--- title: "Hurdle Rate | Altss Glossary" description: "A hurdle rate is the minimum rate of return an investment or fund must achieve before a performance-based payment starts; in private funds, the threshold,…" canonical: "https://altss.com/glossary/hurdle-rate" --- Glossary · Fund economics # Hurdle Rate In private funds the hurdle rate is the return threshold before carried interest is paid; in hedge funds and credit vehicles it is the rate or benchmark a fund must beat before charging an incentive fee; in corporate finance it is the minimum return a company requires before approving a project. A hurdle rate is the minimum rate of return an investment or fund must achieve before a performance-based payment starts; in private funds, the threshold, commonly 8% a year, that LP capital must earn before carried interest is paid. Publisher: Altss LLCPublished 2025-12-29Content modified 2026-10-01 ALTSS-ECON-007 Any performance payment needs a starting line, and the hurdle is that line expressed as a rate of return. What happens once it is crossed depends on the hurdle type. With a soft hurdle the manager catches up and receives its full share of all profit; with a hard hurdle it shares only in returns above the line. ## Formula ### Carry under a hard and a soft hurdle (one contribution, full catch-up for the soft case) ``` Hard: C = c × max(0, Π − H). Soft: C = max(0, min(c × Π, Π − H)). ``` `Π` profit: distributions minus contributed capital `H` hurdle amount: the return on contributed capital at the hurdle rate, e.g. K × ((1 + h)^τ − 1) `c` carry or incentive rate The soft formula assumes a 100% catch-up; a partial catch-up gives a result between the two lines until it completes. "Hard hurdle" is most often used for a hurdle with no catch-up, but the terms are applied loosely, so read the waterfall rather than the label. Calculator ## Whole-fund waterfall calculator One contribution at the start and one distribution after the holding period. Tiers: return of capital, preferred return, GP catch-up, then the carry split. Set catch-up to 0 for no catch-up. Real LPAs add fees, expenses, multiple cash flows and clawback; this shows the mechanics only. Capital contributedTotal distributableYears heldPreferred return (%)Carried interest (%)GP catch-up share (%)Preferred return basisCompounded annuallySimple Waterfall allocation by tier | Tier | LPs | GP | | --- | --- | --- | | 1. Return of capital | 100 | 0 | | 2. Preferred return | 46.93 | 0 | | 3. Catch-up | 0 | 11.73 | | 4. Carried-interest split | 33.07 | 8.27 | | Total | 180 | 20 | GP share of total profit: 20.00% ## Three meanings of the term **Private funds.** The return LP capital must earn, usually expressed as an annual rate on contributed capital, before the GP receives [carried interest](https://altss.com/glossary/carried-interest-carry). The LP's right to receive distributions up to that threshold is the [preferred return](https://altss.com/glossary/preferred-return), and the two terms are often used interchangeably. **Hedge funds and credit vehicles.** A fixed rate or a benchmark (for example a cash rate) that returns must exceed before a performance fee is charged, usually alongside a high-water mark. Business development companies and many private credit funds pay an income incentive fee on net investment income above a periodic hurdle, often with a catch-up. **Corporate finance.** The minimum expected return a company requires before it approves a project, usually set from its cost of capital (WACC) plus a premium for risk. It is a decision rule, not a payment term. ## Hard and soft hurdles A **soft hurdle** must be cleared before any performance payment, but once it is, a [catch-up](https://altss.com/glossary/catch-up) lets the manager receive its percentage of all profit. A **hard hurdle** permanently excludes the hurdle return from the calculation: the manager shares only in profit above it. Between the two sit partial catch-ups, which reach the full share later. In practice, buyout funds have mostly used soft hurdles with a full catch-up, while hard hurdles appear more often in hedge funds, some credit funds and real estate promotes; terms vary by fund. The Institutional Limited Partners Association (ILPA) recommends otherwise in its Principles 3.0: carry should ideally use a hard hurdle, so that the GP shares only in profits above the LPs' preferred return. ## How the hurdle is measured Private-fund hurdles are usually cumulative over the life of the fund or deal: an annual rate compounded on unreturned contributed capital, or an IRR test on all LP cash flows. Some managers use a multiple-of-capital test instead of, or in addition to, a rate. Hedge fund hurdles are normally measured per performance period and reset each period unless the documents make them cumulative. The basis matters: a hurdle tested on contributions that include fees is harder to clear than one tested on invested capital. ## Worked examples ### Illustrative hard hurdle ($ millions) LPs contribute 100 and receive 200 after five years; the hurdle is 8% compounded (46.93); carry is 20%. With a hard hurdle the GP receives 20% of the 53.07 above the hurdle: **10.61, or 10.6% of the 100 profit.** ### Soft hurdle, same fund With a full catch-up the GP receives everything above the hurdle until it holds 20% of all profit, then 20% of the rest: **20.0, exactly 20% of profit.** The hurdle type, not the hurdle rate, accounts for the 9.39 difference. ### Illustrative hedge fund incentive fee with a hard hurdle A hedge fund starts the year at a NAV of 100, equal to its high-water mark, and ends it at 112 after management fees, a 12% return. The incentive fee is 20% with a 5% hurdle, so the threshold is 105. A hard hurdle charges 20% × (112 − 105) = **1.4, or 1.4% of starting NAV**. ### Soft hurdle on the same hedge fund Once the 105 threshold is cleared, a soft hurdle charges the fee on the whole gain above the high-water mark: 20% × (112 − 100) = **2.4, or 2.4% of starting NAV**. Examples are illustrative; figures are not market data. ## Not the same as - [Preferred Return (Pref)](https://altss.com/glossary/preferred-return): In private funds the hurdle is the threshold rate; the preferred return is the LPs' entitlement to distributions up to it. - High-Water Mark: A high-water mark is a previous peak in the fund's own value that must be regained; a hurdle is a rate of return that must be exceeded. A hedge fund can have both. - Weighted Average Cost of Capital: WACC is a company's blended cost of capital; a corporate hurdle rate is usually WACC plus a margin for project risk. ## Common mistakes - Assuming any hurdle reduces total carry. A soft hurdle with a full catch-up does not, once returns are high enough to complete the catch-up. - Carrying the private-fund meaning into hedge fund or corporate finance documents, where the hurdle works differently. - Comparing a fund's net IRR with its hurdle when the hurdle is defined on a different base or compounding convention. ## Edge cases - A benchmark-linked hurdle can be negative in a falling market; documents differ on whether a fee is then payable on a negative absolute return. - With several dated cash flows, an IRR-based hurdle and an annually compounded balance can give slightly different hurdle amounts. ## Questions ### What is the difference between a hurdle rate and a preferred return? In a private fund the hurdle is the threshold rate and the preferred return is the LPs' right to receive distributions up to it before carry. Outside private funds, "hurdle rate" has other meanings and no LP entitlement. ### What is a hard hurdle? A hurdle with no catch-up: the manager earns its performance share only on returns above the hurdle, never on the hurdle return itself. ## Sources - [ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners](https://ilpa.org/wp-content/uploads/2019/06/ILPA-Principles-3.0_2019.pdf). Institutional Limited Partners Association, ILPA, Third edition, released 27 June 2019. Status: Current edition (no 4.0 found as of 2026-10-01) (checked 2026-10-01). p. 10 (Calculation of Carried Interest) — supports: ILPA recommends that carried interest ideally use a hard hurdle, based only on profits above the LPs' preferred return ## Related terms 5 terms - [Preferred Return (Pref)](https://altss.com/glossary/preferred-return) - [GP Catch-Up](https://altss.com/glossary/catch-up) - [Carried Interest (Carry)](https://altss.com/glossary/carried-interest-carry) - [Distribution Waterfall](https://altss.com/glossary/waterfall) - [Business Development Company (BDC)](https://altss.com/glossary/business-development-company) ## Concept record Concept ID ALTSS-ECON-007 Classification Fund economics Topics Fund terms & economics · Hedge funds Version 2.0.0 Last reviewed 2026-10-01 Structured data [JSON](https://altss.com/reference/concepts/hurdle-rate.json) ## Canonical URL https://altss.com/glossary/hurdle-rate