How carried interest vests, and what happens when a partner leaves

The most useful sentence in the sourced literature on this topic is a disclaimer: there is no clear market standard in how carried interest vests. That is not a gap in the research, it is the finding, and it should sit in the front matter of any published treatment because it changes how a professional reads an offer and how a partnership defends a schedule.

The exemplar schedules in the source bear it out. Four appear: twenty per cent per annum across years one to five; twenty per cent at closing and then twenty per cent per annum in years two to five, where the immediate grant recognises a contribution made before the fund existed; twenty per cent at closing, fifteen per cent per annum in years two to five, plus a twenty per cent holdback running to final dissolution; and ten per cent per annum straight-line across the full ten-year term. Withholding ten to twenty per cent to the end is described as a device to induce professionals to remain up to ten to thirteen years.

Those four shapes span an enormous range of economic outcomes for the same nominal grant. A professional fully vested at year five and a professional carrying a twenty per cent tranche to dissolution hold instruments that are not comparable, and neither is comparable to a straight-line ten-year schedule. Schedules also vary by seniority, with the most senior professionals sometimes fully vested from the outset.

Two of those structures function as a period before which nothing vests, and the market word for that is in general use. The source establishes the tranche structures and does not use the word, so the structures ship cited and the label ships as market vocabulary.

The structural default is that carry is allocated and vested with respect to each separate fund the manager runs. Within that, two forms dominate and they follow the shape of the distribution waterfall they sit under. Vesting in the fund is the venture-typical form: a professional vests in the carry derived from an underlying fund regardless of when that fund makes its portfolio investments, which is simple to understand and administer and which fosters teamwork.

Deal-by-deal vesting is the buyout-typical form and mirrors a deal-by-deal distribution waterfall: a departing professional vests only in carry generated by investments made on or before the departure date. It carries a mismatch the source identifies precisely — the professional's deal-level entitlement is still reduced by losses from other deals and remains subject to the fund-level clawback, so the individual holds an upside tied to their own deals and a downside tied to everyone's. The two documented answers are an end-of-fund true-up, or applying aggregate percentages at each distribution to minimise the final true-up.

The hybrid form modifies a deal-by-deal vested percentage to include a certain percentage in every portfolio investment plus an additional vested percentage in each investment completed during that professional's employment. It is the structure that reads best to a candidate and is the hardest to model, because the professional's percentage differs investment by investment and therefore differs at every distribution.

One piece of market vocabulary is worth retiring here. Carry vesting described as running across the firm rather than fund by fund inverts what the source establishes as the structural default, and a professional reading an offer on that assumption will overestimate what a departure preserves.

Departure terms adjust vesting by reason for leaving. On cause — typically defined as bad acts, and specifically not poor performance — all past and future entitlement to carry allocations and distributions is subject to forfeiture, prior amounts may be clawed back, and the manager commonly retains discretion as to the exact penalty. The distinction between bad acts and poor performance is the single most important definition in the paragraph, and it is the one most often left loose in a draft.

Competitive activity is handled separately and works as an economic deterrent rather than a restraint: vested interests are reduced if the departing professional competes. The source is explicit that this is used particularly in states such as California where traditional restrictive covenants are unenforceable as a restraint of trade contrary to public policy, and equally explicit that it is unclear and untested whether such provisions would be enforceable there. Both halves belong in any published treatment; the second half is the one that gets dropped.

Acceleration on death or disability is narrower than candidates expect. The common accommodation is to assume the triggering event occurred one year later, which adds a single additional year of vesting rather than accelerating the whole schedule.

The paired labels for departure reasons that circulate in this market are United Kingdom and European usage and do not appear in the source at all. The mechanics — cause, bad acts, discretion as to penalty, competitive-activity haircut — are sourced and publishable; the labels are not, and attaching a citation to them is the tell that a treatment is restating a vendor page.

This is the part that decides the money. Because a pass-through entity must allocate one hundred per cent of its income to its interest holders each year, every prior allocation to a departing professional was necessarily made as though that professional were one hundred per cent vested. The vesting percentage did not restrict the allocations while the professional was there; it restricts what they keep on the way out.

On a triggering event it is therefore advisable to recalculate the individual's capital account to reflect prior allocations at the reduced vested percentage, reallocating the unvested income to the remaining partners. If that recalculation produces a negative capital account, the departed professional may be required to return distributions to the extent of the negative balance. That is an individual-level obligation running to the partnership, and it is a different object from the fund-level clawback owed to limited partners — a distinction worth drawing carefully, because they can both be live at once and they are computed differently.

Treatment of the resulting balance varies across four documented positions: immediate clawback of excess distributions; payback over a defined period; clawback only at the end of the fund's life; or, particularly in buyout funds with deal-by-deal accounting, no clawback at all, treating all prior distributions as vested. Which of the four applies is a drafting question with a five- or six-figure answer, and it is not usually in the summary a candidate is shown.

The practical instruction is short. Before agreeing a departure, run the recalculation: allocations to date at the vested percentage, less distributions actually received. A positive result is a payout question. A negative result is an invoice, and the professional should know which one they are walking into before they sign anything.