Private Equity Fee Structure: 2 and 20 Explained

The private equity fee structure is how a fund pays its manager: an annual management fee, usually 1.5% to 2% of committed capital, plus carried interest, usually 20% of profits above an 8% preferred return. This is the “2 and 20” model. The average buyout management fee fell to 1.61% in 2025, the lowest Preqin has recorded.

The headline rates are only half the picture. What you pay depends on the fee base, when the fee steps down, how the waterfall works, whether portfolio company fees are offset and which costs are charged to the fund.

This guide walks through each part, with a worked example of a $1bn fund.

What 2 and 20 means

A private equity fund is a limited partnership. The general partner (GP), the manager, runs it. The limited partners (LPs), the investors, provide the capital. The fee structure sets how much of the fund’s cash goes to the GP.

• Management fee (the “2”): an annual fee that pays for the GP’s team, offices and deal sourcing. It is paid whether or not the fund makes money.
• Carried interest (the “20”): the GP’s share of profits, paid only once LPs have their capital back and have earned a minimum return. Read more in our deep dive into carried interest.
• Fund expenses: legal, audit, administration and broken-deal costs charged to the fund on top of the management fee.

Rates are moving down. Preqin data reported by CNBC in January 2026 shows the average buyout fee at 1.61%. Funds over $1bn pulled the average down, while middle-market and smaller funds still charged closer to 2%.

How the management fee works

The rate is only half the calculation. The fee base, the amount the rate is applied to, changes over the life of the fund.

1. Investment period (usually years 1 to 5): the fee is charged on committed capital, so LPs pay on money the fund has not yet invested.
2. After the investment period: the fee usually steps down, either to a lower rate or to a smaller base such as net invested capital (cost of investments not yet sold).
3. Term extensions: ILPA, the LP trade body, recommends lower fees during extensions and no fees after the fund’s original term ends.

Some funds also charge a catch-up management fee to LPs who join at a later closing. Our guide to catch-up management fees explains how that works.

How carried interest and the waterfall work

Carry is paid through the distribution waterfall, the order in which cash from exits is split. A standard European (whole-of-fund) waterfall has four steps:

1. Return of capital: 100% to LPs until they get back everything they contributed, including fees and expenses.
2. Preferred return: 100% to LPs until they earn the hurdle, usually 8% a year.
3. Catch-up: 100% (or 80%) to the GP until the GP has received 20% of all profits paid out so far.
4. Carried interest split: 80% to LPs and 20% to the GP for everything after that.

In an American (deal-by-deal) waterfall, carry is calculated on each exit. The GP gets paid earlier, which is why LPs insist on a clawback, the GP’s obligation to return carry if later deals lose money. ILPA calls whole-of-fund “best practice” and recommends an escrow of at least 30% of carry under deal-by-deal structures. See our guide to the distribution waterfall for more detail.

Worked example: a $1bn buyout fund

Illustrative example. Assumptions:

• Fund size: $1,000m of commitments
• Management fee: 2% on commitments for five years, then 1.5% on $600m of net invested capital for five years
• Total distributions over the fund’s life: $1,800m
• Preferred return owed to LPs at exit: $300m
• Carry: 20% with a 100% GP catch-up, whole-of-fund waterfall

Management fees:

• Years 1 to 5 = 2% x $1,000m x 5 = $100m
• Years 6 to 10 = 1.5% x $600m x 5 = $45m
• Total fees = $100m + $45m = $145m

Waterfall, assuming LPs contributed the full $1,000m:

• Step 1, return of capital to LPs = $1,000m
• Step 2, preferred return to LPs = $300m
• Step 3, GP catch-up: GP needs 20% of profits paid so far, so C = 20% x ($300m + C), which gives C = $75m
• Remaining cash = $1,800m – $1,000m – $300m – $75m = $425m
• Step 4, split: LPs 80% x $425m = $340m, GP 20% x $425m = $85m
• Total carry = $75m + $85m = $160m, which is 20% of the $800m profit
• LP proceeds = $1,000m + $300m + $340m = $1,640m, or 1.64x net

The fund made 1.8x gross. LPs received 1.64x after carry, and the $145m of fees already sat inside their contributions. That gap is the difference between gross and net returns.

Private equity fee structure terms to check

Two funds with the same 2 and 20 headline can cost LPs very different amounts. Check these points in the limited partnership agreement (LPA):

• Fee offsets: transaction, monitoring and director fees charged to portfolio companies. ILPA says they should be 100% offset against the management fee. A 50% offset means the GP keeps half as extra income.
• Fund expenses: ILPA says the GP should pay its own overhead, salaries and most travel from the management fee. Watch for technology, compliance and operating partner costs charged to the fund instead.
• Organisational costs: these should be capped, with any excess offset against the management fee.
• Hurdle type: a hard hurdle pays carry only on profits above the hurdle. A hurdle with a full catch-up gives the GP 20% of all profits once it is cleared, as in the example above.
• Clawback security: ask whether there is an escrow, an interim clawback test and a creditworthy guarantee from the GP’s members. Our post on GP clawback escrows covers this.

How carried interest is taxed

Tax depends on where the GP’s team is based.

• United States: under Section 1061 of the tax code, carry qualifies for long-term capital gains rates only if the underlying asset was held for more than three years.
• United Kingdom: carry was taxed at a 32% capital gains rate from April 2025. From 6 April 2026, qualifying carry sits within income tax and only 72.5% of it is taxed, according to HM Treasury. Osborne Clarke puts the effective rate at about 34.1% for additional rate taxpayers.

Management fees are taxed as ordinary income of the manager in both countries.

FAQ

What is the 2 and 20 fee structure?

2 and 20 means a 2% annual management fee on committed capital and 20% carried interest on profits. Carry is usually paid only after LPs receive their capital back plus an 8% preferred return. Many funds now charge less than 2%, and the buyout average was 1.61% in 2025, according to Preqin.

Is the management fee charged on committed or invested capital?

Usually on committed capital during the investment period and on net invested capital afterwards. This step-down means LPs pay less once the fund stops making new investments. Some funds instead cut the rate, for example from 2% to 1.5%, and keep the same base.

What is a hurdle rate in private equity?

The hurdle rate, or preferred return, is the minimum annual return LPs must receive before the GP earns carry. It is usually 8%, compounded. Once it is cleared, a catch-up provision normally lets the GP receive enough distributions to reach its full 20% share of profits.

Do LPs pay transaction and monitoring fees?

Portfolio companies pay them, which reduces the value of the LPs’ investments. That is why LPs negotiate offsets against the management fee. ILPA recommends a 100% offset against the management fee.

Conclusion

The private equity fee structure combines a management fee of about 1.5% to 2% with 20% carried interest above an 8% hurdle. The real cost to LPs depends on the fee base, offsets, expenses and waterfall type. When you review a fund, model the waterfall with real numbers, as in the example above, before you rely on the headline 2 and 20.

P.S. To model fees, carry and the waterfall across a portfolio of funds, try the Fund of Funds Financial Model. Our Premium Resources have more tools you may find useful, and the Private Equity Bros newsletter sends weekly finance updates and the latest financial reports.

Sources

• Private Equity Management Fees Hit New Low in 2025
• Overview of ILPA Principles 3.0 and Model LPA
• The Tax Treatment of Carried Interest: Government Response and Policy Update (June 2025)
• What fund managers need to know about the UK’s new carried interest tax regime