Wall Street's 2-and-20 fee came from an oil and gas rule of thumb
Former KKR investor Ravi Gupta says Henry Kravis and George Roberts adapted an oil industry split that gave the organizer a bigger share of gains than cash contributed.
Joys of Compounding · Ravi Gupta - Bring Joy - [Joys of Compounding, EP.21]According to former KKR investor Ravi Gupta, who later became chief financial officer at Instacart, the 2-and-20 pay model that became private equity's standard came from an oil and gas rule of thumb.
In plain terms, 2-and-20 means a 2% yearly fee on the money investors commit, plus 20% of the profits.
Gupta says KKR leaders Henry Kravis and George Roberts created it after they left Bear Stearns. Kravis had grown up in Oklahoma, where oil and gas operators used a rough split that Gupta described as: "You put in a quarter of the money, but you get a third of the profits."
Kravis and Roberts carried that idea into their new buyout business. The version that stuck was two and 20, adapted from the oil and gas precedent.
Gupta's larger point is that Kravis and Roberts were entrepreneurs from the start, not just investors.
Questions people ask
What does 2-and-20 actually mean?
It usually means a 2% annual management fee on the money investors commit, plus 20% of the investment profits, known as carried interest. The fee pays salaries and overhead even when deals do poorly, while the 20% is where managers can get very wealthy if deals succeed.
Why would oil investors give someone a third of the profits for a quarter of the money?
The extra share rewards the operator for finding the opportunity, organizing the drilling, and taking on the operating work and risk. Passive money partners accept a slightly smaller profit share relative to their cash because they are not doing that work.
Did KKR stay just a buyout firm?
No. Gupta says it expanded into real estate, infrastructure, credit, and insurance, and built a large balance sheet and an investment banking arm. He says Kravis and Roberts were already billionaires when they pushed that change.