The "hurdle rate" or "preferred return" is
the rate of return that a private fund guarantees to deliver to its
investors before the manager becomes entitled to share in the
fund's profits via its carried interest.
Historically set at 8% compounded annually, it has been a
standard feature of private fund economics since the industry's
earliest days. But in the current fundraising boom hurdle rates
have come under sustained downward pressure from a number of major
private equity firms launching new funds. Will the hurdle
survive?
Why have a hurdle?
The hurdle rate helps to aligns the economic interests of the GP
and LPs. Because the fund has to channel its initial profits
entirely to the LPs before the GP can collect carried interest, it
motivates the managers to devote their effort to finding good
deals. Conversely, if the fund fails to vault the hurdle, the team
won't see any carry.
