Hurdle Rate
The minimum acceptable rate of return a project, investment, or fund must achieve before it is approved or before performance fees are earned.
What is Hurdle Rate?
The hurdle rate is the minimum rate of return that an investment must generate to justify the risk taken. In capital budgeting, a company will only approve a project if its projected Internal Rate of Return (IRR) exceeds the hurdle rate — which is typically the Weighted Average Cost of Capital (WACC), sometimes adjusted upward for project-specific risk. In private equity and hedge funds, the hurdle rate is the minimum annual return (e.g., 8%) that a fund must achieve before the general partner can collect carried interest (performance fees). This ensures managers only profit when they deliver meaningful outperformance above a baseline. When a fund clears the hurdle, performance fees typically apply only to returns above the hurdle (a 'soft hurdle') or to the entire gain once the hurdle is cleared ('hard hurdle'). The hurdle rate is one of the most important discipline mechanisms in fund management.
Example
A private equity fund sets an 8% hurdle rate and a 20% carried interest. In year 5, the fund delivers an IRR of 15% to investors. The first 8% return goes entirely to limited partners. Above the 8% hurdle, the general partner earns 20% of the additional gains ('catch-up' provisions may apply). An IRR of only 6% would generate no performance fee at all, ensuring the manager is only rewarded for meaningful value creation.
Source: CFA Institute — Private Equity