Sustainable finance regulation and related investor expectations continue to grow. This has increased the pressure on private fund impact managers to show true alignment between financial performance and sustainability outcomes.
As the market evolves, we have seen a growth in the demand for environmental, social, and governance (ESG) or impact-linked carried interest mechanisms that make part of the manager’s carry contingent on achieving specific sustainability outcomes.
This has led to a need for managers to create solutions to show how they have achieved the outcomes that investors want. We discuss these solutions in the following section.
Structuring Solutions
Some private fund managers have adopted specific impact-linked carry mechanisms that typically put 10% to 50% of the carried interest at risk. They generally implement this through a forfeiture mechanism under which, if the manager does not meet impact key performance indicators (KPIs), they give up part of the carry.
Various mechanics can be used to achieve this:
| Negotiation Point/Mechanism | What It Means | Comment |
| Gating Mechanism |
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These mechanics are distinct from a traditional clawback and are not intended to enhance investor returns. Instead, they operate as a downside adjustment to the manager’s rewards for impact underperformance. Gating mechanisms are more common than the other two approaches, principally because a variable carry rate adds complexity to the waterfall operation and an end of fund test presents an enforceability risk. However, the likely irrecoverable tax leakage on any 'adjusted' carried interest should also be considered in order to understand the overall efficiency of the different mechanics. |
| Variable Carry Rate |
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| End of Fund Test |
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When carry is forfeited, it is generally not returned or recycled to investors but donated to a mission-aligned charitable organisation, reinforcing the impact framework’s integrity. Uplift of the carry for meeting or exceeding impact KPIs remains rare because impact fund investors tend to view achieving impact objectives as a core part of the fund strategy. Therefore, no additional economic incentives for impact fund managers should be necessary. When it comes to documenting the structure, we see impact-linking mechanics in the general investor documentation when all investors are intended to benefit from them. We also see some managers limiting the benefit to specific investors and addressing them in side letters for those investors. In this case, proper investor disclosure is critical so that prospective investors not only understand that linking arrangements may exist for some investors but also that these arrangements may have an impact on fund returns. |
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Other Considerations
In addition to the structuring solutions, a manager also needs to:
- Identify KPI parameters to ensure clarity and objectivity for measuring impact
- Determine how the choice of investments could affect the operation of any linking mechanism
- Identify and manage any conflicts of interest between achieving investment returns and meeting impact objectives
We look at each of these in more detail in the following subsections.
KPI Parameters
The underlying metrics for impact KPIs are typically unique to the fund strategy and underlying investments, and a manager will have significant discretion to define and set the impact objectives/thresholds for the fund. To maintain credibility with investors without compromising flexibility, it is customary to agree on a set of framework-level metrics with investors. (These can be designed to enable adjustment following investor committee approval.) The manager can then decide the specific metrics to apply on an investment-by-investment basis.
Managers are expected to provide annual or more regular impact reports that show progress against these metrics. Some investors may also expect independent third-party impact auditors/evaluators to audit these reports.
When a fund is managed or marketed in the European Economic Area, the KPI parameters will also need to align with disclosures made under the Sustainable Finance Disclosure Regulation (SFDR). When a manager makes initial disclosures under Article 8 or Article 9 of the SFDR, it needs to consider how the KPIs align or otherwise interact with its disclosure of principal adverse impacts. The KPIs will also be relevant to ongoing disclosure under Article 10 and periodic reporting under Article 11 of the SFDR. Good SFDR compliance practice requires clearly described quantitative, time-bound KPIs supported by effective implementation and monitoring.
Investment-Specific Calibration
Investment sector and asset class also shape impact-linked carry implementation. For instance, unlike private equity, credit and real estate strategies typically lack a single exit event but are designed to generate ongoing income.
For credit strategies, impact KPIs are commonly set at the point of loan origination with loan arrangements aligning with impact outcomes. These arrangements can include sustainability-linked pricing mechanics, such as impact-linked ratchets or impact and ESG covenants. For real estate strategies, carry is often linked to the real estate asset satisfying social and environmental impact targets that are aligned with the fund’s sustainability objectives, calibrated as necessary to the asset in question.
In practice, this involves the manager establishing the relevant impact objectives, target values, and weightings at borrower- or asset-holding level. The manager will also require impact reporting data to support measurement and assessment of impact performance.
Conflicts of Interest
Investor expectations regarding the relative weighting of financial returns and impact outcomes can vary significantly. A manager will need to ensure that impact metrics are sufficiently robust to show that the manager’s financial interests are genuinely tied to achieving impact outcomes. At the same time, the manager will need to ensure that these metrics are not so stringent that they deter the manager from making investments that, while economically attractive, may have less easily quantifiable impact results.
Effective implementation also relies on sufficiently robust ESG covenants and robust information reporting obligations, as previously noted, with the potential for economic penalties for underperformance. In a very competitive marketplace, managers should avoid the temptation to agree with investors on the imposition of investee or borrower obligations that may put the fund at a competitive disadvantage with other prospective purchasers or lenders.
Comment
Changing investor demand is driving managers to examine how impact performance and KPIs are linked to carried interest. Ultimately, a manager needs to understand what an investor wants and, in this regard, consider the current investor ESG landscape and the solutions that respond effectively to this. A manager will need to ensure that the rigour of impact objectives does not deter it from making profitable investments — an outcome that is neither in the manager’s nor the investors’ interests.
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Please do not hesitate to speak to one of the authors of this briefing or your usual Goodwin contact if you have any questions or want to discuss how this framework could be tailored for your fund, including KPI design, verification mechanics, documentation approach, and interaction with SFDR classification.
You may also be interested in our related briefings:
- “Irreconcilable? The EU’s Article 8 and ‘Anti-ESG’ Investor Demands” (October 2023)
- “What does the final draft of the SFDR2 mean for Private Fund Managers?” (November 2025)
- “Simpler and More Streamlined Sustainability Disclosure for UK Private Fund Managers: Taking Stock and Comparing With the EU” (September 2025)
- “ESG and EU Fund Names: ESMA’s Final Guidelines” (May 2024)
- “AIFMD2 Implementation: Key Questions for Private Fund Managers” (March 2026)
- “Horizon Scan for Private Investment Funds: Key Recent Legal and Regulatory Developments to look out for in the coming months" (February 2026)
This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.
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