The fees private equity managers earn on successful deals are no longer just a matter of compensation. For the pension funds and insurers that bankroll the industry, the way those payouts are calculated has become a test of governance, and an increasingly important influence on where capital flows next.
At the center is carried interest: the share of profits, typically 20 percent, that fund managers keep once investors clear an agreed return. It is the mechanism behind some of the largest paydays in finance. After a decade in which private markets ballooned to more than 13,000 billion dollars, the institutions writing the checks want to see the math.
“Over the past few years, there has certainly been an increased desire by LPs to have more granular reporting to better understand the inputs to the various performance calculations,” Emily Kisak, director of industry affairs at the Washington-based Institutional Limited Partners Association, told Investment Officer. That scrutiny is now embedded in ongoing manager evaluation rather than confined to initial due diligence.
“Governance around carry has moved beyond an internal compensation question.”
Richard Change, Allvue Systems
The shift reframes carry as a window into operational discipline. “Governance around carry has moved beyond an internal compensation question. It is increasingly treated by LPs as a measure of a GP’s overall operational maturity,” said Richard Change, co-founder and managing partner of private fund accounting solutions at Allvue Systems, in an interview. For many investors, the credibility of the calculation now matters as much as the size of the check.
Luxembourg this year introduced a major reform of its carried interest regime, simplifying and clarifying tax treatment to replace narrower, more interpretive rules. Since January, a tax rate of 11.45 percent applies to contractual carried interest. For certain participation-linked structures, a full exemption applies.
The reform is designed maintain international competitiveness and “aims to attract highly skilled financial professionals,” said Hugues Hénaff, partner at Atoz Tax Advisers, at a recent conference in the Grand Duchy.
Early signs point to relocations from London and Paris; Andrew Wynn, co-founder of private equity firm Perwyn, for example has moved his official residence from the United Kingdom to Luxembourg at the beginning of this year.
Fragmented practices
There is no industry standard for how the payouts are calculated. “Every GP calculates carried interest a little bit differently,” Kisak said. “Some do deal-by-deal versus some do pooled-to-fund.” In other words, some managers take their cut from each winning deal as it lands, while others only do so after the entire fund has cleared its hurdle. The variation extends to vesting, clawbacks and the treatment of co-investments.
The fragmentation is operational as well as conceptual. “Carry, co-invest and incentive allocations are often run in separate models or systems,” Change said. “Co-invest or sidecar vehicles effectively operate like parallel funds with their own economics and reporting cycles.” Reconciliation is more complex as a result, increasing the risk of inconsistent or mistimed allocations.
The infrastructure has not kept pace with the money flowing through it. “Our data shows that 64 percent of GPs still rely on Excel for critical workflows,” Change said. “Even firms that have invested in technology are still dealing with manual processes that increase the risk of errors.” Comparability across managers is limited, and investors seeking a like-for-like view must reconstruct it themselves.
Principles, not rules
ILPA has standardized reporting rather than calculation. Its templates give investors clearer visibility into fees, expenses and profit splits, but adoption remains uneven. Roughly half of US general partners use them in some capacity, Kisak said, with lower international uptake.
“We at ILPA have refrained from producing a standardized carried interest model,” she said. Boundaries are set through principles instead. “The biggest takeaway from that guidance is that we recommend that GPs only earn carried interest on true net gains to LPs.” The approach anchors expectations in outcomes, leaving the plumbing to individual funds.
“People really just want to understand what’s in their portfolio and what is driving returns.”
Emily Kisak, ILPA
The reporting framework itself is becoming part of the governance assessment. “Through initiatives like the ILPA Reporting Template, LPs have made clear that transparency around how carry is calculated, accrued, and paid is a core governance expectation rather than a best-efforts exercise,” Change said. Managers aligned with those expectations are better placed to build credibility as the industry’s pay structures come under sharper scrutiny.
Valuation gap
The most consequential weakness emerges earlier in the chain. Carried interest depends on performance, performance depends on valuation, and the valuation of an unlisted company remains, by nature, an estimate.
ILPA’s template tracks movement from opening to closing net asset value, including contributions, distributions, fees and carry. But, as Kisak put it, “it takes those values at face value at the manager-reported values.” The numbers feeding into multimillion-euro payouts are the same numbers the manager itself produces.
The exposure is sharpest in Europe, where Luxembourg’s financial regulator, the CSSF, has flagged inconsistent valuation practices among alternative fund managers. Reporting cannot resolve uncertainty in the underlying data.
Testing the dialogue
Investor relationships in private markets have historically rested on direct engagement rather than disclosure. Kisak does not see that changing. “I don’t think there’s necessarily a credibility risk. If the manager is acting in good faith and being transparent, LPs are more than happy to work with managers.”
That model is being tested nonetheless. Granular templates, fee validation exercises and standardized disclosures are shifting part of the relationship into documentation that can be compared across funds. With exits slower and holding periods longer, that need has only sharpened.
“People really just want to understand what’s in their portfolio and what is driving returns,” Kisak said.