Deal-by-Deal Carry vs Whole Fund Carry in PE: Comparing Performance Fee Distribution Models

The collapse of the European Venture Capital Association’s (EVCA) model clause for deal-by-deal carry in early 2025, following sustained pushback from the Institutional Limited Partners Association (ILPA), has reignited a structural debate that directly impacts how Hong Kong-headquartered private equity firms structure their fund economics. The EVCA’s withdrawal, confirmed in its March 2025 guidance note, leaves the industry without a standardised template for the most contentious element of carried interest allocation: whether a general partner (GP) can take performance fees on individual realised investments before the fund as a whole has returned all capital plus a preferred return. This is not an abstract accounting preference. For a mid-market buyout fund managing USD 500 million in committed capital, the difference between a deal-by-deal and a whole-fund waterfall can shift the GP’s aggregate carried interest by 150 to 300 basis points over the fund’s life, according to a 2024 study by placement agent Campbell Lutyens. For Hong Kong GPs, where the Securities and Futures Commission (SFC) regulates fund managers under the Code of Conduct for Persons Licensed by or Registered with the SFC (Chapter 571, subsidiary legislation), the choice of waterfall model directly affects investor reporting obligations, alignment of interest disclosures, and the potential for disputes during the clawback period. The following analysis compares the two models across deal mechanics, investor protection, and regulatory treatment in Hong Kong.

The Structural Mechanics of Carry Waterfalls

Deal-by-Deal Carry: The GP-Favoured Accelerator

A deal-by-deal carry model, also referred to as an “American-style” waterfall, permits the GP to receive its carried interest allocation—typically 20% of profits—from each portfolio company investment upon realisation, provided that investment has generated a positive net return above a hurdle rate. The fund’s Limited Partner Agreement (LPA) must specify the exact trigger: usually a return of 1.0x to 1.2x of the invested capital for that specific deal, after deducting deal-level expenses and management fees attributable to that investment.

The mechanics are straightforward in concept but complex in execution. Assume a Hong Kong-based GP manages a Main Board-listed sponsor vehicle under the SFC’s Fund Manager Code of Conduct. The fund makes three investments: Deal A (realised at 2.5x multiple), Deal B (realised at 1.1x), and Deal C (still unrealised). Under a deal-by-deal model, the GP takes 20% carry on Deal A’s profits immediately, subject to a clawback provision. Deal B, falling below the hurdle, generates no carry. The GP pockets carry from Deal A before the fund’s aggregate performance is known.

The key regulatory consideration for Hong Kong GPs is the SFC’s requirement under Paragraph 12 of the Code of Conduct for fund managers to maintain “proper books and records” that enable independent verification of waterfall calculations. In a deal-by-deal structure, this means the GP must maintain separate P&L statements for each realised investment, with clear attribution of costs and management fees. The SFC’s 2023 thematic inspection report on private equity fund managers specifically flagged inconsistent treatment of transaction costs in deal-by-deal waterfalls as a common deficiency, leading to enforcement actions against two Hong Kong-licensed firms in 2024.

Whole-Fund Carry: The LP-Favoured Equaliser

The whole-fund carry model, or “European-style” waterfall, prohibits the GP from taking any carried interest until all limited partners (LPs) have received their full capital contributions plus the preferred return (typically 8% IRR) across the entire fund portfolio. Only after the fund’s aggregate net asset value exceeds this threshold does the GP begin to participate in profits, often through a catch-up mechanism that accelerates the GP’s share to 20% of total profits thereafter.

Consider the same three-deal fund. Under a whole-fund model, the GP receives zero carry from Deal A’s 2.5x return because Deal B’s 1.1x return and Deal C’s unrealised losses may keep the fund below its 8% IRR hurdle. The GP must wait for the fund’s aggregate performance to surpass the threshold, which could take 5 to 7 years for a typical 10-year fund life.

This model imposes a stricter alignment of incentives. The GP cannot monetise early winners without carrying the losers. For Hong Kong GPs managing funds that invest in PRC-based assets through variable interest entity (VIE) structures—a common strategy for Greater China-focused buyout funds—the whole-fund model is particularly relevant because VIE exits are subject to PRC regulatory approvals under the 2023 Measures for the Administration of Overseas Securities Offerings and Listings by Domestic Companies, which can delay realisations unpredictably. A whole-fund waterfall protects LPs from a scenario where the GP takes carry on an early VIE exit that later faces clawback due to regulatory changes.

Investor Protection and Clawback Provisions

The Clawback Mechanics Under Each Model

The clawback is the enforcement mechanism that rebalances the GP’s carry if the fund’s ultimate performance falls short of the hurdle. In a deal-by-deal model, the clawback provision is non-discretionary and must be explicitly quantified in the LPA. The standard Hong Kong market practice, as documented in the Hong Kong Venture Capital and Private Equity Association (HKVCA) 2024 Model LPA, requires the GP to establish a clawback escrow account holding 25% to 30% of gross carried interest received, releasing funds only after the fund’s final audit.

The clawback calculation under a whole-fund model is simpler because the GP has received no carry until the fund clears the hurdle. However, the catch-up mechanism introduces complexity. If the fund’s performance exceeds the hurdle, the GP may receive a disproportionately large share of profits during the catch-up phase, which could itself trigger a clawback if subsequent investments underperform. The ILPA’s 2024 reporting template recommends that whole-fund models include a “clawback cap” limiting the GP’s liability to the net carried interest received, plus interest at a rate tied to the Hong Kong Interbank Offered Rate (HIBOR).

Regulatory Treatment in Hong Kong

The SFC’s regulatory framework for carried interest is embedded in the Code of Conduct, which requires all licensed fund managers to disclose the carry waterfall structure in the fund’s offering document and annual report. For deal-by-deal models, the SFC expects explicit disclosure of the deal-level hurdle rate, the allocation of transaction costs, and the clawback mechanism. The SFC’s 2024 consultation paper on “Enhancing Transparency in Private Equity Fund Fees” proposed that deal-by-deal carry models must include a “clawback guarantee” from the GP, backed by either a letter of credit from a Hong Kong Monetary Authority (HKMA)-authorised institution or a segregated escrow account.

For whole-fund models, the SFC has indicated a lighter disclosure requirement, as the model inherently aligns GP and LP interests. The SFC’s 2025 revised Code of Conduct, effective 1 July 2025, explicitly exempts whole-fund waterfalls from the clawback guarantee requirement, provided the fund’s LPA includes a catch-up mechanism that does not exceed 20% of total profits on a cumulative basis.

Market Practice and Structural Implications for Hong Kong GPs

Prevalence and Fundraising Implications

Data from Preqin’s 2025 Asia-Pacific Private Equity Report indicates that among Hong Kong-headquartered buyout funds raised between 2020 and 2024, 62% employed a whole-fund carry model, up from 48% in the 2015-2019 vintage. This shift reflects LP pressure, particularly from North American institutional investors, who now represent 38% of capital commitments to Hong Kong PE funds according to the HKVCA’s 2024 fundraising survey. US public pension funds, governed by their own fiduciary rules under the Employee Retirement Income Security Act (ERISA), generally require whole-fund waterfalls as a condition of investment.

The deal-by-deal model remains prevalent among smaller funds (below USD 300 million in commitments) and family office-backed vehicles, where the GP has stronger negotiating leverage. The HKVCA’s 2024 model LPA includes both options, with a note that deal-by-deal models should be reserved for “specialist or co-investment vehicles” rather than commingled blind-pool funds.

Tax Treatment in Hong Kong

Hong Kong’s tax regime for carried interest, governed by the Inland Revenue Ordinance (IRO) Chapter 112, treats carried interest as a capital gain rather than trading income, provided the fund meets the “profits tax exemption” conditions under Section 20AN of the IRO. The exemption applies to both deal-by-deal and whole-fund carry, but the timing of tax recognition differs. For deal-by-deal carry, the GP recognises the gain upon receipt, potentially creating a tax liability before the fund’s final performance is known. For whole-fund carry, the gain is recognised only at the fund’s termination, which may defer tax but also increases the risk of a clawback if the GP’s tax position changes.

The Inland Revenue Department’s 2024 practice note on private equity carried interest clarified that clawback repayments are deductible in the year of repayment, reducing the GP’s net tax liability. However, the note warned that if a GP consistently uses deal-by-deal carry and subsequently makes clawback payments, the IRD may re-characterise the carried interest as trading income, subjecting it to the full 16.5% profits tax rate rather than the 0% capital gains rate.

The 2025-2026 Regulatory Shift and Its Impact

The EVCA Withdrawal and Its Ripple Effects

The EVCA’s March 2025 withdrawal of its model deal-by-deal clause was driven by ILPA’s 2024 report, which found that 73% of European LPs considered deal-by-deal waterfalls “inherently misaligned” and that 41% had rejected fund commitments specifically due to the carry model. While the EVCA’s decision directly affects European fund documentation, Hong Kong GPs raising capital from European LPs—who contributed USD 8.2 billion to Asia-focused PE funds in 2024, per the Asian Venture Capital Journal—must now negotiate carry terms without a standardised reference point.

The practical consequence is that Hong Kong GPs must now draft deal-by-deal carry provisions from scratch, referencing the HKVCA model LPA or engaging international law firms to adapt US-style provisions. This increases legal costs by an estimated 15-20% for fund formation, according to a 2025 survey by law firm Deacons.

The SFC’s 2025 Code Revision

The SFC’s revised Code of Conduct, effective 1 July 2025, introduces a new requirement for all licensed fund managers to include a “carried interest waterfall summary” in the fund’s annual report, detailing the amount of carry accrued, the model used, and any clawback liabilities. For deal-by-deal models, the summary must include a “clawback reserve ratio” calculated as the percentage of gross carry held in escrow. This requirement mirrors the disclosure standards in the UK’s Financial Conduct Authority (FCA) rules and brings Hong Kong in line with international best practices.

The SFC has also signalled that it will conduct thematic inspections on carry waterfall compliance in Q4 2025, focusing on deal-by-deal models. GPs using this model should expect enhanced scrutiny of their clawback escrow arrangements and the accuracy of deal-level cost allocations.

Actionable Takeaways for Hong Kong PE GPs

For fund formation, default to the whole-fund model unless the fund has a clear mandate for specialist or co-investment strategies, as the SFC’s 2025 Code revision imposes lighter disclosure requirements and exempts whole-fund waterfalls from the clawback guarantee requirement.

If adopting a deal-by-deal model, establish a clawback escrow account holding at least 30% of gross carried interest, backed by a letter of credit from an HKMA-authorised institution, to satisfy both SFC disclosure expectations and ILPA investor demands.

Negotiate the catch-up mechanism in whole-fund models to cap the GP’s share of profits during the catch-up phase at 20% on a cumulative basis, avoiding the risk of a disproportionate payout that could trigger a clawback under the SFC’s 2025 Code.

For tax planning, recognise that deal-by-deal carry accelerates tax recognition under the IRO Section 20AN exemption, while whole-fund carry defers it; the IRD’s 2024 practice note warns that frequent clawback payments may trigger re-characterisation as trading income.

When raising capital from European LPs, be prepared to justify any deviation from the whole-fund model with a written alignment-of-interest analysis, as the EVCA’s withdrawal of its model clause has removed the industry’s standard reference point for deal-by-deal terms.