Hurdle Rate

A hurdle rate (also called a preferred return) is a minimum threshold return, commonly 8% annually in venture and private equity, that LPs must receive before the GP is entitled to any carried interest. It's meant to ensure GPs only get paid performance compensation once LPs have earned a baseline return on their capital.

Hurdle rates are more common and more strictly enforced in buyout and private equity funds than in venture capital, where many funds — particularly at the earlier stages — forgo a hurdle entirely given the difficulty of predicting venture-style outlier returns and the long time horizon before any distributions occur.

A hurdle changes what the GP is incentivized to maximize. Without one, a GP earning carry on any profit cares only about the multiple, however long it takes. With a hurdle, time becomes money: a 2x return in four years clears the bar easily, while the same 2x stretched over twelve years may leave little or nothing for carry.

The hurdle is a threshold for GP compensation, not a guaranteed return to LPs. If a fund returns 1.2x over ten years, LPs simply get their money back plus whatever profit exists — nobody tops them up. The hurdle only decides how profits are split when profits exist.

Two details in the LPA change the economics: whether the hurdle compounds or accrues as simple interest, and whether a GP catch-up follows it. In a catch-up tier, the GP receives a disproportionate share of distributions — often all of them — until it has its full carry percentage of total profits. Catch-ups at less than 100% also exist and are friendlier to LPs.