The market's buyout billionaires

That may soon change. A bill sponsored by Democratic Sen. Max Baucus of Montana and Republican Sen. Chuck Grassley of Iowa would force investment shops that go public to be taxed like regular companies. That would mean payouts to executives would be taxed like ordinary income. But the change wouldn't affect Blackstone until 2013, says the company, because it has already filed to go public.

Juicy management fees

The top managers at the big private-equity shops pull in the big bucks for two reasons: First, they typically take 20% of any profits the companies' investments generate, after earning 8% for investors, plus an annual fee of 2% of assets under management. Second, that 20% cut has been adding up to a lot of money because these managers have been getting great returns.

Private-equity shops typically invest by borrowing lots of money to buy an ailing or undervalued company. Then they fix it up and sell it for large gains. Blackstone's private-equity investments are up 30.7% a year since 1987, or 22.6% after management fees. Its real-estate investments are up 39.7% a year since 1992, 31% a year after fees.

Blackstone isn't the only private-equity shop where results like these translate into big bucks for top executives:

• Execs get sweet pay at Fortress Investment Group (FIG, news, msgs), a leveraged-buyout and hedge-fund shop that went public in February. The company's five principals -- Wesley Edens, Peter Briger, Robert Kauffman, Randal Nardone and Michael Novogratz -- got between $66 million and $104 million each in distributions last year.

• Executive pay at the other major private investment shops -- such as Kohlberg Kravis Roberts, Texas Pacific Group and the Carlyle Group -- is equally stratospheric, says Simon Francis, a partner at CTPartners, an executive search firm that helps private-equity shops find talent.

• The top managers at the biggest private hedge funds, like Edward Lampert at ESL Investments and George Soros at Soros Fund Management, all made around $1 billion or more last year, according to Alpha magazine.

Top hedge funds, 2006 pay

Lead manager	Hedge fund	2006 pay
James Simons	Renaissance Technologies	$1.7 billion
Kenneth Griffin	Citadel Investment Group	$1.4 billion
Edward Lampert	ESL Investments	$1.3 billion
George Soros	Soros Fund Management	$950 million
Steven Cohen	SAC Capital Advisors	$900 million
Source: Alpha magazine

Critics such as the AFL-CIO's Pedrotty denounce these rich pay levels because they reinforce how "fundamentally un-level the playing field is in this country." He cites a New York Times analysis that concluded the $14 billion earned by the top 25 hedge-fund managers last year would have been enough to pay New York City's 80,000 public-school teachers for nearly three years.

Ferlauto, of the public-employees union, believes these huge payouts in the private-equity space contribute to upward pressure on CEOs at public companies. "It distorts pay throughout the market," he says.

To the defense

The companies themselves decline to comment, other than to write in filings that the lucrative pay structure makes sense because it makes top managers work harder for investors -- and that they donate hundreds of millions of dollars to charity.

Blackstone plans to donate $150 million raised in the IPO to the Blackstone Charitable Foundation. Peterson, Blackstone's chairman, intends to donate to charity a "substantial" amount of the $1.9 billion he'll get out of the IPO.

Many observers are quick to defend the rich pay levels with the following points:

• Money managers like the ones at the top at Blackstone are justly rewarded for doing a great job. "It's hard to criticize them because they have built such a great business," says Phil Stiller, an analyst who is reviewing the Blackstone IPO at IPO Home.

• The big money paid to executives at private-equity shops is just coming out of the pockets of other rich people because you have to be a high-net worth individual to invest in these funds, points out Bill Coleman, the chief compensation officer at Salary.com.

• The execs are taking on big risks to make their profits. They put a lot of their own money in these funds. Top execs at Blackstone have invested more than $2.7 billion into the shop's funds since it was founded in 1985. But they also make highly leveraged bets, borrowing lots of money to buy targets. If an investment fails, private-equity companies are left holding the bag on a huge amount of debt. "It's not an easy business," says Michael Gray, the chairman of the Fund Formation & Investment Management Practice Group at the law firm Neal, Gerber & Eisenberg in Chicago. "There are a lot of people in this field who go out of business. I've done a lot of workouts."

Indeed, many wonder whether the fact that partners at Blackstone are now cashing out by selling their companies to public shareholders is a signal that the private-equity party is over.

"On a historical basis, the valuations that are being paid for companies and the leverage they are putting on are high," Gray says.

Plus, most of the good bargains out there may have already been picked over. "Duplicating the kinds of returns that have been achieved will not be as easy to do," Gray adds.

Just don't feel too sorry for Schwarzman if the juicy investment returns vanish and his annual 20% dwindles. Sure, his base salary is a mere $350,000 a year, but given all the money he has raked in over the years, he's probably banked billions.

At the time of publication, Michael Brush did not own or control any shares of companies mentioned in this column.

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