Preferred return (hurdle rate)

The preferred return (or hurdle rate) is the minimum annual return that a private equity fund must deliver to its Limited Partners before the General Partner is entitled to any carried interest. It is typically set at 8% per annum on an IRR basis, though it ranges from 6% to 10% depending on fund type and vintage. The hurdle ensures that the GP only benefits from carried interest once LPs have received an adequate base return on their capital.

There are two common hurdle structures. In a "European waterfall" structure (most common in European PE funds), all capital and the hurdle must be returned to LPs before any carried interest is paid — providing maximum LP protection. In an "American waterfall" structure (more common in US funds and some European growth funds), carried interest is paid deal-by-deal as each investment is realised, with a clawback obligation if the overall fund fails to meet the hurdle over its life. The European waterfall is significantly more LP-friendly.

A catch-up clause typically follows the hurdle: once LPs have received their capital and the hurdle return, the GP receives 100% of subsequent distributions until it has received its target carry percentage (typically 20%) on the total profits. After the catch-up, distributions are split 80% LP / 20% GP. For a CHF 100 million fund at 8% hurdle, the GP receives no carried interest until LPs have received CHF 100 million × (1.08)^n — and then 100% of distributions until the carry is balanced.

At Hectelion, we model preferred return and waterfall structures for PE funds in our financial structuring and fundraising mandates.