Carried interest and other forms of profit sharing have been used as an incentive for employees for quite some time. The concept of carried interest valuation can be traced all the way back to medieval times and the profit split between ship captains and their cargo. Carried interests are common in many different fields and markets, as noted by the American Investment Council. They occur when one party invests money and another party spends time or "sweat equity."

Private equity and venture capital firms in the United States have relied on carried interest for decades. The majority of the funding for a private equity or venture capital firm comes from unaffiliated investors, sometimes known as limited partners. The fund's sponsor, or general partner, invests just a little amount of money but shares in the fund's returns in exchange.

So why is Carried Interest Important?

Valuation of Carried Interests may result in substantial payouts to a holder during the life of an investment fund if the fund is profitable. It's no wonder that private equity and VC professionals in the US have been favoring this asset in their gift and estate plans. Valuing carried interests is done for more than just income tax purposes, although it is required when transferring a carried interest as part of gift or estate planning under the U.S. Internal Revenue Code. Litigation (including marriage and employment conflicts), transactions, and financial reporting sometimes include questions about the value of carried interests.

Summing Up

In the realms of private equity and venture capital, profit sharing in the form of carried interest is a common practice. In these industries, carried interest is an element of an investment fund's net income from the sale of portfolio investment. The allocation waterfall determines how much of this part is carried out. Because of the potential for the holder of a carried interest to receive significant cash distributions throughout the course of an investment fund's lifespan, the value of a carried interest is a subject that often comes up in the context of tax law, litigation, and other contexts.

Also, Alternative Asset Valuation is a tool that should not be overlooked.