Carried interest is both boring and disruptive

Carried interest is the percentage of an investment’s gains that a fund manager takes as compensation. At most private equity/VC firms and hedge funds, the share of profits paid to managers is about 20%. Under existing US law, that money is taxed at a capital gains rate of 20% for top earners. That’s about half the rate of the top individual income tax bracket, which is 37 %

Yes, carried interest is a boring wonky subject.

Back in 2017 I opined that carried interest was the wild card that could disrupt the massive fund management business. That is the exciting disruptive part of carried interest, so please keep reading.

The recent news is that an agreement was reached between Senators  Chuck Schumer and Joe Manchin that could end the special tax treatment of carried interest.

Latest news is political again which was that, in order to get Kyrsten Sinema on board with the main bill, the casualty was ending the special tax treatment of carried interest.

I still believe that politicians will find a way to explain a boring wonky subject to electors in a populist way and that it is only a question of when(not if) carried interest gets taxed at income tax rates.

Many smart investors are already thinking this way. This will make the massive fund management business move from 2 and 20 to 0 and 30 and that is wildly disruptive to the status quo.Let me explain.

Let’s say you are an angel investor with a good track record. You invest your own money which is properly taxed at the capital gains rate – it is a high risk investment. You then invite other investors to copy/follow your investments if they will pay you 30% of the profits. Investors will probably pay 30% to the angel, rather than 20% to a traditional fund because investors won’t have to pay the usual 2% Assets Under Management fund fee to the angel. The following investor could make a return on 70% without any upfront risk.

That 30% carry/follow fee will be taxed at income tax rates, as it should be as it is risk-free income.

Angel List could be the firm that makes this happen and will reap a big reward if they do.

Angel List shows why boring is good business. They have built a huge business connecting Angel investors and entrepreneurs by taking care of all those “boring” back office details – like being paid correctly! Angel List clearly understand carried interest.

One boring detail that Angel List could take care of is tax deductions for the 30% carry/follow fee.