Bridger Pennington, who runs two 8-figure funds, breaks down how fund managers get paid: the standard 2% management fee plus 20% of profits above an 8% hurdle rate. He walks through a real example where 23% gross returns become 18.4% net to investors and 6.6% to the fund manager.
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What is a fund waterfall and how do fund managers get paid? We're going to answer this question in 2 minutes or less. My name is Bridger Pennington. I currently run 2 8-figure investment funds. We've helped over 300 people launch their funds in Fund Launch. So what we're going to do, down to the iPad. Let's dive in. This is what they call a waterfall structure. This is how fund managers get paid. If you've seen our other videos, you'll see GPLP structure and other things here. And this is how the actual payment structure works. A lot of you have maybe heard of a thing called a 2 and 20 fund. This is what this stands for is a 2% management fee and 80/20 split on performance. Let's actually do the numbers here and show you how this plays out. Down below, we got a timeline here. You see 0% all the way up to 23% after fees. Let's say this fund we have right now just got 23% after fees. By fees, what I mean is a lot of funds charge right here what we call a 2% management fee. Okay, this is off the top. So if we raised $100 million, we would charge 2% per year or 0.5% per quarter. It's typically how that's paid out. Okay. Now, in these returns, a lot of funds do something like this. They do what they call a pref. So what they would say is the first 8% of all returns goes to the investor as a preferential rate of return. So, for example, If this year our fund only got, you know, a 7% return and we're right here, we got a 7% return this year after fees, all 7% would go or 8% would go to the investor first. It's kind of what they call a hurdle marker, a preferential rate of return. You follow along so far? Now, after this, what a lot of funds do is what they call a catch-up where 2% goes now to the general partner or the fund manager here. Now, the way I've organized this, the top here is what fund managers are paid. The bottom down here you're going to see is what the investors are paid again on a 23% rate of return. So again, the first 8% goes to the investors. The next 2% in this example would go to the general partner as a 2% catch-up to get them back to 80/20. Above 10%, we will do an 80/20 split. So if I'm doing the math here, I'm going to, you know, erase some stuff here. We do 80/20 split. How this kind of plays out here is we do 80% to the investors and LPs. And we do 20% to the general partners under a thing called carried interest. So again, if I add this stuff up together, we have 2% here, 2% here, and then 80/20 here, which is 2.6% from 10th percentile to 23rd percentile. And then this would be a 10.4% from the, again, the 10 to the 23 with the 8% pref. If I'm adding these up on this example, after fees, the— 10.4%. Fund managers paid 6.6% with the fee included, and then the investors took home 18.4%. This is what they would call as a net rate of return. Over here, this would be the gross. This is the gross rate of return, 23%, and investors actually took home an 18.4% net rate of return. So if you're investing into funds, it's always good to ask, what's the net? What's the take-home after fees that I would get? Now, I know some of you guys are adding this up. 6.6% plus 18.4% does not equal 23%. I know. Okay. It equals 25% because we're adding the 2% management fees here. Okay. This is 23% after fees. Now, you might be sitting there as well and go, well, Bridger, 6.6% isn't a lot of money. Come on. Like, I'm here to make much more than that. No, that is a lot of money. You're making 6.6%. On the entire fund. So if you were running a $100 million fund, you just made $6.6 million. If you're running a billion-dollar fund, you just made $66 million. If you're running a $10 billion fund, that's $660 million. And these actually scale just like this. Many funds can run with a pretty small team. That's why fund management is one of the most lucrative opportunities on earth. The Forbes 100 list, the number one category of billionaires is finance and investment fund management. It's because this structure is crazy. Last thing I'll share. Carried interest is charged a lower tax rate. Trump raised, I think in 2017, 2018, but still it's around capital gains rate. It's around a 20% to 25%. 25%. 35% capital gains rate that they get charged, which is pretty cool. That's why fund managers pay low taxes. Now you might say that's unfair. I'm just telling you what the rules are. I'm telling you why I love being a fund manager. Okay? This is awesome. This is how you get paid the big bucks in fund management game. This is why fund managers make tons of money and how you could structure a similar waterfall structure for what you are doing. Now, if you want, you can change these. Again, in the GPLP structure, you can change the LP and PPM. You could do a 75/25 split. You can change. You can do a 7% prep if you'd like. But again, I'm just telling you what's standard. Hopefully, this is useful. Go check out our other videos. We'll see you in the next one. Bye-bye.
