Carried Interest Debate (Blog Post)
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Abstract
To many, the concept of carried interest is confusing or meaningless, and the question as to why anyone would debate something so arcane is even more so. In all likelihood, the concept of the exorbitantly wealthy Wall Street bankers or hedge-fund managers is much more familiar, so we will start from there. The objective of this blog post is to shed some light on the obscure world of "hedge funds," explain why the managers are perceived to pay so little tax, and explore recent political developments that may or may not affect that perception in the future.
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First, let's clear one thing up. When Donald Trump and Hillary Clinton rally against "hedge-funds" for paying so little tax [1], they are actually referring to private investment funds in general. In short, a private investment fund invests capital in order to achieve returns for investors. It is that simple; although, the types of funds, means through which capital is raised for the funds, how the capital is invested, where the profits are distributed, etc... can complicate the situation.
Before considering the aforementioned complications, one must understand the basic structure of a private investment fund. These funds, set up as limited partnerships or limited liability companies, are organized under general partners and limited partners. The general partners are the funds' managers or managing firms, while the limited partners are the funds' investors. These investors are typically made up of financial institutions, pension funds, and wealthy individuals.
Types of private investment funds include private equity funds, venture capital funds, and, of course, hedge-funds. What are the differences between all of these funds? Here is a brief summary of each.
Private equity funds generally invest in large companies with the intent to restructure and sell the firms for a gain. Venture Capital funds aim to invest in high-tech startups with high-growth potential in exchange for a stake in the company with the eventual goal of a liquidity event, i.e. a(n) acquisition, merger, or initial public offering. Hedge funds tend to focus on achieving high returns through risky investments that may come in the form of stocks, bonds, commodities, derivatives, and just about anything else that promises a strong gain. It is worth noting that, in practice, the distinctions between these funds can be blurred.
