Private equity firms buy and sell other businesses. The industry can be roughly divided into two parts: venture capital and buyout funds. Venture capitalists invest in small, startup firms, providing financing and management expertise. Their payoff usually comes when the firms are sold, either by selling shares into the public stock market through an initial public offering (IPO), or by an outright sale to a larger company. Buyout funds acquire ownership stakes in businesses of all sizes. The best-known form of buyout transaction is the leveraged buyout (LBO). In an LBO, an existing publically traded company is purchased using a combination of equity and debt and then taken private. For example, in the proposed $24.4 billion LBO of Dell Computers by a group headed by Dell founder and CEO Michael Dell a consortium of banks is being used to fund the debt portion of the proposed deal. If the LBO is completed the company will stop being traded on a public stock exchange (go private). The LBO deal can be very lucrative for the private equity investors: they receive a premium above the going market price for their stake in the target, and at the end of the transaction they own the entire target company, even though they have sold their shares. After completion of the LBO, as owners of a private corporation, they can pay themselves fees, salaries, and dividends without having to answer to public shareholders or Wall Street analysts. An increasingly common practice is to issue debt and use the proceeds to pay a special dividend to the shareholders—who are the private equity investors themselves. At the end of the process, usually several years after the acquisition, the company is resold, either to public investors through an IPO (in this case called a "reverse LBO"), or to another firm. Hedge funds trade in all financial markets, employing a very broad range of investment strategies. Some take simple speculative positions on the direction of prices of financial assets—stocks, bonds, commodities, currencies, etc.—while others construct very complex portfolios based on price relationships across asset classes and across markets, designed to produce positive returns whatever the direction of prices in the underlying markets. Some funds follow high risk strategies; others are quite conservative. Hedge fund trading is not always based on short-term strategies, but in general their investment horizons are shorter than those of private equity funds, whose holding periods average 6 to 10 years. The line between private equity and hedge funds is often blurred. A significant subset of hedge funds, called "activist" funds, also operates in the corporate takeover market. Such funds typically buy a stake in a public company and then pressure the target firm to make changes in operations (such as spinning off underperforming units or assets), governance (e.g., replacing top executives or appointing a hedge fund designee to the board of directors), or financial structure (announcing a stock buyback or a special dividend) that will boost the share price. If these efforts do not succeed in the short term, the funds may hold on to their investments for years, in essence replicating the strategy of value investors like Warren Buffett. Between 2000 and 2007, both private equity and hedge funds grew rapidly in size and number, because of a number of factors that some call a "perfect storm." When the bull market ended in 2000 and interest rates fell, institutional investors such as pension funds and foundations turned to "alternative" investments to make up for low yields in traditional asset classes. Hedge funds and private equity were the primary beneficiaries of this shift. Falling share prices and the availability of low-cost debt capital created an unusually favorable situation for private equity funds: they could borrow to finance acquisitions at relatively low cost, and expect to sell into a recovering stock market. Private equity and hedge fund performance, however, has not been immune to the economic turmoil which began in 2008. Hedge funds ended 2008 and 2011 with negative aggregate returns for the first times on record (since 2000). Similarly, private equity returns are forecast significantly below historical levels through 2014. While there are no official or comprehensive statistics on the size of either industry, an often cited estimate is that there are now over 9,000 hedge funds, with over $2.2 trillion in investor funds under management. A decade ago, the comparable estimates were 2,500 funds and $200 billion in capital. In private equity, firms have raised more than $1 trillion in the past decade, with about $200 billion-$250 billion in 2006 alone. In 2012, LBOs accounted for 9% of the dollar value of all corporate mergers, up from about 2% in the late 1990s but within the range of 3% to 29% observed in the past 10 years. In short, private equity and hedge funds, once marginal players, now exert what could be characterized as significant influence in the markets where they operate. As a result, how those who operate in this industry are taxed, relative to other participants in this industry and the general public, has come under increased congressional scrutiny. While private equity firms and hedge funds may differ in their investment strategies, their structures are similar. Nearly all are organized as partnerships, which means that their earnings are not taxed at the firm level. Most partnerships are simply straightforward conduits of taxable income or loss and tax attributes to the individual partners. They can, however, also be used to manipulate the allocation of tax attributes and to shelter income and assets from taxation as a result of the allocation of tax attributes. There are two kinds of partners. The fund managers, who guide the investment strategy, are general partners. Their background typically includes experience at a Wall Street investment bank, although two former Secretaries of the Treasury and a former Securities and Exchange Commission (SEC) chairman now run hedge funds. The general partners often invest their own capital in the funds, but this is usually a small share of the total managed by the fund. Outside investors, who contribute capital but have no say in investment or management decisions, are the limited partners. They are generally institutional investors—public and corporate pension funds, insurance companies, foundations, and endowments—or individual investors with significant amounts of resources. In contrast to the general partners, the contributions of limited partners is usually a large share of the total managed by the fund. Hedge funds typically establish multiple funds to accommodate the tax planning preferences of different investors. While they generally share a common pool of underlying assets, they are chartered in different jurisdictions to cater to different clientele. By one estimate, nearly 11,000 hedge funds, or about 80% of the total, are registered in the Cayman Islands as well as their home country. Foreign investors and U.S. tax-exempt institutions may prefer to invest in foreign-chartered funds, while other types of U.S. investors find it disadvantageous to invest in foreign funds. Small public investors are generally not able to invest in hedge funds, because they lack either the assets or income. Under U.S. law, the sale of shares, or interests, in an investment partnership constitutes an offering of securities, and must be registered with the SEC if the offering is public. In order to avoid registration, and the associated disclosure requirements, most funds rely on exemptions in the securities laws that allow them to make unregulated "private" offerings. In order to qualify for these exemptions, prospective limited partners must meet various income and asset thresholds. (The most basic is the "accredited investor" standard—income of $200,000 or more in the past two years and at least $1 million in assets.) Recently, a number of hedge funds and private equity partnerships have gone public, by selling shares (or units) in an IPO. Their securities are now traded on the New York Stock Exchange and other major markets, and may be purchased by anyone. These firms, which include the Fortress Investment Group and Blackstone, will operate much as before, but will be required to file quarterly and annual financial statements and make the full range of disclosures required by the SEC. When the funds' investments yield a positive return, both limited and general partners receive income, as the value of their share of the fund increases. This income, as mentioned above, is not taxed at the partnership level; only the individual partners pay taxes, usually at the capital gains rate. In addition, the general partners receive compensation from the limited partners. Compensation structures may vary from fund to fund, but the standard pay formula is called "2 and 20." That is, fund managers take 2% of the fund's assets each year as a management fee, and 20% of the total profits as a kind of performance bonus. The percentage-of-assets management fee is usually paid in cash and is taxed at ordinary income rates. The 20% performance fee is sometimes paid in cash, and sometimes credited to the manager's account. Because the amount is often carried over from year to year until a cash payment is made, usually following the closing out of an investment, it is called "carried interest." The carried interest is taxed at the capital gains rate (20%) which is currently below the top ordinary income tax rate (39.6%). Given the fact that these funds are private, no comprehensive figures on managers' compensation are available, although a number of consultants and trade groups do publish estimates. According to Alpha magazine, the top 25 hedge fund managers earned $14.4 billion in 2012, down from more than $22 billion in 2010. Comparable annual lists are not published for private equity managers, probably because cash distributions occur less frequently than in hedge funds, and there is greater year-to-year variation. One estimate is that managers earned $45 billion over the past six years. Congressional proposals have evolved since the 110 th Congress from the full taxation of carried interest as ordinary income to more nuanced approaches that account for "enterprise value" and tax carried interest at some blend of the capital gains and ordinary income tax rates.