Don’t get carried by Carry Rights in Funding Rounds!
Carried interest, or Carry Rights refer to the in share in the profits of an investment paid to the Investors. Rather than being based on the quantum of investment, it works as a performance based fee, rewarding the investors for enhancing performance. Therefore, Carried Interest is due to investors based on their role rather than an initial investment in the fund. Carried interest is often only paid if the start-up/ target company achieves a minimum return known as the hurdle rate/ qualifying rate.
Though the same is argued as unfair exploitation of profits of a start-up/ target company, however, the same also makes the investment more attractive for the investors and therefore, start-up founders gain an edge by offering the Carry Rights.
Given the above, it is critical for the founders to analyse whether the outflow as a result of Carry Rights outweighs the benefits of getting investors. Further, as the start-up becomes more lucrative by offering the Carry Rights, the founders can even pitch for a higher valuation from the investors in lieu of offering Carry Rights. At the same time investors must evaluate the investment in start-up independent of the Carry Rights so as to avoid over valuation.
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