European and American Carried Interest Compared

Carried interest — the share of a fund’s profits that goes to its general partners — is the single biggest driver of how investment professionals are paid, and how it is actually distributed varies more than most people outside private equity realise. Two models dominate: the American-style, deal-by-deal waterfall and the European-style, whole-fund waterfall. The difference sounds technical, but it shapes GP behaviour, the fund’s risk profile and the alignment between general partners (GPs) and limited partners (LPs) — and it matters when you are hiring the finance and investment leaders who will operate inside that structure. This guide sets out how the two models work, where each is used, how hurdles, catch-ups, clawbacks and escrow fit around them, how carry is now taxed in the UK and the US, and why the choice matters for senior hiring. (For how carried interest is defined more generally, see our guide to how carried interest works in practice.)

The American-style (deal-by-deal) waterfall

In the American-style waterfall, carried interest is distributed deal by deal. GPs are eligible to receive their share of the profits from each individual investment as soon as it generates a return, without waiting for the whole fund to become profitable. A successful early exit can pay carry to the GPs even if other portfolio companies have not yet returned capital — or have lost money. This model is more common in the United States, and is often favoured by venture capital firms and used in special purpose vehicles (SPVs) where investments are discrete.

The obvious risk for LPs is that GPs get paid early on winners while the fund as a whole may still end up underwater. The deal-by-deal model therefore leans heavily on protective mechanisms — principally the clawback (covered below), plus escrow and holdback provisions — to claw money back if later results disappoint. Done properly, it lets GPs realise carry on genuine successes promptly; done without strong safeguards, it can leave LPs exposed.

In its purest form the deal-by-deal waterfall looks only at the investment being realised: the LPs get back the capital they put into that deal, plus any preferred return on it, and the profit above that is split with the GP. Very few institutional funds now run it in that pure form. Most American-style funds add conditions that look beyond the single deal — for example, requiring that the cost of any investments already written off or written down is also returned before carry is paid on the latest exit. That is why “deal-by-deal” in practice covers a spectrum of structures, and why the detail in the limited partnership agreement matters more than the label.

The European-style (whole-fund) waterfall

The European-style waterfall applies the carry calculation to the entire fund rather than to individual deals. Before any carried interest is paid to the GPs, LPs are typically returned all of their contributed capital and, in most funds, a preferred return or hurdle rate on top. Only once the whole fund has cleared that threshold do the GPs begin to receive carry. This model is more common in European private equity and among institutional buyout funds, where the focus is on the cumulative return of the whole portfolio.

Because carry depends on aggregate performance, the whole-fund model ties the GPs’ reward tightly to the fund’s overall success rather than to isolated wins. It is conventionally described as offering stronger LP protection and closer alignment — the GPs cannot be paid until LPs have their capital and hurdle back. The trade-off is on the GP side: carry is realised much later in the fund’s life, which affects the timing of reward for the investment team and can matter a great deal when you are recruiting and retaining senior investment talent.

“Contributed capital” in a whole-fund model usually means everything the LPs have paid in, not just the cost of investments: management fees and fund expenses drawn from LPs normally have to be returned too before carry starts. That detail alone can push the first carry payment back by years in a fund with a long investment period, and it is one reason the European model is described as the more LP-friendly of the two.

Comparing the two — and why the choice matters

Neither model is simply better; they reflect different preferences on risk, timing and alignment. The practical differences worth holding in mind:

• Timing of carry. American: potentially early, as individual deals exit. European: later, once the whole fund has returned capital and hurdle.
• LP protection. European is structurally more protective up front; American relies on clawback and escrow to achieve a similar end result after the fact.
• GP incentives. Deal-by-deal can reward quick individual wins and a higher risk appetite; whole-fund encourages a more holistic, long-term view of portfolio performance.
• Typical use. American is common in US funds, VC and SPVs; European is common in European PE and institutional buyout funds — though many funds blend features of both.
• Administrative burden. Deal-by-deal funds need more careful tracking of interim carry, valuations at each distribution and the running clawback position; whole-fund calculations are simpler until the fund approaches its hurdle.

In practice the line is not absolute. Plenty of funds run hybrid structures — a deal-by-deal mechanic with a full return-of-capital test layered on top, for instance — and LPs increasingly negotiate the specifics rather than accepting a standard template. The waterfall is one of the most heavily-negotiated terms in a fund’s limited partnership agreement, precisely because it determines when real money reaches the investment team.

Hurdle, catch-up and the tiers of a waterfall

Whichever model a fund uses, the waterfall itself is usually built from the same four tiers. The difference between American and European structures is mainly about what pool of proceeds and capital each tier is measured against — a single deal, or the whole fund.

• Return of capital. LPs receive back the capital they contributed (for the deal, or for the fund, depending on the model).
• Preferred return (the hurdle). LPs then receive a minimum return on that capital, commonly expressed as an annual compounding rate — 8% is the long-standing market convention in buyout funds, though it is negotiable and some funds have no hurdle at all.
• GP catch-up. Once the hurdle is met, the GP receives most or all of the next slice of profit until it has “caught up” to its agreed carry percentage of total profits. A full (100%) catch-up gets there quickly; a partial catch-up (for example, 80/20 in the GP’s favour) gets there more slowly.
• Carried interest split. Everything above that point is split between LPs and GP at the agreed ratio — typically 80/20.

The catch-up is where many candidates and even some boards misread fund economics. With a full catch-up and a fund that clears its hurdle comfortably, the hurdle affects timing rather than the GP’s final share — the GP still ends up with 20% of all profits. With no catch-up, the hurdle becomes a permanent reduction in the GP’s share. Two funds with the same “2 and 20” headline can therefore produce very different carry for the investment team, depending on the hurdle, the catch-up and the waterfall model sitting underneath.

A simple worked example

The difference is easiest to see with a stylised example. Imagine a fund with a standard 20% carry over an 8% hurdle. Early in the fund’s life, one investment is sold at a strong profit while the rest of the portfolio is still developing. Under an American-style, deal-by-deal waterfall, the GPs could receive their 20% carry on that single realised gain now — subject to clawback if the fund as a whole later falls short. Under a European-style, whole-fund waterfall, that same gain would first go toward returning LPs’ capital across the whole fund and meeting the 8% hurdle; the GPs would receive nothing in carry until those tests are met for the fund in aggregate, however profitable that one deal was in isolation.

To put hypothetical numbers on it, take an illustrative £100m fund that invests £25m in each of four companies at the start, with an 8% compounding hurdle, a full GP catch-up and 20% carry. Fees, expenses and the GP’s own commitment are ignored to keep the arithmetic simple. These figures are invented purely to show the mechanics; they do not describe any real fund.

Pure deal-by-deal. When Company A is sold in year 3, the LPs first get back the £25m cost of that deal plus an 8% compounding return on it (about £6.5m). The full catch-up then takes the GP to 20% of the deal’s £25m profit, so the GP receives £5m of carry in year 3 and the LPs receive £45m. Companies B and C generate no further carry, and Company D’s £15m gain is not enough to clear its own seven-year hurdle, so it produces no further carry either. The GP’s total is the £5m paid in year 3.

Whole-fund. The £50m from Company A goes entirely to the LPs, because they have £100m of capital outstanding. Tracking the LPs’ balance forward at 8% a year and deducting each distribution, the fund ends year 7 with the LPs still around £23m short of their capital plus hurdle, despite a £25m overall gain. The hurdle has absorbed all of the profit, and the GP receives no carry at all.

The end position over the full life of a successful fund can be similar — the clawback exists precisely to reconcile them — but the timing and the risk of overpayment differ sharply. In this hypothetical, the deal-by-deal GP has been paid £5m that a fund-level test says it never earned, and the clawback (below) is what brings that money back. That timing difference is exactly what a senior candidate weighing an offer will focus on, which is why the structure is a recruitment issue and not only a legal one. It also explains why two funds advertising the same headline “20% carry” can represent materially different propositions to the person being hired.

The clawback clause

The clawback is the safeguard that makes the deal-by-deal model workable and reinforces the whole-fund one. It allows LPs to reclaim carried interest previously paid to GPs where, over the life of the fund, it turns out that too much was distributed relative to the fund’s final performance — because later investments underperformed, earlier deals were over-valued at the point of distribution, or through errors in calculation.

Its purpose is straightforward: to ensure GPs’ total carry reflects the net profit they actually generated for the fund after all investments and all returns to LPs are accounted for. Knowing that carry may have to be returned changes GP behaviour — it rewards prudent risk management and thorough diligence, and discourages banking early gains on deals that may not hold up.

Clawbacks are simple in principle and harder in practice. The fund’s governing documents have to define the triggers, the method for calculating the amount reclaimed, and the mechanism for actually recovering it. Enforcement is the difficult part: if carry has already been distributed and spent, or if individual GPs face liquidity constraints, recovering it is not trivial. That is why many funds hold part of the carry in escrow, or use holdback provisions, so a portion always remains accessible if a clawback is triggered.

Three points in a clawback clause are worth reading closely. First, timing: some clawbacks only bite at the end of the fund’s life, while “interim” clawbacks test the position at set points along the way. Second, tax: many agreements cap the clawback at the after-tax amount the individual actually received, which protects the GP but leaves the LP short. Third, who is liable: the clawback obligation sits with the GP entity, but whether individual carry holders are liable for their own share only (several liability) or for each other’s shares as well (joint and several) makes a real difference to anyone holding carry points.

Escrow, holdbacks and GP guarantees

Because a clawback is only as good as the ability to collect it, LPs in deal-by-deal funds usually ask for security alongside it. The common tools are:

• Escrow. A proportion of each carry distribution is paid into an escrow account rather than to the carry holders, and released only once the fund’s position is secure or the fund is wound up.
• Holdbacks. Similar in effect, but the carry is simply retained in the fund rather than placed in a separate escrow.
• Coverage tests. Carry is only released if the remaining portfolio is valued at a set multiple of the capital still invested, so there is headroom if later deals disappoint.
• Personal guarantees. Individual carry holders, or the sponsor, guarantee the GP’s clawback obligation, so LPs have a solvent party to pursue.

For the individuals concerned these are not abstract. A partner whose carry is part-escrowed sees less cash in the year a deal exits, and a partner who has signed a guarantee carries a contingent liability that may run for years after the payment. Both feature in how senior investment professionals compare offers from different funds, and both come up regularly in recruitment for private equity firms at partner level.

Hybrid models

Between the two pure models sits a wide range of hybrids, and many funds described as “American” or “European” are in fact one of these. Common variants include:

• Deal-by-deal with loss carry-forward. Carry is paid as each deal exits, but only after the cost of realised deals and any written-down investments has been returned.
• Deal-by-deal with a fair-value test. Carry is paid on an exit only if the fund as a whole, including unrealised investments at fair value, is above its capital and hurdle.
• Whole-fund with early release. A European waterfall that allows some carry to be paid before full return of capital once the fund passes a set coverage threshold, usually with escrow attached.

Hybrids exist because both sides want something from the other model: GPs want earlier liquidity for the team, and LPs want whole-fund protection. The result is that every fund’s waterfall has to be read on its own terms, which is as true for a candidate assessing an offer as it is for an investor assessing a commitment.

What the ILPA Principles say

The Institutional Limited Partners Association publishes the ILPA Principles, now in their third edition (Principles 3.0, published in 2019), as guidance on alignment of interest, governance and transparency between LPs and GPs. They are not regulation, but they shape what institutional LPs ask for in negotiations on both sides of the Atlantic.

On waterfalls, Principles 3.0 states a preference for the whole-of-fund model. For funds that use a deal-by-deal structure, it sets out expectations on how distributions are assessed and how unrealised investments are valued, and it supports holding back part of accrued carry in escrow. On clawback, it recommends that amounts are calculated gross of taxes paid, that repayment is made within two years of the liability being recognised, and that individual members of the GP should ideally be jointly and severally liable. ILPA also expects the GP’s own commitment to the fund to be paid in cash rather than through fee waivers. ILPA has published model limited partnership agreements for both whole-of-fund and deal-by-deal funds, which are a useful benchmark for anyone reviewing fund terms.

How carried interest is taxed in the UK

UK tax treatment of carry has changed twice in quick succession, and anyone hiring or being hired into a UK fund needs to understand the current position. From 6 April 2025, carried interest gains were taxed at a single Capital Gains Tax rate of 32%, replacing the previous higher and lower carried interest rates. That was an interim step.

From 6 April 2026, carried interest has moved out of CGT altogether into a revised regime that sits wholly within the Income Tax framework. Carry is treated as trading profits, but where it is “qualifying” carried interest only 72.5% of it is brought into charge. For an additional-rate taxpayer, 45% Income Tax plus 2% Class 4 National Insurance on 72.5% of the carry gives an effective rate of about 34.1%. Carry that does not qualify is taxed in full as income.

The main qualifying test is the average holding period condition (previously known as the income-based carried interest rules): carry qualifies by reference to the fund holding its investments for at least 40 months on average. Following consultation, the government’s June 2025 response confirmed it would not introduce a minimum co-investment requirement, and set a UK workday threshold for non-residents, who are taxed on carry relating to UK-performed services only where they spend at least 60 workdays in the UK in the tax year. The waterfall model interacts with this: in a deal-by-deal or single-asset structure, the holding period may effectively be measured against fewer investments, which can make the test harder to pass. Individuals should take specialist tax advice on their own position.

The US position: the three-year holding period

In the United States, carry is generally taxed as capital gain when the fund disposes of investments, but section 1061 of the Internal Revenue Code requires a holding period of more than three years, rather than the usual one year, for gains on “applicable partnership interests” to be treated as long-term. Gains on assets held for three years or less are recharacterised as short-term capital gain, taxed at ordinary income rates.

The 2025 federal tax legislation (the One Big Beautiful Bill Act) left the treatment of carried interest unchanged, despite earlier discussion of closing the so-called loophole. Further reform bills have been introduced in Congress since, but as of November 2026 none has been enacted and section 1061 remains the governing rule. For transatlantic hires, the practical point is that the same carry can be taxed under quite different tests in the UK and the US, and the interaction between the two needs advice at the offer stage, not after the first distribution.

Why the waterfall matters when you are hiring

For anyone building or hiring into a fund or a PE-backed business, the waterfall structure is not just a back-office detail — it shapes how, and when, your senior people are rewarded, and therefore how you attract and retain them. Candidates at partner and investment-director level understand the difference between a whole-fund and a deal-by-deal structure acutely, and they will compare your fund’s terms with the ones they are leaving. Understanding the structure — and being able to explain it credibly to candidates — is part of running a successful private equity executive search.

At GP level, the questions a senior hire will ask go well beyond the headline carry percentage. How many carry points are allocated to the role, and from which funds? What is the vesting schedule, and what happens to unvested carry under good-leaver and bad-leaver provisions? Is there a GP commitment they are expected to fund personally, and in cash? Does the clawback make them liable for colleagues’ shares? Our guide to the role of the general partner in private equity covers the wider responsibilities that come with that seat.

Timing is often the decisive factor. A partner moving funds usually walks away from unvested carry in earlier vintages, and in a whole-fund structure the first carry from a new fund may be many years away. That gap is why senior moves in private equity are slow to negotiate and why compensation for lost carry is so often the sticking point. It applies whether you are appointing a managing partner or senior partner or a private equity chief investment officer, whose reward is weighted heavily toward fund performance. Our private equity salary guide sets out how base, bonus and carry typically combine across PE roles.

Portfolio company executives are a different case. A CEO or CFO inside a PE-backed business is usually rewarded through management equity in that company rather than fund carry, but they still need to understand the fund’s waterfall and timetable, because it drives the sponsor’s exit timing and appetite for risk. Whether the brief is a fund-level partner or a portfolio leadership team, our private equity recruitment work starts by understanding how the sponsor’s economics will shape the role and the package.

Frequently asked questions

Which is better for LPs, the European or American waterfall?

The European (whole-fund) waterfall is generally seen as more protective of LPs, because no carry is paid until all contributed capital and the hurdle have been returned. The ILPA Principles state a preference for it. A well-drafted deal-by-deal structure with strong clawback and escrow can reach a similar end result, but with more collection risk.

Why would a GP prefer a deal-by-deal waterfall?

Because carry arrives earlier. That improves cash flow for the investment team and makes it easier to retain people through a long fund life, which is why the model remains common in US funds, venture capital and single-deal vehicles.

What is a GP catch-up?

After LPs have received their capital and preferred return, the catch-up gives the GP most or all of the next profits until it has received its agreed share of total profits, typically 20%. Without a catch-up, the hurdle permanently reduces the GP’s share.

How is carried interest taxed in the UK now?

From 6 April 2026 it is taxed within the Income Tax framework as trading profits. Qualifying carry is brought into charge at 72.5%, giving an effective rate of about 34.1% for an additional-rate taxpayer; non-qualifying carry is taxed in full. Between 6 April 2025 and 5 April 2026, carry gains were taxed at a 32% CGT rate.

Do portfolio company executives receive carried interest?

Usually not. Carry belongs to the fund’s investment team. Portfolio company management are normally incentivised through equity in the business itself, although some operating partners and senior advisers employed by the fund do receive carry points.