Henry Kravis, Co-founder of private equity firm Kohlberg Kravis Roberts & Co (KKR) sat down for a wide ranging interview with Bloomberg's Jason Kelly.
We encourage readers to read the full interview (here), however one item that caught our attention was that in explaining how KKR came into existence, Kravis also enlightened readers on how the "20" came to be in the 2-and-20 compensation model that is the industry standard today.
JK Take me back to 1976. How did the whole KKR experiment begin?
HK We started with $120,000. George and I each put up $10,000—that was all we had—and Jerry put up $100,000, because he was 20 years older. And then we went out to raise our first fund, a $25 million private equity fund. There was no such thing then, but the first people we talked with—mostly insurance companies we’d worked with at Bear—all liked what they heard. But the catch was they wanted to be the investment committee. Well, we’d just done that and had left Bear for a reason: to make our own mistakes and our own right decisions.
JK So no $25 million fund. What did you do?
HK George and I went to Joe and Rose Restaurant—there’s a picture of it right over there—and said, “Why don’t we go to eight individuals and ask them to put up $50,000 each for 5 years?” That would give us $400,000 a year. Then, if you’ve given us $50,000, in return you get the ability to come into any of our deals. But if you do invest, we want 20 percent of the profits.
JK How did you come up with 20 percent, which became the industry standard?
HK George’s father and my father were in the oil-and-gas business, and in those days there was something called “a third for a quarter.” If I had a lease and wanted to drill a well, I would go to the money person and say, “I’ll put up 25 percent of the cost, you put up 75 percent, and you’re going to get a two-thirds interest and I’m going to get a one-third interest for my 25 percent.” We thought 20 is close enough to 25. I’m often asked, “Why didn’t you pick 25 percent because that would have stuck and carried interest?” We were just trying to get started, so that was literally what we started from.
Interestingly, sometimes there are no complex mathematical formulas or deep thoughts for how things come to be, on occasion, it really is just that simple.
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