Hurdle Rate (PE)

In private equity and venture capital, the hurdle rate is the line a fund manager must clear before they earn their cut. Investors who put up the money — the limited partners (LPs) — are promised a minimum annual return first. Only once that "preferred return" is delivered does the general partner (GP), the manager, start collecting carried interest, their share of the upside. It is a core feature of aligning incentives so managers are paid for genuine outperformance, not just for showing up.

How It Works

The near-universal standard is an 8% hurdle — by one industry database, roughly 80% of buyout funds set it exactly there. If a fund returns only 6% a year against an 8% hurdle, the GP earns zero carry; LPs simply get their capital plus those gains. Cross the hurdle, and a catch-up mechanism typically lets the GP rapidly draw carry until the overall profit split settles at the familiar 80/20 — 80% to LPs, 20% to the GP.

The design comes in two flavours. A hard hurdle means the GP earns carry only on returns *above* the threshold. A soft hurdle, far more common, means that once the hurdle is cleared, the catch-up lets the GP earn carry on *all* profits from the first rupee. The distinction sounds technical but can shift crores between investors and managers over a fund's life.

The India Context

For Indian investors, this lives inside the Alternative Investment Fund (AIF) world — SEBI-regulated Category I, II and III funds through which most domestic private equity and venture capital is structured. AIFs are restricted to sophisticated investors, with SEBI setting a high minimum commitment, and their term sheets spell out the hurdle, catch-up and carry in detail.

With Indian startup valuations resetting and exits getting harder, the hurdle rate has become more than fine print. In a tougher return environment, clearing 8% is no longer automatic, which sharpens LP scrutiny of fee structures. Anyone evaluating an AIF should read these waterfall terms carefully — they determine who really keeps the gains when a fund performs, and who eats the disappointment when it doesn't.