Module IV· IRR / MOICIntermediate
Question
What is a 'hurdle rate' and how does it affect carried interest?
Answer
What
The hurdle rate is the minimum return on LP capital that must be reached BEFORE the sponsor (GP) earns carried interest. Standard: 8% IRR.
Four-tier waterfall
- Return of capital: the LP gets its investment back.
- Preferred return (hurdle): the LP gets an 8% IRR on the investment.
- Catch-up period: the GP gets 100% until cumulative GP / total = 20%.
- 80/20 split: everything above that is split 80% LP / 20% GP.
Consequence
With a net IRR below 8%, the GP gets no carry — only management fees.
Deep diveShow more details
Example — fund with $1,000m LP capital
| Tier | LP receives | GP carry | Threshold |
|---|---|---|---|
| 1. Return of capital | $1,000m | 0 | until $1,000m is returned |
| 2. Preferred return | $469m | 0 | until IRR = 8% (total ~$1,469m) |
| 3. Catch-up | 0 | $117m | GP takes 100% until cumulative GP = 20% of total |
| 4. 80/20 split | 80% | 20% | everything beyond |
Comparison (hurdle structures in the middle market)
| Hurdle | LP-friendliness |
|---|---|
| 6% with 100% catch-up | more LP-friendly |
| 8% with 100% catch-up (standard) | balanced |
| 10% with 100% catch-up | very LP-friendly (rare) |
Common pitfalls
- Junior analysts forget the catch-up period: they think the carry comes right after the hurdle.
- "Hurdle" and "preferred return" are often used synonymously.
Pitch tip
Question: "What happens with mediocre performance?"
Answer: "Below an 8% IRR the GP gets no carry — only management fees. At a 12% IRR the carry is ~4 percentage points over the hurdle (80/20 logic). The hurdle is critical protection for LPs and often the main negotiation point in the fundraise"