Hurdle Rate

What Is a Hurdle Rate?

A hurdle rate — also called a preferred return — is the minimum annual return that a private equity fund must deliver to its limited partners (LPs) before the general partner (GP) begins receiving carried interest (Investopedia). The hurdle rate ensures that the GP only shares in profits after LPs have earned a baseline return on their capital.

The standard hurdle rate in private equity is 8% per annum, compounded annually. This convention has been remarkably stable over decades, though some funds — particularly those with strong track records — negotiate different terms.

How the Hurdle Rate Works

The hurdle rate operates within the fund’s waterfall distribution structure:

1. Return of capital — LPs receive their invested capital back first
2. Preferred return (hurdle) — LPs receive an 8% annual return on their capital
3. GP catch-up — the GP receives a disproportionate share of subsequent distributions until it has received its carried interest percentage (typically 20%) of total profits to date
4. Carried interest split — remaining profits are split 80/20 between LPs and the GP

Example

A fund invests $100M. After 5 years, it exits with total proceeds of $200M.

• Step 1: LPs receive $100M (return of capital)
• Step 2: LPs receive $46.9M (8% compounded annually for 5 years)
• Step 3: GP catches up — receives distributions until it has 20% of total profit ($20M in this case, with $53.1M remaining after hurdle)
• Step 4: Remaining profit split 80/20

Without the hurdle, the GP would earn carry on the first dollar of profit. The hurdle ensures LPs reach a meaningful return threshold first.

Hard Hurdle vs Soft Hurdle

Hard Hurdle

The GP only earns carry on returns above the hurdle rate. If the fund returns 10% and the hurdle is 8%, carry is calculated only on the 2% excess return. This is less common in practice.

Soft Hurdle (with Catch-Up)

Once the hurdle is met, the GP “catches up” — receiving a disproportionate share of the next tranche of profits until total carry equals the agreed percentage (usually 20%) of all profits from dollar one. This is the standard structure in most PE funds and is more favourable to the GP.

The distinction matters significantly for GP economics. A soft hurdle with full catch-up means the GP ultimately receives 20% of all profits once the hurdle is cleared — the hurdle determines when carry is paid, not how much (Corporate Finance Institute).

Hurdle Rate in M&A Context

The hurdle rate directly influences private equity deal behaviour:

• Maximum bid price — PE buyers back into the price they can pay while achieving their target IRR (which must exceed the hurdle rate). A fund with an 8% hurdle effectively has a 20%+ IRR floor for most investments (since LPs expect more than just the hurdle)
• Leverage decisions — higher leverage amplifies equity returns, helping clear the hurdle with a lower purchase multiple
• Hold period — shorter hold periods are preferred because the hurdle compounds annually; longer holds require higher total returns
• Exit timing — GPs may be incentivised to exit early if returns are front-loaded, or to delay if more growth is achievable

Hurdle Rate vs Discount Rate

The hurdle rate should not be confused with the WACC or discount rate used in DCF analysis. The hurdle rate is a contractual threshold in a fund’s partnership agreement. The discount rate (WACC) is a financial metric used to value cash flows. While both represent required returns, they serve different purposes and are set through different mechanisms.

Hurdle Rates in Asia Pacific

Hurdle rate conventions in Asia Pacific private equity generally follow global standards — 8% is the norm for most regional funds. However, some APAC-focused funds denominated in local currencies may adjust their hurdle rate to reflect higher risk-free rates in emerging markets. Private equity firms in Singapore and other regional hubs typically use the same 8% hurdle / 20% carry structure as their global counterparts. AI-native platforms like Amafi help PE firms identify investments that can generate returns above their hurdle rate by sourcing high-quality deal flow across Asia Pacific markets.