Hurdle Rate
Also known as Preferred Return, Pref, Hurdle, Preferred Rate
A hurdle rate is the minimum annual return LPs must receive before the GP earns carried interest. The market standard is 8% IRR, compounded annually on contributed capital, applied across roughly two-thirds of private equity and venture funds.
Formula
Preferred Return = Σ (Capital Contribution_i × Hurdle Rate × Time Outstanding_i)- Capital Contribution_i
- Each LP capital call dollar
- Hurdle Rate
- Negotiated rate, typically 8% per annum, often compounded
- Time Outstanding_i
- Days each contribution has been at risk, since the date drawn down
In depth
The hurdle is a gate, not a guarantee. LPs do not earn 8% by signing the LPA; they earn 8% only if the fund generates it. What the hurdle does is decide where the GP starts collecting carry. Distributions flow to LPs first to return committed capital, then to pay the accrued preferred return at the hurdle rate. Only after both are satisfied does the GP begin earning a carry share, either through a catch-up tier or directly through the 80/20 split.
The hurdle is most consequential on funds that end near 1.5x to 2.0x. A 3x fund clears any reasonable hurdle and pays the GP its full 20%. A 1.2x fund fails any hurdle and pays the GP zero carry. In the middle, the structure of the hurdle (compounded vs. simple, soft vs. hard, with or without catch-up) can swing GP carry by tens of millions on a mid-sized fund.
Why it matters
The hurdle disciplines GP behavior. Without a hurdle, every dollar of profit is shared, which means a GP can produce 5% returns and still earn carry, undermining the asymmetric-bet logic that justifies the 2/20 structure. With an 8% hurdle, the GP earns nothing on mediocre outcomes and is forced to underwrite for material outperformance. LPs view a hurdle-free fund the way a bank views an interest-free loan: technically possible, structurally suspicious.
Worked example
$100M fund, 8% compounded annual hurdle, 20% carry, full GP catch-up. Fund returns $180M after 8 years, with capital deployed evenly years 1-4.
Average capital outstanding: ~$100M for 8 years
Preferred return owed: $100M × (1.08^8 − 1) = $100M × 0.851 = ~$85.1M
Capital + pref owed to LPs: $100M + $85.1M = $185.1M
Distributions ($180M) fall short of the $185.1M LP entitlement. The GP earns zero carry. If the fund had returned $220M, LPs would receive the first $185.1M, the GP would catch up by collecting the next ~$21.3M (20% of profits to date), and the remaining $13.6M would split 80/20, for a total GP carry of approximately $24M.
Frequently asked
What is the standard hurdle rate in venture capital?
8% IRR compounded annually on contributed capital, used by roughly 67% of funds per ILPA market research. Some venture funds use a lower or zero hurdle on the argument that venture's risk profile and J-curve make an 8% pref unrealistic; LPs increasingly push back on hurdle-free terms.
What is the difference between a hard hurdle and a soft hurdle?
Soft hurdle: once the hurdle is cleared, the GP catches up to its agreed share of all profits, including profits below the hurdle. Hard hurdle: the GP only earns carry on profits above the hurdle, with no catch-up. Hard hurdles are LP-friendly and rare in venture.
Is the hurdle compounded or simple?
Compounded annually in the strong majority of funds, per ILPA data. Compounding matters: 8% compounded over 10 years is 1.16x cumulative versus 1.08x simple, which means the GP catches up to a higher number before sharing in profits.
When does the hurdle clock start?
The ILPA Model LPA starts the clock on each capital contribution from the date it is drawn down from LPs, not from the date the fund invests it. This favors LPs because it captures the time capital is sitting in the fund pre-investment.
What happens to the hurdle if the fund underperforms?
Below-hurdle returns mean the GP receives no carry at all. The hurdle does not reset or reduce; LPs simply collect 100% of distributions until contributed capital plus the pref is paid out, and the GP earns only management fees over the fund's life.