Glossary · Fund economics

What is a hurdle rate?

A hurdle rate, or preferred return, is the minimum yearly return, often 8%, that investors must receive before the manager can start earning carried interest.

In practice

The hurdle sits in the LPA’s distribution waterfall and usually compounds annually on contributed capital from the date each capital call is funded. It is not a guarantee: a fund that never clears it simply pays no carry. With a catch-up, the manager then takes most of the next distributions until it holds its full share of the profit; without one, carry is paid only on the profit above the hurdle.

An example

Round numbers, not a real fund

Say a fund has an 8% hurdle and returns 6% a year. The manager earns no carry. Only returns above the hurdle start paying it.

Why it matters

It stops a manager collecting performance fees on returns investors could have had from something safer.

A definition, not advice; where usage varies the entry says so. Something wrong? Tell the desk.

Related terms

GP catch-upThe catch-up is the part of a fund’s waterfall, after the hurdle, where the manager takes most or all distributions until it holds its full share of the profit.
Carried interestCarried interest is the share of a fund’s profits, typically 20%, that the manager earns after investors get their money back and clear the preferred return.
Distribution waterfallA distribution waterfall is the order a fund pays out proceeds: investors’ capital, then the preferred return, then the manager’s catch-up, then the split of what remains.
LPAThe limited partnership agreement, or LPA, is a private fund’s main contract. It sets the fees, carry, investment limits and the rights of the manager and the investors.
IRRIRR, internal rate of return, is the yearly return that accounts for when money goes into and comes out of a fund, so earlier payouts raise it.

The terms, in the news each morning.

FundOps Daily carries the day’s fund closes, deals and moves across private markets. Free, seven days a week.