The '2 and 20' model is no longer the default. Here is how carry actually works in modern Cayman fund structures, and the tax traps that first-time managers miss.
Carried interest is the economic engine of fund management. It is the reason people start funds instead of staying in salaried jobs. But the mechanics of structuring carry in a Cayman vehicle are more involved than most first-time managers expect. I have seen managers lose real money, or create problems with their investors, because they treated carry as a boilerplate term instead of a structural decision that requires careful planning. Here is what I tell every emerging manager who is putting together their first LPA.
The basic mechanics
Carried interest is the manager's share of fund profits, typically structured as a special allocation to the general partner or a carry vehicle owned by the fund's principals [1][2]. The standard arrangement: the GP receives 20% of net profits after investors have received their capital back plus a preferred return, usually 8% per annum [2][3]. That 8% threshold is the "hurdle rate." Until investors clear it, the GP earns nothing beyond management fees.
In a Cayman ELP, carry is documented in the limited partnership agreement as a profits allocation to a specific class of partnership interest [1][2]. The GP (or its affiliates) holds the carry interest; limited partners hold their own class. The LPA specifies exactly when carry crystallises, how it is calculated, and when it is distributed.
The distribution waterfall
The waterfall is the sequence in which fund proceeds flow to investors and the GP. For emerging managers, the two main models are the American waterfall and the European waterfall.
American (deal-by-deal) waterfall. The GP receives carry on individual investments as they are realised, after returning invested capital and the preferred return on that specific deal. This lets the GP receive carry earlier in the fund's life, but it creates the risk that the GP earns carry on early winners while later losses reduce the fund's overall return below the hurdle.
European (whole-fund) waterfall. The GP receives carry only after all invested capital has been returned to investors across the entire portfolio, plus the preferred return on all capital. This is more investor-friendly and is increasingly what institutional LPs expect from first-time managers.
Most of the Cayman fund LPAs we work on use a European waterfall or a modified European waterfall. If you are raising from institutional investors for the first time, expect them to push for whole-fund economics. It is the standard.
Clawback provisions
A clawback is the mechanism that protects investors when the GP has received interim carry distributions that, at the end of the fund's life, exceed the GP's entitled share of overall profits [2][3]. If early realisations generate carry but later investments perform poorly, the GP must return the excess carry.
Almost every institutional LP will require a clawback provision. The negotiation is over the details: gross or net of taxes the GP has already paid on the carry? Is it a fund-level or GP-level obligation? What about individual carry recipients who have left the firm?
For first-time managers, my advice is simple: include a full clawback. Trying to negotiate your way out of one will signal the wrong things to sophisticated investors. Better to agree to it and structure your cash management so you can meet the obligation if it arises.
Beyond "2 and 20": what the market actually looks like
The traditional "2% management fee, 20% carry" model is no longer the default, particularly for emerging managers. Recent data on funds launched in 2024 and early 2025 shows meaningful shifts in fee structures [3]:
- Approximately 74% of funds charge both management fees and incentive fees, but management fees have declined below the historical 2%, with many funds now charging between 1.0% and 1.5% annually [3].
- The 20% incentive fee rate remains common, though some managers offer tiered rates that vary by investor commitment size or vintage [3].
- High-water marks appear in roughly 90% of funds that charge incentive fees [3].
- Hurdle rates are present in about half of newly launched funds [3].
For emerging managers, fee negotiations with anchor investors often result in reduced management fees in exchange for larger carry allocations, or stepped management fees that decrease after the investment period. The key is understanding that your fee structure is a negotiation, not a fixed industry standard.
Carry pools and team economics
Unless you are a solo GP, you will need a carry pool that allocates carry among your team [1]. This is one of the most important decisions you make as a first-time manager, and one of the hardest to change later.
The typical approach is to create a carry vehicle (often a separate Cayman entity) that holds the GP's carry interest and allocates it among principals and key employees according to a carry plan [1][2]. The carry plan specifies each participant's percentage, vesting schedule (if any), forfeiture provisions for departing team members, and the mechanics for reallocating forfeited carry.
Two structuring points matter for US tax purposes:
Profits interests vs. capital interests. If carry allocations are structured as "profits interests" under US tax law, they are generally not taxed when granted [1]. The recipient is treated as a partner from the grant date and pays tax only when profits are actually distributed. This is the preferred structure. If instead the allocation is treated as a capital interest or as compensation, the recipient may face immediate tax on the fair market value at grant [1].
Section 83(b) elections. Even when carry awards qualify as profits interests, it is standard practice to file a protective Section 83(b) election within 30 days of the grant [1]. This election ensures that if the IRS later reclassifies the interest, the recipient's tax exposure is based on the value at grant (typically zero for a profits interest) rather than the value at vesting. Missing the 30-day deadline is irrevocable. I have seen it happen, and it is expensive.
Section 1061: the three-year holding period
For US-resident GPs, Section 1061 of the Internal Revenue Code is the single most important tax provision affecting carry [1]. It requires a three-year holding period before gains allocated to carry interests qualify for long-term capital gains treatment.
Without Section 1061, gains on investments held for more than one year would qualify as long-term capital gains taxed at 20% (plus the 3.8% NIIT). With Section 1061, gains on investments held between one and three years from the date of the carry allocation are recharacterised as short-term gains taxed at ordinary income rates, which can reach 37% [1].
For a typical venture fund with five-to-seven-year holding periods, most exits will satisfy the three-year rule. But early exits, secondary sales, or partial realisations within the first three years will hit the higher rate. Factor this into your return modelling and your team's compensation expectations.
Newer carry structures
The carry world is getting more complex. A few trends I am seeing in Cayman fund structures [2]:
Continuation funds. When a manager creates a successor vehicle to hold existing portfolio companies beyond the original fund's term, carry from the predecessor fund may be "rolled" into the new vehicle. This requires careful documentation in both the original LPA and the continuation fund documents [2].
Deal-specific carry pools. Multi-strategy funds may tie carry to the performance of individual deals or strategies rather than the overall fund, allowing different team members to participate in the deals they sourced [2].
NAV-based carry. Some hybrid or open-ended structures calculate carry based on unrealised gains at current NAV rather than waiting for actual exit events [2]. This lets managers participate in paper gains, but creates complexity around true-ups if those gains are not ultimately realised.
Each of these structures requires specific documentation and administration. The LPA must explicitly authorise the carry mechanics, and the carry plan must specify calculation methodologies, accrual timing, and distribution conditions [2][3].
Getting the documentation right
Three documents define your carry structure:
- The limited partnership agreement, which authorises the carry arrangement and specifies the high-level economics (percentage, hurdle, waterfall) [2][3].
- The carry plan or incentive plan, which details individual allocations, vesting, forfeiture, and reallocation rules [2][3].
- Tax counsel opinion, which confirms the carry interests qualify as profits interests, addresses Section 1061 implications, and validates the structure for all relevant jurisdictions [1].
Do not treat these as afterthoughts. I have seen managers who drafted their LPA carry provisions without tax input, only to discover months later that the structure created unintended tax consequences for their team. Get tax counsel involved before the LPA is finalised, not after.
How Infra One helps
We administer carried interest calculations, accruals, and distributions for our Cayman fund clients. Our fund administration platform tracks waterfall mechanics, hurdle rates, clawback obligations, and individual carry allocations across team members. We work with your legal and tax advisors to ensure the administration matches your documented carry structure precisely.
If you are structuring carry for the first time and want to make sure your economics are properly set up before you start raising, get in touch.
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