Hurdle Rate

The hurdle rate is the minimum return that a fund's investors must receive before the manager participates in the profits. Only once this threshold has been exceeded does the manager receive a performance-based share. This ensures that capital providers are served first.

Eight percent per year on capital drawn, calculated from the date of each drawdown, is market standard. This is a guide value, as the actual level varies by fund and market environment. The term is often used interchangeably with preferred return, though the detailed design matters far more than the percentage. A soft hurdle must be distinguished from a hard one: under the widespread soft version a catch-up follows once the threshold is reached, in which the manager receives a disproportionate share until it holds 20 percent of total profits, so the hurdle changes only the timing and not the size of its participation.

Under the hard version all profit up to the threshold stays with investors and the manager shares only in the excess, which is considerably less favourable for it. The level of application matters equally, since calculating across the whole fund gives different results from calculating deal by deal. The level of the hurdle is regularly negotiated, because a fixed eight percent is differently demanding depending on the interest rate environment.

Comparable thresholds appear in management incentive plans. When the hurdle starts to accrue matters for the assessment, because calculating it from each drawdown produces different results from calculating it from the first closing. Whether it also applies to recycled capital should also be checked. Both points sound technical but shift the moment at which the manager participates, sometimes by years, and are therefore part of every serious fund negotiation.