Hedge Funds, Venture Capital, and Private Equity

One thing I probably
should make clear

is that this idea of
getting a 2% management fee

and then participating in
the profits at around 20%,

getting this 20%
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%

for managing the fund and
they'll get 20% of the profits.

The only difference really, in
terms of how it's structured,

in a venture capital
or 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 could get the money
right from the get-go

and put that money to
work because it tends

to invest in fairly
liquid assets.

So this is 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 do is
they'll say, look,

I'm going to raise
$100 million fund,

but I'm not going to be able to
just go out the door tomorrow

and invest $100 million.

In the case of a
venture capital firm,

they're going to have to
look at business plans

and entrepreneurs and
do their due diligence.

Same thing for a
private equity firm.

They're going to have to
look for companies that they

might want to buy
private equity.

You're normally talking
about more mature companies

that maybe this firm thinks that
they can buy and turn around.

Maybe more 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 kind
of more, I guess

we should call it,
more risky companies.

But in either of
these situations,

they won't just
find them tomorrow.

So what they do is they
go to their investors

and they get their investors
to commit a certain amount

of money, to say
commit $100 million.

And 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 investment.

I now need this percentage of
what you committed to so that I

can go out and make the
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 these are
kind of the careers

that, at least the people
who are interested in-- 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.