Questions? Let me know in the comments happy to discuss. 🚀 Also, if you want to learn how to systematically scale your startup without ending up as one of the 90% of startups that fail, check out my free training webinar ⇒ www.ericandrewsstartups.com/financeforstartups
Great Explanation, basically I am working in real estate fund accounting but wanting to switch private equity fund. These types of video really helpful👍
Great explanation, is there any other considertations when the PE firm is a publically traded company? Does that affect taxes or they usualyl still operate out of this shell company format?
Glad to hear it vincent. It is a pretty crazy world, but I think an increasingly important one. If you want to learn more about it I have a whole module on fundraising / VC in my upcoming course.
@@veetsec23if you get on the list I'm going to be sending out some emails explaining all about in about a week, it launches Nov 14. But it covers financial modeling, growth strategy, digital marketing, and venture capital, and includes live Q&As and a private community. It's gonna be pretty awesome
Hey - thanks for letting me know!! I think I'm going to be launching a startup / VC focused financial modeling course later in the year...stay tuned for that 😎
@@eric_andrews Awesome! Yours is the only quality content I can find online! You’ve helped me with some of my VC interviews so thanks a bunch! As for startups, most founders do not know what metrics VC’s look for nor what to measure, I’m sure they would find great value too!
@@OOzd95 I'm really happy to hear that my content has been valuable for you. I started this channel out of frustration that all of this stuff wasn't easy to learn anywhere!!!
Great Lesson. I have a question here. carried interest is paid at the end of fund period right? If yes, then do we calculate it on yearly basis to analyze the amount of carried interest payable to GPs or its calculated at the end in the manner as you've shown in video ?
It only starts getting paid once the entire fund is paid back, so it just depends on the performance of the fund. If the fund never returns all the original capital, there will be no carry. There is no "annual" carried interest, it is only paid out when individual portfolio companies get exits, so the timing will depend on that and it will be over a period of time.
I believe it’s simplicity. As someone starting an investment firm and is tax accountant. I would advise General Partners to restructure ownership through a holding company. Limited Partnerships investment would be treated as a loan and hurdle/preferred return would be the interest rate to LP company. Then ownership would split 80% Limit Partner Company and 20% General Partners Company aka investment firm. Profits still tax as capital gains
Hi Eric Is the Carried Interest ,expense to the PE fund or an appropriation out of profit ? Since from perspective of LP's,GP 's income is carried interest, So doubt on this pls let me know. Thanks
Carried interest is a % of the profit. GPs have 2 ways they can earn income, fees & carried interest. LPs pay GPs a management fee each year automatically, but the carried interest is only paid if the fund generates profits (after paying back management fees).
Well done. As a (former) GP in PE, I loved this but couldn't figure out how this was justified in the tax code. Of course, the answer is: It can't be. This shows you the power of campaign contributions. It's complete bullshit, for lack of a better word.
In your opinion, would an extension of the holding period from 3 years to 5 years for long-term capital gains treatment have any meaningful impact on closing this loophole?
@@eric_andrews it’s interesting because there’s been attempts to close this loophole in the past. I guess the house might be proposing something like what I just described. Interesting to hear how effective it would be.
@@colincasey241 Interesting. I don't really have a point of view on it myself but it certainly comes up in every political campaign (bipartisan) but never seems to get done. I'm not sure how much tax revenue it would raise, etc, or really what the full impact would be on growth capital going (or not going) into startups. Following along though!
Yes, those need to be paid back before the carried interest kicks in. So the profit share only kicks in once management fees taken by the GPs are paid back fully.
Just found your channel, great stuff. Isn't the reason LT cap gains are taxed at a lower rate to incentivize stable, long-term investment? People who invest in shorter periods and buy/sell in
Hey! No this is slightly different, the general partners of a private fund (like a venture or hedge fund) are investing the money of other people (limited partners), and the GPs make a share of any profits they make for their investors (LPs). So if fund makes $100mm in profits on behalf of the investors, and the fund managers take a 20% cut of the profits, they also get to pay the low LT cap gains rate even those the money invested to make those returns wasn't their own personal capital. So it's more like a performance based bonus than a LT gain. Does that make sense?
@@eric_andrews I see what you mean, this is the first time they are earning the money as they didn't put any capital in to begin with. Really sweat equity. I'm OK with the LT gain treatment, they've been working on the investment for > 1 year.
Thank you so much for your entire explanation. Rather than worrying about the carried interest loophole and the gains/profits gained by General Partners of private investment funds for not paying income tax upfront, the government must reduce income tax for people who invest in these kinds of financial instruments and cut payroll taxes (wage income) if employees would like to invest. Such an approach will facilitate the creation of many new investments that the country needs right now. In my view, taxes should be created to facilitate and promote economic growth, not to reduce it.
Good video however your example is not typical real world. The GP is expected to have skin in the game, somewhere between 1-5% (typically 2%) (The capital stack). Also the LP's expect a return over and above their initial investment typically 8% before GP's start to catchup (The hurdle rate). Your example focusses on the carried interest alone which is certainly relevant but not the whole picture. I only comment on this because of the tax incentives that take into account that added context.
This argument that allowing GPs to treat what is obviously wage (or regular) income as capital gains is good for the investment industry and therefore should be allowed is absurd. The same argument can be made about literally any industry in the US. If we lower taxes on energy, the country will benefit in some way. If we lower prices on baked goods, the country will benefit. Selecting one single industry and claiming they should have this tax benefit that no other industry enjoys is ridiculous. Every industry wants lower taxes. If you want to create a tax benefit for the investment industry, then lower the capital gains rate entirely. Don't make an arbitrary tax loophole for one specific class of very wealthy people. There is a simple way to know if one should pay a capital gains tax on some piece of income, and that is tying that income to capital at risk. If 100% of your own personal capital (not somebody else's) was at risk, and this capital produced the capital gain; then you should pay the capital gains rate. The matter is extremely clear. Obviously, the investment lobby and the politicians they have paid to make unfair tax laws want to pretend the matter is subtle or nuanced. They muddy the waters by allowing the GP to be a partial investor as if that should fool us into thinking 100% of their capital is at risk in relation to their return. It would be fair and reasonable for the GPs to pay capital gains on that portion of their payments that are associated with their capital that is 100% at risk; and they should pay ordinary income tax on that portion of their income which is fee for service; that is, investing someone else's money and being paid for doing that job --- just like everyone else in the country. Eric Andrews, I don't believe your comments at the end of this video which make it seem that there could be meritorious arguments for the carried interest loophole are helpful or enlightening. You start out with math in a spreadsheet and then you devolve into some nonsense verbiage at the end of the video. Those arguments you make at the end of the video could be made for literally every industry in the US. So, explain to me how the investment industry is different? Or am I missing something? Are the GPs making only capital gains on their own investment money that is 100% at risk?
Hey, I simply presented both sides of the argument for each viewer to decide for themselves, I never stated any personal opinion. I'm glad the video got you thinking about this subject. I happen to agree with you but that's irrelevant because I just wanted to present the story and create more awareness around this issue.
🤯 highly suggest a look at the wiki article on this one (en.wikipedia.org/wiki/Carried_interest): "Treatment of active partners' return on investment as capital gains in the United States originated in the oil and gas industry of the early 20th century. Oil exploration companies, funded by financial partners' investments, explored and developed hydrocarbon resources. The profits generated were split between the explorers and the investors. The explorers' profits were subject to favorable capital gains treatment alongside the investors'. The logic was that the non-financial partner's "sweat equity" was also an investment, since it entailed the risk of loss if the exploration was unsuccessful."
Questions? Let me know in the comments happy to discuss.
🚀 Also, if you want to learn how to systematically scale your startup without ending up as one of the 90% of startups that fail, check out my free training webinar ⇒ www.ericandrewsstartups.com/financeforstartups
I am in Business Innovation and Venture Capital class, Masters in Finance, and I am dying out here. This video was a life saver. Thank you.
Great Explanation, basically I am working in real estate fund accounting but wanting to switch private equity fund. These types of video really helpful👍
Great explanation, is there any other considertations when the PE firm is a publically traded company? Does that affect taxes or they usualyl still operate out of this shell company format?
Great video. I am not in the PE/VC industry so this explanation of the topic was easy to comprehend.
Glad to hear it vincent. It is a pretty crazy world, but I think an increasingly important one. If you want to learn more about it I have a whole module on fundraising / VC in my upcoming course.
@@eric_andrews where do I learn more about the course
@@veetsec23if you get on the list I'm going to be sending out some emails explaining all about in about a week, it launches Nov 14. But it covers financial modeling, growth strategy, digital marketing, and venture capital, and includes live Q&As and a private community. It's gonna be pretty awesome
Very good Eric
Thank you!
¡Excelente como siempre! Gracias Eric
Me alegra que te haya gustado!!
Great summary. Very timely considering the vote happening in the senate.
Glad it was helpful info!
Amazing content! If you do a complete VC series for financial modelling I’d happily pay a reasonable price!
Hey - thanks for letting me know!! I think I'm going to be launching a startup / VC focused financial modeling course later in the year...stay tuned for that 😎
@@eric_andrews Awesome! Yours is the only quality content I can find online! You’ve helped me with some of my VC interviews so thanks a bunch! As for startups, most founders do not know what metrics VC’s look for nor what to measure, I’m sure they would find great value too!
@@OOzd95 I'm really happy to hear that my content has been valuable for you. I started this channel out of frustration that all of this stuff wasn't easy to learn anywhere!!!
Hey - launching on Nov 14th!!! Jump on the early-bird waitlist to get access 1 day before the public: www.startupfinancecourse.com/earlybird-opt-in
@@eric_andrews already signed up!
Great Lesson. I have a question here. carried interest is paid at the end of fund period right? If yes, then do we calculate it on yearly basis to analyze the amount of carried interest payable to GPs or its calculated at the end in the manner as you've shown in video ?
It only starts getting paid once the entire fund is paid back, so it just depends on the performance of the fund. If the fund never returns all the original capital, there will be no carry. There is no "annual" carried interest, it is only paid out when individual portfolio companies get exits, so the timing will depend on that and it will be over a period of time.
@@eric_andrews perfect. Thanks for the explanation.
amazing content, subscribed
Cheers Alberto I really appreciate that!
I believe it’s simplicity. As someone starting an investment firm and is tax accountant. I would advise General Partners to restructure ownership through a holding company. Limited Partnerships investment would be treated as a loan and hurdle/preferred return would be the interest rate to LP company. Then ownership would split 80% Limit Partner Company and 20% General Partners Company aka investment firm. Profits still tax as capital gains
Hi Eric
Is the Carried Interest ,expense to the PE fund or an appropriation out of profit ?
Since from perspective of LP's,GP 's income is carried interest,
So doubt on this
pls let me know.
Thanks
Carried interest is a % of the profit. GPs have 2 ways they can earn income, fees & carried interest. LPs pay GPs a management fee each year automatically, but the carried interest is only paid if the fund generates profits (after paying back management fees).
Well done. As a (former) GP in PE, I loved this but couldn't figure out how this was justified in the tax code. Of course, the answer is: It can't be. This shows you the power of campaign contributions. It's complete bullshit, for lack of a better word.
That's pretty wild to hear from you, thanks for sharing
In your opinion, would an extension of the holding period from 3 years to 5 years for long-term capital gains treatment have any meaningful impact on closing this loophole?
No. Venture and private equity investors usually hold for 5 to 10 years so I don't think that would really do anything
@@eric_andrews Thanks!
@@colincasey241 no problem! could potentially affect some hedge funds but ya, probably wouldn't move the needle much.
@@eric_andrews it’s interesting because there’s been attempts to close this loophole in the past. I guess the house might be proposing something like what I just described. Interesting to hear how effective it would be.
@@colincasey241 Interesting. I don't really have a point of view on it myself but it certainly comes up in every political campaign (bipartisan) but never seems to get done. I'm not sure how much tax revenue it would raise, etc, or really what the full impact would be on growth capital going (or not going) into startups. Following along though!
Never theirs? How is the risk management skill off this discussion table?
The point here is the GPs did not contribute their own capital.
@@RehanSyed29 so why is that the only point in a supposed “fiduciary relationship”?
@@KunleBabajide This point is only describing an issue. Not exactly sure how you are inferring any opinions being given.
Do you consider expenses in your fund returns?
Yes, those need to be paid back before the carried interest kicks in. So the profit share only kicks in once management fees taken by the GPs are paid back fully.
Does the Carried Interest loop hole applies to Hedge Fund with long term stock holdings?
Yes
@@eric_andrews side pockets?
Does the fund get to deduct the amount paid as carried interest?
The GPs basically need to pay back all their fees (from exits) before they get any carried interest....
Just found your channel, great stuff. Isn't the reason LT cap gains are taxed at a lower rate to incentivize stable, long-term investment? People who invest in shorter periods and buy/sell in
Hey! No this is slightly different, the general partners of a private fund (like a venture or hedge fund) are investing the money of other people (limited partners), and the GPs make a share of any profits they make for their investors (LPs). So if fund makes $100mm in profits on behalf of the investors, and the fund managers take a 20% cut of the profits, they also get to pay the low LT cap gains rate even those the money invested to make those returns wasn't their own personal capital. So it's more like a performance based bonus than a LT gain. Does that make sense?
@@eric_andrews I see what you mean, this is the first time they are earning the money as they didn't put any capital in to begin with. Really sweat equity. I'm OK with the LT gain treatment, they've been working on the investment for > 1 year.
I belive this in inacurate since the GP serve themselves after the hurdle rate is reached
That's more how it's done in real estate, venture is a straight split of profits no hurdle
Thank you so much for your entire explanation. Rather than worrying about the carried interest loophole and the gains/profits gained by General Partners of private investment funds for not paying income tax upfront, the government must reduce income tax for people who invest in these kinds of financial instruments and cut payroll taxes (wage income) if employees would like to invest. Such an approach will facilitate the creation of many new investments that the country needs right now. In my view, taxes should be created to facilitate and promote economic growth, not to reduce it.
Fees taken of $40 also need to be deducted form the fund return bucket as management fees our the liability then your profit calculation carry forward
Good video however your example is not typical real world. The GP is expected to have skin in the game, somewhere between 1-5% (typically 2%) (The capital stack). Also the LP's expect a return over and above their initial investment typically 8% before GP's start to catchup (The hurdle rate). Your example focusses on the carried interest alone which is certainly relevant but not the whole picture. I only comment on this because of the tax incentives that take into account that added context.
@user-tt6jb7oe4w you are talking about real estate not venture right?
It's capital gain only if you put up capital. Otherwise it's just gain, aka income for labour. Pay the taxes like everyone else.
Play the game on the field. Need more political support if it’s to be changed.
This argument that allowing GPs to treat what is obviously wage (or regular) income as capital gains is good for the investment industry and therefore should be allowed is absurd. The same argument can be made about literally any industry in the US. If we lower taxes on energy, the country will benefit in some way. If we lower prices on baked goods, the country will benefit. Selecting one single industry and claiming they should have this tax benefit that no other industry enjoys is ridiculous. Every industry wants lower taxes. If you want to create a tax benefit for the investment industry, then lower the capital gains rate entirely. Don't make an arbitrary tax loophole for one specific class of very wealthy people. There is a simple way to know if one should pay a capital gains tax on some piece of income, and that is tying that income to capital at risk. If 100% of your own personal capital (not somebody else's) was at risk, and this capital produced the capital gain; then you should pay the capital gains rate. The matter is extremely clear. Obviously, the investment lobby and the politicians they have paid to make unfair tax laws want to pretend the matter is subtle or nuanced. They muddy the waters by allowing the GP to be a partial investor as if that should fool us into thinking 100% of their capital is at risk in relation to their return. It would be fair and reasonable for the GPs to pay capital gains on that portion of their payments that are associated with their capital that is 100% at risk; and they should pay ordinary income tax on that portion of their income which is fee for service; that is, investing someone else's money and being paid for doing that job --- just like everyone else in the country. Eric Andrews, I don't believe your comments at the end of this video which make it seem that there could be meritorious arguments for the carried interest loophole are helpful or enlightening. You start out with math in a spreadsheet and then you devolve into some nonsense verbiage at the end of the video. Those arguments you make at the end of the video could be made for literally every industry in the US. So, explain to me how the investment industry is different? Or am I missing something? Are the GPs making only capital gains on their own investment money that is 100% at risk?
Hey, I simply presented both sides of the argument for each viewer to decide for themselves, I never stated any personal opinion. I'm glad the video got you thinking about this subject. I happen to agree with you but that's irrelevant because I just wanted to present the story and create more awareness around this issue.
ponzi scheme
🤯 highly suggest a look at the wiki article on this one (en.wikipedia.org/wiki/Carried_interest):
"Treatment of active partners' return on investment as capital gains in the United States originated in the oil and gas industry of the early 20th century. Oil exploration companies, funded by financial partners' investments, explored and developed hydrocarbon resources. The profits generated were split between the explorers and the investors. The explorers' profits were subject to favorable capital gains treatment alongside the investors'. The logic was that the non-financial partner's "sweat equity" was also an investment, since it entailed the risk of loss if the exploration was unsuccessful."
That's crazy I didn't realize that was the origin. Thanks for sharing.