commitment grown at the net multiple, not the gross.

Drawing the numbers…
5

See it move

Same fund. Change the GP's commitment, the fund's outcome, a downside outcome and the LP's test.

Drawing the numbers…
Try this
  • Raise the GP commitment. Carry does not change, the commitment grows as a share of it, and so does the downside loss.
  • Raise the gross multiple. Carry and the gain on the commitment both grow, but the share from carry does not move; the commitment shrinks relative to carry, so the test needs more.
  • Raise the downside multiple. The loss shrinks. Carry in the downside is zero whatever you set.
  • Raise the LP's test. The commitment it requires rises in step.
6

Run it backwards

Same fund, reversed: an LP wants the commitment to be worth a set share of the carry the GP expects. What percentage of the fund must the GP put in?

Drawing the numbers…

Expected carry as a share of the fund is carry rate × (gross − 1). The commitment must be the LP's share of that, so multiply.

Notice the test gets harder as the expected outcome improves: a GP that promises a bigger multiple is promising itself more carry, so the LP asks for more money at risk.

7

Traps

Growing the commitment at the gross multiple.
The GP's money earns the net multiple, after carry, like any LP's.
Thinking the GP loses carry in a bad fund.
There is no carry to lose. What it loses is the commitment itself.
Treating 1% as a meaningful stake.
Next to carry it is tiny. That is why LPs push for 2–5%.
Assuming a better fund makes carry a bigger share of the GP's gain.
With a flat carry rate the share depends only on the commitment percentage.
Counting a fee waiver as cash at risk.
It is money forgone, not money added. LPs accept it but prefer a check.
8

Say it in the interview

The interviewer asks

“Why do LPs require a GP commitment, and how big is it?”

Say yours out loud first, then compare.
9

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4
Drawing your questions…
Remember
  • Carry = 20% × profit; no downside.
  • The commitment earns the net multiple: 1 + 80% × (gross − 1).
  • Commitment % for the test = share × 20% × (gross − 1).
  • Below 1x, only the commitment moves.