Preferred Return (Hurdle Rate)

Preferred return (or hurdle rate) is the minimum return that Limited Partners must receive before the General Partner earns carried interest.

How Preferred Return Works

Typical Structure:
1. LPs receive 100% of distributions until 8% IRR achieved
2. GP "catches up" until they reach 20% of profits
3. Remaining profits split 80/20 (LP/GP)

Preferred Return Example

LP Investment:    $1,000,000
Hold Period:      5 years
8% Pref Return:   $469,328 (compounded)

Until LPs receive $1,469,328, GP gets $0 carry

Types of Preferred Return

Simple vs. Compound

• Simple: 8% per year on original investment
• Compound: 8% IRR (more common, more LP-friendly)

Cumulative vs. Non-Cumulative

• Cumulative: Unpaid pref accrues to future periods
• Non-Cumulative: "Use it or lose it" each period

Impact on GP Incentives

Higher preferred return:

• More LP protection
• Reduces GP economics
• May incentivize riskier investments to clear hurdle

Lower preferred return:

• GP earns carry sooner
• Less LP downside protection
• More common in hot fundraising markets