Co-Investment and Carry Arrangements at PE Firms

Co-Investment and Carry Arrangements at PE Firms

Co-investment and carried interest are the two primary financial instruments through which senior professionals at private equity firms — and the executives who manage their portfolio companies — participate in investment returns. Understanding the mechanics, tax treatment, and negotiation dynamics of these arrangements is essential for any senior executive operating in the PE ecosystem, whether as a fund professional or as a portfolio company management team member.

This guide explains how co-investment and carry arrangements work at UK PE firms, how they are structured for different seniority levels and firm types, the UK tax treatment (including the carried interest reforms of recent years), and the specific considerations for executives joining PE firms or portfolio companies where these instruments are a central component of their compensation. It complements the companion Sweet Equity for PE Management Teams guide, which covers portfolio company management equity specifically.

Carried Interest: The PE Profit Share

Carried interest — commonly called “carry” — is the PE fund manager’s share of the fund’s profits above a defined preferred return threshold (the hurdle rate). Carry is the primary long-term compensation instrument for senior PE fund professionals, and it is the mechanism through which successful PE careers generate the transformational personal wealth that makes the PE industry attractive to ambitious finance professionals.

The standard carry structure is 20% of profits above the hurdle rate (“20 over the hurdle”), with the hurdle typically set at an 8% annual preferred return on invested capital. This means that the fund must first return all invested capital to LPs plus an 8% annual return before the fund manager receives any carry. Above the hurdle, the fund manager receives 20% of additional returns, with LPs receiving the remaining 80%.

Carry is allocated among the fund team through a carry schedule — a document setting out each team member’s percentage of the carry pool. Senior partners at established PE firms typically receive carry allocations of 5–15% of the total carry pool; mid-level principals and VPs receive 1–5%; junior professionals receive less than 1%. The carry schedule is one of the most commercially sensitive documents in a PE firm, and the negotiation of carry allocation when a senior professional joins or is promoted is one of the most consequential financial negotiations of their career.

Co-Investment at the Fund Level

Fund-level co-investment — the ability of PE firm professionals and certain LP investors to invest alongside the fund in specific deals at fund terms — is an important supplement to carry for PE firm professionals. Co-investment provides direct economic exposure to individual portfolio companies rather than the diversified fund exposure that carry provides, and can generate significant returns from successful deals independently of the fund’s overall performance.

The right to co-invest is negotiated at fund closing and is set out in the fund documents. Senior professionals at established PE firms typically have the right to commit a defined amount — often 1–3% of their annual compensation — to co-investment opportunities in each deal. The co-investment is made at fund terms (the same entry price, the same deal economics) rather than at a discount, but it benefits from the fund’s operational oversight and the same governance rights as the fund’s own investment.

UK Tax Treatment of Carried Interest

The UK tax treatment of carried interest has been the subject of significant HMRC scrutiny and legislative change in recent years. Historically, carried interest was treated as a capital gain — subject to CGT rather than income tax — reflecting the argument that carry is a profit share from investment activity rather than a reward for employment services. The effective rate was further reduced by Entrepreneurs’ Relief (now BADR) and by the non-domicile provisions that allowed some PE professionals to shelter carry from UK tax entirely.

The carried interest legislation introduced in 2015 and amended in subsequent Finance Acts has materially changed the tax treatment. “Disguised investment management fees” — carry arrangements that economically function as management fees rather than profit participations — are now treated as income for tax purposes. Carry that meets the qualifying criteria (genuine profit participation from a fund that holds investments for at least 40 months on average) retains capital gains treatment at the CGT rate, which was 28% for investment gains before being reduced to 24% for the 2024/25 tax year.

BADR on carried interest — the 10% reduced CGT rate that applies to qualifying business asset disposals — is available for carry in certain circumstances but subject to significant conditions and recent restriction. The specific availability of BADR for any individual’s carry arrangement depends on the specific fund structure, the nature of the underlying investments, and the individual’s own qualifying conditions. Specialist tax advice from advisers with specific PE carry expertise is essential for any PE professional managing carry and co-investment returns.

Portfolio Company Co-Investment

Portfolio company co-investment — the ability of fund professionals to invest directly in portfolio company management equity alongside the management team — is increasingly offered at major PE firms as an additional incentive instrument. This gives deal team members who have driven specific transactions the opportunity to participate in the portfolio company’s equity return independently of their fund carry allocation.

Portfolio company co-investment is typically offered on the same terms as management sweet equity — at market value with the same hurdle and ratchet structure — and is subject to the same good leaver and bad leaver provisions as management equity. The tax treatment follows the employment-related securities framework applied to management sweet equity rather than the carried interest framework, and the Section 431 election mechanics discussed in the companion BADR and Section 431 guide apply equally to portfolio company co-investment held by fund professionals.

Negotiating Carry Arrangements When Joining a PE Firm

The negotiation of carry allocation when joining a PE firm is one of the most commercially significant employment negotiations in finance. Key dimensions include: the percentage of the carry pool allocated; which fund or funds the carry relates to (existing fund, next fund, or both); the vesting schedule (most carry arrangements have a multi-year vesting period, often four to five years, with cliff and ratchet provisions); the good leaver and bad leaver definitions; and the escrow and clawback provisions that govern the timing and conditionality of carry distributions. Senior candidates joining PE firms should engage specialist legal counsel — with specific PE fund documentation experience — to review the carry documentation before signing.

Further Reading

The BVCA publishes guidance on PE fund structures and carried interest. The HMRC Investment Funds Manual provides the technical framework for UK tax treatment of investment fund returns including carry. Related guides: Sweet Equity for PE Management Teams · BADR and Section 431 · PE-Backed Executive Hiring

Fund Structures and Carry Mechanics

Understanding the fund structure is essential context for evaluating a carry allocation. UK PE funds are typically structured as English Limited Partnerships with a separate General Partner (GP) entity that manages the fund and receives the carried interest. The LP investors — pension funds, sovereign wealth funds, university endowments, family offices, and fund of funds — commit capital at fund close and draw it down as the GP identifies investments. The GP manages the portfolio and, after returning LP capital plus the preferred return, receives carry on the remaining profits.

The timing of carry distributions — when fund professionals actually receive cash from their carry allocation — depends on the fund structure. Deal-by-deal carry (also called American waterfall) distributes carry after each individual investment exit, as long as the overall fund is performing above the hurdle at that point. European waterfall (fund-as-a-whole carry) distributes carry only after all LP capital across all investments has been returned plus the hurdle. European waterfall funds — now the dominant structure in UK and European PE — create a longer wait for carry distributions but provide LPs with greater protection against paying carry on early exits that are subsequently offset by later write-downs.

The clawback provision — which allows LPs to recover carry distributions already made if the fund’s final performance falls below the hurdle — is a significant feature of all major PE funds. If carry has been distributed early in the fund’s life on the basis of favourable performance, and later investments underperform sufficiently to reduce the overall fund return below the hurdle, the GP may be required to return some or all of the carry previously distributed. This clawback risk creates specific financial planning considerations for PE fund professionals who have received carry distributions — maintaining liquid resources to meet potential clawback obligations rather than immediately investing all carry distributions in illiquid assets is standard risk management practice for experienced PE professionals.

Co-Investment Economics: The LP Perspective

LP co-investment — where the fund’s LP investors invest directly in specific portfolio companies alongside the fund, typically without paying the fund’s management fee or carry on the co-invested capital — is a major feature of the modern PE market. Major LPs — Canada Pension Plan, CalPERS, the Abu Dhabi Investment Authority, and the major European pension funds — have large co-investment programmes that provide significant additional capital to the PE market at reduced cost.

GP co-investment — where fund professionals invest their personal capital alongside the fund — operates on different terms from LP co-investment. GP co-investment is typically at fund terms (the same valuation and economic structure as the fund’s investment), rather than at the fee-free, carry-free terms that major LP co-investments typically receive. This means that GP co-investment generates returns that are calculated before management fees and carry, unlike the LP’s co-investment economics. The GP co-investment is still typically an attractive investment because it is made at the same price as the fund’s investment and benefits from the fund’s governance and management of the portfolio company; but it is not as favourable as some PE professionals expect when they first encounter LP co-investment terms.

Tax Planning for Carry and Co-Investment Returns

The interaction between carry distributions, co-investment returns, and the UK tax system creates significant tax planning opportunities and risks for PE fund professionals. The most important planning decisions include: the election to treat carry as business income rather than investment income in certain circumstances (which may enable Business Asset Disposal Relief on qualifying carry disposals); the timing of carry distributions relative to the executive’s personal income in adjacent years (carry distributions in a year with lower other income are taxed at a lower marginal rate); the use of ISA and SIPP wrapper strategies to shelter future investment returns from co-investment proceeds; and the management of carried interest distributions in the context of the annual pension allowance.

PE fund professionals resident in the UK pay UK tax on their worldwide income and gains, including carry and co-investment returns from funds structured in other jurisdictions (Cayman, Delaware, or Luxembourg limited partnerships). The UK’s Controlled Foreign Corporation rules, the offshore income gains provisions, and the disguised investment management fee legislation all affect the tax treatment of different fund structures. Specialist tax advice from advisers with specific expertise in UK PE fund taxation is essential for any PE professional managing significant carry and co-investment positions.

Exec Capital’s Financial Services and PE Firm Practice

Exec Capital’s practice covers senior appointments at PE firms and financial services businesses where carry, co-investment, and management equity structures are central to the compensation package. Our financial services practice includes investment professionals (deal partners, directors, and associates at PE, VC, and growth equity firms), CFOs and COOs of PE firms and fund managers, and senior portfolio company management team appointments where management equity is a primary component of the offer. Our understanding of the financial economics of PE compensation — including the carry allocation negotiation, the co-investment economics, and the tax implications — allows us to brief candidates accurately and to support both sides in the offer construction process. For the portfolio company management equity context, the companion Sweet Equity guide provides the relevant framework.

Carry Allocation Negotiation

The negotiation of a carry allocation when joining a PE firm is one of the most commercially significant negotiations in financial services. The key parameters are: the carry percentage (the individual’s share of the carry pool), which fund or funds the carry applies to, the vesting schedule, the escrow arrangements (how much carry is held back in escrow to cover potential clawback), and the good leaver and bad leaver definitions. Experienced PE professionals entering carry negotiations should engage specialist legal counsel — from firms with specific PE fund documentation expertise such as Travers Smith, Macfarlanes, or Clifford Chance — before signing any carry documentation. The difference between well-negotiated and poorly-negotiated carry terms can represent millions of pounds across a PE career.

The carry percentage is the most commercially significant parameter but also the most publicly sensitive — carry allocations within a PE team are typically not disclosed to other team members, and negotiating carry allocation requires discretion from both the candidate and the firm. Benchmarking carry allocation percentages against market practice is difficult because the data is not publicly available, and the candidate typically relies on their own judgment (informed by experience of prior carry negotiations if any), the specific advice of their legal counsel, and any market intelligence available through trusted advisers who have visibility into carry allocation norms at comparable firms.

Portfolio Company Management Equity and Fund-Level Carry

PE fund professionals who hold both fund-level carry and portfolio company co-investment positions manage two distinct equity instruments with different economic profiles. Fund-level carry provides diversified exposure across all the fund’s investments, typically vesting over the full fund life; portfolio company co-investment provides concentrated exposure to specific deals, vesting at each individual deal’s exit. The combination creates a portfolio of equity positions with different return profiles, different vesting timelines, and different tax treatments — which requires active management and specific financial planning to optimise the after-tax outcome across all positions. For the portfolio company management equity context, the companion Sweet Equity guide covers the mechanics in detail.

Carry Escrow and Clawback Management

Most European PE funds withhold a portion of carry distributions in an escrow account to protect against future clawback obligations. The escrow amount — typically 20–30% of each carry distribution — is held by the fund administrator and released to the carry recipients either at fund wind-down or once it becomes clear that no clawback obligation will arise. For fund professionals who have received significant carry distributions, the escrow balance represents a meaningful deferred asset that is reflected in the fund’s ongoing financial reporting to LPs.

Managing the personal financial implications of the escrow — including the tax treatment of escrowed carry (taxed in the year of distribution even though the cash is withheld), the investment of the escrow balance while it is held, and the accounting for the escrow in the individual’s personal tax returns — requires specific financial planning. The standard approach is for the carry recipient to pay UK tax on the full carry distribution in the year of distribution, including the escrowed portion, and to treat the escrow balance as a contingent receivable until it is released. If a clawback subsequently requires repayment of escrowed carry, the recipient can claim a tax credit against prior year tax paid, though the specific mechanism depends on the timing and circumstances.

Fund professionals who leave PE firms before carry is distributed — either by resignation, redundancy, or retirement — face specific escrow and clawback considerations. The good leaver provisions in the carry documentation typically allow departing fund professionals to retain their vested carry entitlement in the fund, subject to the escrow and clawback arrangements. However, the timing of carry distributions after departure — which can be five to ten years after the individual left the firm — creates tax and financial planning complexity that should be managed with specialist advice.

LP Co-Investment Opportunities: A Different Economic Profile

Limited Partner co-investment — where major institutional LPs invest directly in specific deals alongside the fund — has grown substantially as a proportion of total PE transaction volume. From the GP’s perspective, LP co-investment provides additional capital for larger deals without requiring the GP to syndicate to other PE firms; from the LP’s perspective, it provides deal-specific exposure at reduced cost (typically fee-free and carry-free). This creates a different economic profile for co-invested capital than for capital invested through the fund: the LP co-investment return is the gross deal return, while the fund investment return is the gross deal return minus management fees and carry.

For large, successful PE transactions, the difference between co-investment economics and fund economics is material. A deal generating a 4x gross MOIC returns 4x to the co-investing LP on their directly co-invested capital; the same deal, invested through the fund, returns approximately 3x net MOIC after management fees and carry. This economics differential is the primary commercial rationale for LP co-investment programmes, and it is why major LPs have invested heavily in their internal teams’ ability to assess, execute, and manage co-investment deals independently.

Fund professionals who move from GP roles to LP investment roles — joining pension funds, sovereign wealth funds, or institutional endowments — find that co-investment is a significant part of their role. The skills required to assess co-investment opportunities — rapid deal evaluation, relationship management with GP sponsors, portfolio monitoring at the deal level — overlap significantly with the GP deal execution skills, making former PE fund professionals valuable to institutional LP teams building co-investment capability.

Regulatory Requirements for Carried Interest in FCA-Regulated Firms

PE fund managers authorised by the FCA under the AIFMD (Alternative Investment Fund Managers Directive) framework are subject to specific remuneration code requirements that affect how carried interest and other variable remuneration can be structured and paid. The FCA’s AIFMD Remuneration Code — set out in SYSC 19B of the FCA Handbook — requires that a specified proportion of variable remuneration (including carry) for senior identified staff be paid in instruments (shares or fund units) rather than cash, and be subject to a minimum deferral period. For the largest AIFMD managers, at least 40% of variable remuneration must be deferred for at least three to five years, and a minimum of 50% of the variable remuneration must be in instruments.

These AIFMD remuneration code requirements interact with the commercial structure of carried interest in ways that require careful planning. Carry paid as cash distributions from the fund may need to be restructured into fund units or other instruments to meet the “in instruments” requirement; and the timing of carry distributions may need to be adjusted to meet the deferral period requirements. FCA-regulated PE fund managers should take specific legal and compliance advice on how their carry structure interacts with the AIFMD remuneration code requirements, and should build this compliance analysis into their fund documentation at fund close rather than addressing it reactively when distributions are due.

Negotiating Co-Investment Rights as a New PE Hire

Co-investment rights — the ability to invest personal capital alongside the fund in specific deals — are a negotiated benefit that varies significantly between PE firms and between seniority levels within a firm. Senior partners at major PE firms have well-established co-investment rights documented in their partnership agreements or employment contracts; mid-level and junior professionals at the same firms may have access to a smaller co-investment budget, or may access co-investment through a managed vehicle rather than direct deal-level participation. New senior hires joining PE firms should negotiate their co-investment rights explicitly as part of their employment package — including the annual co-investment budget, the right of first offer on specific deal types, and the process for proposing and approving co-investment participation — rather than assuming these rights will be granted as part of the standard employment package.

The tax planning for co-investment returns — specifically the interaction between the deal return, the individual’s marginal income tax rate, the CGT regime, and BADR availability — should be addressed at the time the co-investment is made rather than at exit. Co-investment that qualifies for BADR treatment — either through EMI qualification routes for portfolio company co-investment, or through the qualifying trading company tests for fund-level co-investment — can significantly reduce the effective tax rate on co-investment returns. The companion BADR and Section 431 guide provides the full framework for understanding when and how BADR applies to different forms of PE-related equity participation.

The PE compensation ecosystem — combining base salary, annual bonus, fund carry, portfolio company co-investment, and in some cases LP co-investment opportunities — creates one of the most financially complex total compensation packages in professional life. Managing these instruments as a coherent personal financial portfolio — with appropriate diversification, tax planning, and liquidity management — requires specialist financial advice from advisers with specific PE compensation expertise. The financial planning considerations extend beyond the investment decisions to the estate planning implications of significant carry and equity wealth accumulation, the insurance requirements for key person risk, and the pension planning that must be managed alongside the equity and carry programme. Exec Capital’s senior appointments practice maintains relationships with specialist financial advisers who work with PE professionals and can provide referrals to appropriate advisers for executives managing complex PE compensation portfolios.