Private Funds: Six considerations when negotiating carry clawback provisions

Private Funds: Six considerations when negotiating carry clawback provisions

From the very inception of the private equity fund model, limited partners (LPs) have been sensitive to sponsors benefitting disproportionately to investors. This wariness resulted in the carried interest clawback. The idea behind a clawback is to ensure that sponsors have not been overpaid beyond the remit of the waterfall. In the event of overpayment, a sponsor is under an obligation to return distributions until the amounts distributed to the investors and the sponsor are in the agreed profit-sharing ratio.

 

In this piece, we review one of the most contentious fund terms – the carried interest clawback – and outline some considerations that stakeholders should keep in mind when negotiating clawback provisions. This is Part 1 of our two-part series on carried interest and clawback provisions.

Key Takeaways:
  • Clawback liability must be ascertained with respect to each investor.
  • Standalone clawback obligations may not be sufficient.
  • The clawback provision should include a true-up mechanism for sponsors.
  • Tax leakages must be accounted for when determining clawback liability.
  • The waterfall sequence must be maintained when clawed back amounts are distributed to the LPs.
  • In a no-fault removal scenario, the original carry recipients must be released from future clawback liability.

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