If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content

Hedge funds, venture capital, and private equity

Similarities in compensation structure for hedge funds, venture capital firms, and private equity investors. Created by Sal Khan.

Want to join the conversation?

  • piceratops ultimate style avatar for user Mike Xie
    I just want to know how does Sal know this much about finance, science, and math?!
    (21 votes)
    Default Khan Academy avatar avatar for user
    • blobby green style avatar for user dustz33
      He used to work for a hedge fund and he's got two degrees from MIT and a Harvard MBA. Most of the stuff he teaches here is slightly above highschool level, so even if he does not know something I'm sure it does not take him long to read up on it!
      (57 votes)
  • leaf grey style avatar for user Lindsey
    Is it possible to track the long and short positions of any hedge fund?
    (2 votes)
    Default Khan Academy avatar avatar for user
    • leaf green style avatar for user Ryan
      Every investment fund with assets over 100 million must file a 13F with the SEC each quarter. This form will report the long positions of the fund and are available to the public on the SEC's website.

      Couple of drawbacks:
      -Shorts and derivatives are not reported
      -There is a 45 day delay between when the form is filed and when it is made public, so changes may have happened during that time
      -A long being reported may actually be a hedge on a larger short position that is not reported.
      -A fund could sell the position the day of reporting and buy it back the next day to avoid reporting.

      For these reasons, the forms are really only of use for tracking longer term buy and hold fund managers. For anyone that employs a high turnover strategy, or a market neutral or arbitrage strategy, their 13F won't be of much use.
      (12 votes)
  • leaf green style avatar for user Brettsky_99
    How does a qualified investor research and "choose" a hedge fund (or vice versa, how do hedge funds find investors) if hedge funds can't market to the public?
    (5 votes)
    Default Khan Academy avatar avatar for user
    • blobby green style avatar for user jjblair1
      This question is particularly relevant now as new regulations are being proposed to make Hedge Funds more transparent as well as potentially enabling them to raise money more easily.
      Major investors in Hedge Funds have typically included University Endowments, major pension funds, sovereign wealth funds, and large family offices (wealthy individuals). However, recent news has been increasingly covering funds that are taking a more active role with their own investments and divesting from their hedge fund positions owing to the exorbitant fees charged by the latter.
      (1 vote)
  • blobby green style avatar for user Robert Smith
    What makes a company or hedge fund too big to fail?
    (1 vote)
    Default Khan Academy avatar avatar for user
    • male robot hal style avatar for user Andrew M
      Mostly, it is a strong desire by a regulator or politician to protect rich people at the expense of taxpayers.

      The argument is that if you owe me a lot of money, and I owe Sal a lot of money, and Sal owes Bill a lot of money, then if you don't pay, not only do I go broke but so do Sal and Bill and anyone who relies on them, and supposedly the macroeconomic consequences of this (for employment, essentially) are too dire to even take the chance.

      Clearly a better solution would have been for me not to lend you so much, and for Sal not to lend me so much, and for Bill not to lend Sal so much, and then we wouldn't have that domino-effect problem.
      (6 votes)
  • blobby green style avatar for user Phillip Chapman
    For the purposes of calculating fees and carried interest, how do hedge funds value assets that are not very liquid, e.g. a 50% ownership of a private company.
    (2 votes)
    Default Khan Academy avatar avatar for user
  • blobby green style avatar for user Arman  Jalali
    If an investor decides to return 10 percent of their stake in the hedge fund in turn for that percentage of the value, then does the fund then find a way to sell the 10 percent stake in their fund to another "sophisticated" investor?
    (1 vote)
    Default Khan Academy avatar avatar for user

Video transcript

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.