The fee structure used in private equity, hedge funds, venture capital, private credit, and many real estate funds is famously summarized as “2 and 20.”
Although simple in appearance, this model has deep implications for investor returns, manager incentives, and the long-term economics of alternative investing.

This article breaks down what 2-and-20 means, why it became the industry standard, how it affects performance, and what investors must understand before committing capital.

1. What Does “2 and 20” Actually Mean?

The term describes two components:

1. A Management Fee (~2%)

An annual fee charged on either:

• Total committed capital (common in private equity and VC)
• Assets under management (AUM) (common in hedge funds)

Purpose:
To cover operating costs, salaries, research, deal sourcing, compliance, overhead, and general business expenses.

2. A Performance Fee (~20%)

Also called carried interest or carry, this is a share of the profits the manager receives after meeting certain benchmarks.

Purpose:
To incentivize the manager to generate strong, absolute returns — not just collect management fees.

Together, these fees align the interests of the GP (General Partner) and LPs (Limited Partners) while ensuring the manager is compensated for both effort and success.

2. Why the 2-and-20 Structure Exists

A. Alternatives Require Specialized Skill

Private equity, hedge funds, and venture capital depend on:

• Expert deal sourcing
• Operational improvement
• Deep financial modeling
• Risk management
• Global macro analysis
• Proprietary technology and research

The skills required exceed those used in passive index investing, justifying a premium structure.

B. Alternative Managers Are Entrepreneurs, Not Administrators

Top GPs operate like:

• Business operators
• Restructurers
• Negotiators
• Technologists
• Industry specialists

Their work is closer to running companies than managing stocks — and their compensation reflects this.

C. Performance Fees Align Incentives

Carry forces the manager to:

• Grow the value of the portfolio
• Create operational improvements
• Pursue high-quality opportunities
• Think long-term

If the fund performs well, both the GP and LP benefit.
If it performs poorly, the GP collects little beyond their management fee.

3. How Management Fees Work

Management fees typically range from 1% to 2.5% depending on:

• Strategy
• Fund size
• Experience of the GP
• Asset class
• Liquidity characteristics

Private Equity / Venture Capital

Fees are most often charged on committed capital during the investment period (usually the first 3–5 years).
Afterward, they may decline based on:

• Invested capital
• Net asset value
• Cost basis

Hedge Funds

Fees are usually charged on assets under management, recalculated daily or monthly.

Real Assets & Private Credit

Fees may vary based on:

• Gross asset value
• Invested capital
• Loan book size
• Equity + debt positions

Management fees ensure the GP can operate effectively, but they also create a baseline cost that investors must factor into expected returns.

4. How Performance Fees (Carry) Work

The standard performance fee structure is 20% of profits, although:

• VC funds may charge 25–30%
• Elite hedge funds may charge 30–50% on certain strategies
• Private credit funds may charge 10–15%
• Real estate funds vary widely

Performance fees depend on hitting specific hurdles.

5. The Hurdle Rate (Preferred Return)

Many funds include a preferred return or hurdle rate, which ensures LPs receive a minimum return before the GP is paid carry.

Common hurdle: 6%–8% annualized return.

If the fund fails to achieve the hurdle, the GP receives no performance fee.

6. The Waterfall: How Profits Are Distributed

A typical distribution waterfall looks like this:

Step 1 — Return of Capital

LPs get back all contributed capital.

Step 2 — Preferred Return (Hurdle)

LPs receive their required minimum return.

Step 3 — Catch-Up Provision

Once the hurdle is met, additional profits temporarily go mostly to the GP until the agreed split is reached.

Step 4 — Carried Interest Split (e.g., 80/20)

All remaining profits split 80% to LPs, 20% to GP.

The waterfall ensures fairness, sequencing, and alignment.

7. Variations of the 2-and-20 Model

Although 2-and-20 is the classic structure, alternatives often use variations:

1. “1 and 10” or “1.5 and 15”

Used by some private credit and real estate funds.

2. Tiered Carry

Performance fees increase at higher return thresholds.

Example:

• 20% carry after 8% hurdle
• 25% carry after 15% hurdle

3. Discounted Fees for Large LPs (Institutions)

SMAs or large commitments may negotiate:

• 0.5% management fees
• Reduced or zero carry
• Co-investments with no fee, no carry

4. Founders’ Share Classes

Early investors receive lower fees.

5. Hedge Funds with “2 and 30” or “0 and 30”

Some elite funds eliminate management fees but charge higher performance fees.

8. How Fees Affect Investor Returns

Fees matter — especially in private funds where compounding occurs over long periods.

Management Fees Reduce Net IRR

Because committed capital is charged even when undeployed.

Performance Fees Reduce Absolute Returns

Especially when alpha is strong.

High Fees Demand High Manager Skill

Fees amplify the importance of choosing top-tier managers.

Comparison to Public Market Funds

Public market index funds may charge as little as 0.03%.
Private funds charging 2-and-20 must outperform to justify the premium.

Despite high fees, investors continue allocating to alternatives because:

• Long-term returns tend to be strong
• Performance is less correlated to public markets
• Access to private markets is valuable
• Skilled GPs consistently outperform

9. Why Investors Still Accept 2-and-20

Despite the cost, LPs continue to invest heavily in high-fee private funds because:

1. Returns justify the fees (for top managers)

Top-quartile private equity and venture funds routinely outperform public market indices.

2. Access to unique opportunities

Private deals, growth equity, buyouts, and early-stage startups are inaccessible without private funds.

3. Alignment of incentives

Performance fees motivate GPs to maximize value.

4. The illiquidity premium

Private investments offer higher returns partly because they are illiquid.

5. Sophisticated LPs can negotiate

Large institutions often pay far less than the headline rates.

10. The Future of Fund Fees

Several trends are changing the fee landscape:

1. Downward pressure on management fees

Competition is forcing managers to reduce fixed fees.

2. Carry is becoming more important

Managers want to earn based on performance rather than scale.

3. Co-investments are rising

LPs increasingly expect free or low-fee co-investment opportunities.

4. Fee transparency is improving

Regulators are demanding clearer reporting.

5. Retail access is expanding

Regulated structures (interval funds, tender funds, BDCs) use modified fee models.

The traditional 2-and-20 model remains dominant, but the ecosystem is evolving.

Final Takeaway

The 2-and-20 fee structure is more than a pricing model — it’s the economic engine that powers the alternative investment industry.
It works because:

• Management fees support long-term operations
• Performance fees align incentives
• Skilled managers can justify premium pricing
• Investors gain access to private markets they cannot replicate themselves

Understanding how fees work is essential for evaluating private funds, comparing managers, and setting realistic expectations for net returns.