Preferred Return
Preferred return is the minimum return LPs receive before the GP earns carried interest, often expressed as an annual hurdle.
Allocator relevance: A key LP protection—shapes fairness of the waterfall and the timing of when carry begins.
Expanded Definition
Preferred return (hurdle) ensures LPs receive a baseline return before incentive compensation is paid. Details matter: whether it compounds, how it accrues, and whether a catch-up exists. Two funds with the same headline preferred return can have materially different economics due to catch-up and distribution mechanics.
Allocators analyze preferred return as part of the full waterfall system, alongside carry and clawback.
How It Works in Practice
Distributions first go to return capital, then to pay the preferred return to LPs. After that, catch-up may direct distributions to the GP until the carried interest split is reached, then ongoing splits apply.
Decision Authority and Governance
Governance requires careful review of LPA language and scenario modeling. LPAC may address disputes or interpretation issues over time.
Common Misconceptions
- Preferred return guarantees good net economics.
- Preferred return eliminates carry misalignment.
- Preferred return is standardized across strategies.
Key Takeaways
- Mechanics matter more than the headline rate.
- Evaluate preferred return + catch-up + clawback together.
- Model outcomes under multiple performance paths.