Bridger Pennington walks through how to structure a private equity fund's waterfall for investors and managers. He recommends an 8% preferred return to limited partners, 2% catch-up to the general partner, and an 80/20 carried interest split above the 10% mark. His first fund was $50k with seven investors.
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Hey, welcome back. So in this video, I'm gonna walk you through how to structure your fund with investors. So a lot of people ask me how I structure my fund, and right now I'm gonna walk you through all of it. So the whole goal of structuring your fund is to align incentives with investors and fund managers. And the system I'm gonna walk you through right now works if you're managing a $5 billion fund or a $50,000 fund. And my first fund was around 50 grand, like I've said before. I had 7 investors. You don't need millions of dollars and huge investors to start. You can start small and get your feet wet and understand this model and then scale from there. That's what I did, and I would highly suggest you do the same thing. So right here, I'm gonna draw out a timeline of your returns in a fund. Right here is gonna be 0% return, and let's put all the way up here, let's put this at like, you know, a 22% return. And I hope you guys get a lot higher returns than that, but 22% would be great for your fund. So this is the timeline. A lot of funds charge a management fee. So what a management fee is, and a lot of people charge 2%, so I'll put that right here, 2%. This is a management fee. And what that says is this: a lot of fund managers in big funds will say, we get 2% automatically for just sitting around and doing nothing. If we just woke up and stayed alive for a year and we ran a $100 million fund, we would make $2 million on a management fee. I strongly suggest against that. When you're starting your first, second, even third fund, do not do a management fee. I will— if you do a management fee on your first fund, good luck trying to raise money. But a lot of investors are going to gawk at that and say, why would I give you a management fee? The big guys up there, you know, on Wall Street, They can charge a management fee because they have the credibility. They went to Harvard. We didn't go to Harvard. We're freaking entrepreneurs. And this is how we have to structure our fund to incentivize investors. So secondly, after you hit 0%, the first section is called your pref. And I typically do an 8% pref on my fund. So I'm going to draw this out right here. These are good terms to remember as well. So from 0 to 8%, this is called your pref. And remember these types of terms. I'm going to write them in blue. Remember them. You'll hear them a lot in the fund world. They are important. And if you can talk this game to people, They're going to think you're head and shoulders above everybody else. So this is really important to know. So your pref is essentially your preference is what you're saying here is, hey, Mr. Investor, from 0 to 8%, you are going to make all of that return. So what I pitch investors to is I say, I'm not going to take a management fee. I don't make any money unless you make 8% first. Sound good? Yeah, it sounds great. Right? So your pref, I'm going to draw this up right here. Goes to your limited partners. So you're saying the first 8% of all returns goes to limited partners. After the pref, there's a thing called a catch-up, and in my fund I do a 2% catch-up. What this means is the next 2% in my funds, for example, go directly to the fund to catch us up a little bit, to get us back in the game. So I'm gonna draw a little arrow down. And say this goes to the general partner. First 8% goes to the limited partner. Next 2% is a catch-up that goes to the general partner or the fund or the managers. Now, what I've done in my fund is I've done everything above 10%. We're going to split 80/20. And this is called carried interest. And we're going to split it 80/20. 20. So 80% goes to the limited partners and 20% comes to the general partner. Carried interest is a heavily disputed topic right now. If you'll look at, you'll see Trump, they're always talking about carried interest. They're worried about carried interest because fund managers are taxed at such low rates. Everyone's asking for Trump and Mitt Romney and all these fund managers' tax returns, and the truth of the fact is they don't pay a lot in taxes because they make a ton of money on this model and they make all their money on carried interest. Rich and wealthy families, they send their kids to Ivy League schools, they send them to work in a fund because they want them to get a piece of the general partner and to make money on carried interest. Carried interest traditionally has been taxed at capital gains rates, which is around 20%. That's the same as your limited partners as well. They get a tax break and get taxed at 20%. If you're an employee, you get taxed at 35% to even maybe 50% taxes you're paying. It depends on what state you're in. If you're a fund manager, you're paying around 20%. That's why this is the most lucrative model in the world and that's why all the richest people in the world come out of this model in some way, shape or form. So this is how I set up my first fund. Now I just tweaked things and I want to walk you through that tweak just to show you what's possible out there. So I said in my next fund, I said we can do an 8% pref just like normal, we're going to do the same thing, we're going to do a 2% catch-up. We're going to do an 80/20 split until we hit a 20% IRR. So I'm going to write right here, 20% IRR. Everything above 20%, we're going to split 50/50. Instead of 80/20, we're going to do 50/50, which incentivizes me even more to make more money, right? I've seen funds that do, hey, if we hit— if we once we can do a 16% pref, first 16% of all returns go to you, investor. Everything above 16% we keep as the fund. And I've seen investors be like, man, that sounds great. I love a 16% return. And these guys are doing trading or whatever and they make 150% returns, right? They give their investor 16% and they're happy as ever, right? Little do they know you just made over 100% return on their money, which is the best part about funds is you might look at this and say, oh man, I'm only making 20% on carried interest. You're making 20% on the fund as a whole. The investors are making money on their, you know, let's say they— $100 million fund, they put in $5 million, they're gonna make 16% on $5 million. You're making 4 to 5% on $100 million or $500 million. That's why running this model is so lucrative. And everybody sends their kids to college to do this because it makes so much Money. Awesome. If you have questions, put them in the comment box below or put them in the Facebook group. I want to hear and, and answer your questions and maybe make another video version of this. Please let me know, but I'll see you in the next video.
