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Similarities in compensation structure for hedge funds, venture capital firms, and private equity investors. Created by Sal Khan.
Video transcript
One thing I should probably make clear is that this idea of getting a 2 percent management fee and then participating in the profits at around 20 percent - getting this 20 percent carried interest - this isn't unique to hedge funds. This is actually the same compensation structure that you'll normally have at a venture capital fund or a private equity fund. And just to be clear, venture capital really is a form of private equity. But normally, when someone says "private equity" they're not talking about venture capital in particular. In all of these situations, the managers will get roughly 2 percent on the - for managing the fund they'll get 20 percent of the profits. The only difference, really, in terms of how it's structured - and, a venture capital or a private equity fund will still have kind of a limited partnership for the actual fund and then they would have a management company that gets the management fees and the profits. The only difference is, because a hedge fund for the most part is probably going to invest in public securities, it can get the money right from the get-go and put that money to work because it tends to invest in fairly liquid assets that they can just go out and buy. So a hedge fund will normally just take as much money as it needs to invest right from the beginning. A venture capital firm or a private equity firm, what they'll to is say, look, "I'm going to raise a 100 million dollar fund, but I'm not going to be able to just go out the door tomorrow and invest 100 million dollars. In the case of a venture capital firm, they're going to have to look at entrepreneurs and do their due dilligence, same thing for a private equity firm, they're going to have to look for companies they might want to buy. Private equity, you're talking about more mature companies that maybe this firm thinks it can buy and turn around, maybe some mature companies that need some money to grow really fast. Venture capital tends to be investing in some guys and a business plan, or, maybe these smaller, more risky companies. But in either of these situations they won't find them tomorrow, so what they do is they go to their investors and get their investors to commit a certain amount of money. To say, commit 100 million dollars, and they'll get the management fee. They'll get the management fee on what those investors commit, but they won't take the money right then and there. They'll take the money as they need it - they'll do what's called a "capital call" to their investors, saying, "Hey, I just found a good 5 million dollar investment, I now need this percentage of what you committed to so I can go out and make this investment in the hedge fund," that's not the case, all of it is up front. But it really is the same compensation scheme. And that's why if you go to any fancy business school, you'll find that these are kind of the careers that, at least people who are interested in...well, I don't want to give them any kind of characteristics...there's a bunch of reasons why people would want to go into these, but these are definitely sought-after careers at a lot of fancy business schools