What Does 2 and 20 Fee Structure Mean?
The 2 and 20 fee structure is the way that most private equity firms are compensated. The 2 represents the 2% annual management fee on capital deployed that is used to pay salaries, cover overheads and generally "keep the lights on." The 20 represents the 20% carry over of a certain return threshold that the private equity firm gets to keep.
Divestopedia Explains 2 and 20 Fee Structure
Most private equity firms work for the 20% carry since this is where most of their compensation is made. A general partnership will stipulate a set return of, say, 8% for its limited partners. If the fund delivers returns of, say, 14%, then the 20% carry kicks in on the incremental 6% return. The private equity firm keeps 20% of 6%, or 1.8%. This can be a substantial bonus when large funds are managed.
The 2 and 20 fee structure is also used in the hedge fund industry. It's important for business owners to understand this compensation structure so he/she can better assess the motivations and strategies of financial buyers and how it will impact their own business post-transaction.