How do management fees and carried interest typically structure across PE funds, and what is their impact on sponsor economics over the fund life?

• A. Commonly 1-2% management fee and 20% carry with a hurdle; fees erode early-stage returns; carries align incentives; structure can include catch-up provisions
• B. 0% management fee and 100% carry
• C. 5% management fee and 5% carry
• D. Only management fees; no carry

Answer: (A)

The idea being tested is how private equity sponsor economics are designed to cover ongoing operations while rewarding performance. In practice, funds charge a management fee—typically about 1-2% per year of committed capital—during the investment period. This fee provides steady cash flow to run the firm, source deals, and manage the portfolio, but it also means some returns are siphoned off early, reducing what LPs earn in the near term. On the upside, sponsors earn carried interest, usually around 20% of profits above a hurdle rate (often around 8%). A catch-up provision is common, allowing the GP to receive a larger share of profits after the hurdle is met so that, once the hurdle is surpassed, the standard 20% carry can be reached more quickly. After the investment period, management fees commonly decline or shift to being based on invested capital, while carry is only paid if the fund’s returns exceed the hurdle, which concentrates the GP’s upside on successful exits. This structure explains why the option reflects both the typical fee levels and the incentive mechanics: fees fund operations, while carry aligns interests and drives performance across the fund’s life. The other options don’t fit industry practice because they either omit ongoing fees, set implausibly high carry, or remove upside incentives entirely.