Hurdle Rate (Preferred Return)

Quick Definition

The minimum return a fund must deliver to LPs before GPs can take their share of carried interest.

What is a Hurdle Rate?

The hurdle rate (also called preferred return) is the minimum annualized return a fund must deliver to its LPs before the GP can start collecting carried interest. The standard hurdle rate in venture capital is 8%.

It's a performance floor. GPs don't earn carry until LPs get their money back plus the hurdle return.

Why the Hurdle Rate Exists

LPs need a reason to lock up capital in illiquid venture funds for 10+ years instead of parking it in public markets. The hurdle rate ensures GPs only share in profits after delivering returns that justify the risk and illiquidity.

How the Hurdle Rate Works

Two common structures:

Hard hurdle: GPs only earn carry on returns above the hurdle. If the hurdle is 8% and the fund returns 12%, carry applies only to the 4% excess.

Soft hurdle with catch-up: Once the hurdle is cleared, GPs receive a "catch-up" on all profits (not just the excess) until they've received their full carry percentage. Most VC funds use this structure.

Formula

• Hurdle Amount = Committed Capital x Hurdle Rate x Years
• GP Carry Threshold = Committed Capital + Hurdle Amount
• Carry begins after fund distributions exceed GP Carry Threshold

Example:

• $100M fund, 8% hurdle, 5-year hold
• Hurdle amount: $100M x 8% x 5 = $40M
• LPs must receive $140M before GP earns carry
• Fund returns $200M total
• GP carry (20%): applied to $60M above threshold = $12M (hard hurdle)
• Or with catch-up: 20% of full $100M profit = $20M (soft hurdle)

Example

$50M fund with 8% annual hurdle rate. After 4 years, the fund has $90M in realized returns.

• Capital returned: $50M (1x)
• Hurdle: $50M x 8% x 4 = $16M
• LP threshold: $66M
• Profits above threshold: $24M
• GP carry (20% with catch-up): $8M (20% of total $40M profit)

Without the hurdle, GP would earn carry on the full $40M profit from dollar one. The hurdle ensures LPs get a baseline return first.