Resources / Glossary / Hurdle rate

Hurdle rate.

Aka. Preferred return · the hurdle · pref
All terms

What is a hurdle rate?

A hurdle rate is the return threshold a fund must clear before its general partner is entitled to share in profits. Until limited partners have earned at least this rate on their contributed capital, the GP's carried interest is zero. In private equity the convention sits around 8% per year, compounding.

The hurdle is the gatekeeper of carry. It exists to ensure the GP is rewarded for genuine outperformance, not for returns an investor could have earned passively. A manager who merely delivers the hurdle has, in effect, given LPs a baseline return and earned nothing extra for itself.

In practice "hurdle rate" and "preferred return" are used almost interchangeably, though purists distinguish them: the preferred return is the dollar amount LPs are owed first, while the hurdle is the rate that defines that amount. Both describe the same gate.

How the hurdle works in the waterfall

The hurdle sits in the middle of a fund's distribution waterfall, between the return of capital and the GP's profit share.

  1. Return of capital. LPs first get back every dollar they contributed.
  2. Preferred return (the hurdle). LPs then receive a compounding return — around 8% — on that contributed capital. Only once this is satisfied does the GP become eligible for carry.
  3. GP catch-up. Most funds then give the GP a catch-up tranche, letting it collect a disproportionate share until its carry equals its full percentage of all profits, hurdle included.
  4. Carry split. Remaining profits are divided on the carry ratio, typically 80/20.

A critical distinction is whether the hurdle is a hard or soft hurdle. With a hard hurdle, the GP only ever earns carry on returns above the hurdle rate. With a soft hurdle — the more common arrangement — clearing the hurdle triggers a catch-up that lets the GP earn carry on the entire profit, including the portion below the hurdle. The difference materially changes the split on a marginal fund.

Why the hurdle level is negotiated

The hurdle rate is a central term in any LPA negotiation because it directly trades off LP protection against GP incentive. A higher hurdle protects investors but raises the bar a manager must clear before getting paid; a lower or absent hurdle is more GP-friendly.

Context matters. In a low-interest-rate environment, an 8% compounding hurdle is a high bar; in a higher-rate world it looks more modest relative to what cash earns. Strong managers with persistent track records sometimes negotiate lower hurdles, or none, on the argument that their skill — not a fixed threshold — should define their compensation. Venture funds frequently have no hurdle at all, while buyout and credit funds usually do.

Frequently asked.

5 questions
01 Is the hurdle rate the same as the preferred return?

In everyday use, yes — practitioners use the terms interchangeably to describe the return LPs must receive before the GP earns carry. Strictly, the preferred return is the dollar amount owed to LPs first, and the hurdle rate is the percentage that determines that amount.

The practical takeaway is identical: profits flow to the GP only after LPs have been credited their preferred return at the hurdle rate.

02 What's the difference between a hard and a soft hurdle?

With a hard hurdle, the GP earns carry only on the profit that exceeds the hurdle rate — the return up to the hurdle belongs entirely to LPs. With a soft hurdle, once the fund clears the hurdle a catch-up provision lets the GP earn carry on the full profit, including the portion below the hurdle.

Soft hurdles are the more common market structure. The distinction can meaningfully change the GP's take on a fund whose returns land just above the threshold.

03 Why is the hurdle conventionally set at around 8%?

The roughly 8% figure is a long-standing market convention rather than a derived number. It loosely reflects a reasonable baseline return that investors feel they should earn before paying a manager for outperformance, and it has stuck as a default across much of the buyout and credit world.

It is not universal — the appropriate level depends on the strategy and the interest-rate environment, and it is always a point of negotiation between GP and LPs.

04 Do all funds have a hurdle rate?

No. Buyout, credit, and many real-asset funds typically include one, but venture capital funds often do not, on the logic that a hurdle is less meaningful for a strategy built on a few outsized winners. Some elite managers across strategies also negotiate away the hurdle entirely.

Whether a hurdle exists, and at what level, is one of the clearest signals of the balance of power between a manager and its investors.

05 How is hurdle clearance tracked over a fund's life?

The hurdle is a moving target: it compounds on contributed capital, so every capital call and every distribution changes the threshold and the GP's eligibility for carry. Determining whether the hurdle has actually been cleared at any moment requires tying each cash flow back to the waterfall terms in the LPA.

When the fund's cash-flow history and the LPA's waterfall logic live in one queryable layer, hurdle clearance and carry eligibility can be verified continuously rather than reconstructed at each reporting cycle.

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