According to Carta's 2025 private funds analysis, more than 50% of private equity funds globally set their hurdle rate at exactly 8% annually. That number is not arbitrary. It is the floor below which a GP earns nothing in carried interest. Before you sign an LP agreement or sell your business to a PE firm, you need to understand what that floor means — and who it protects.
What the hurdle rate actually is
The hurdle rate is the minimum annual return a private equity fund must deliver to its limited partners before the general partner (the fund manager) earns any performance-based compensation. It is also called the preferred return. Same concept, different name depending on who is in the room.
Here is the plain version: LPs commit capital. The GP deploys it into businesses. When those businesses are sold, cash flows back. Before the GP takes a cut of the profits (called carried interest, typically 20%), the LPs must first receive all their capital back plus an annualized return equal to the hurdle rate.
That 8% is not a fee. It is a performance threshold. Miss it, and the GP collects zero carry. Beat it, and the waterfall opens.
Why 8% became the standard
The 8% hurdle rate traces back to a simple logic: LPs can earn reasonable returns in lower-risk, liquid markets. In the 1980s and 1990s, Treasury yields and investment-grade bonds routinely paid 6% to 9%. PE funds needed to offer a premium over those alternatives to justify illiquidity, complexity, and a 10-year lock-up.
The 8% benchmark stuck. Even when interest rates fell toward zero between 2010 and 2022, most fund LPAs kept the 8% standard. Some institutional LPs pushed back (arguing that 8% looked generous in a zero-rate world), but the convention held because of its familiarity in negotiations and its compounding over a full fund life.
In today's environment, with risk-free rates back above 4%, the 8% hurdle remains relevant. It still asks the GP to meaningfully outperform before collecting their 20%.
Hard hurdle vs. soft hurdle
The mechanics matter more than the rate itself. There are two versions in common use.
A hard hurdle means the GP earns carry only on profits generated above the hurdle threshold. If LPs put in $100M and the hurdle is 8%, and the fund returns $120M after five years, the GP calculates carry on the $12M earned above the preferred return. Not on the full $20M gain.
A soft hurdle means once the fund clears the preferred return, the GP earns carry on all profits, including the dollars used to meet the hurdle. From the first dollar of gain. The GP is often restored to their full carry percentage through a catch-up clause (covered below).
Hard hurdles are more LP-friendly. Soft hurdles are more common in middle-market and lower-middle-market funds, where terms favor the GP slightly more than at the institutional tier.
The catch-up clause
Most PE fund agreements include a GP catch-up provision immediately after the preferred return is cleared. Here is how it works.
Assume: $100M fund, 8% hurdle, 20% carried interest, soft hurdle with a 100% catch-up. The LPs receive their capital back and their 8% preferred return. Then the waterfall shifts: the next dollars flow entirely to the GP until the GP has received 20% of all profits generated so far. After that, distributions split 80% to LPs and 20% to GP on remaining gains.
A 100% catch-up means that transition happens fast. A 50% catch-up slows it down: profits above the hurdle split 50/50 between GP and LPs until the GP reaches their full 20% share. LPs prefer the slower catch-up; GPs prefer the faster one. This is negotiated in the LPA.
For a business owner evaluating a PE buyer, understanding the catch-up tells you something about how hungry the GP is for near-term performance. A fund that structured an aggressive 100% catch-up is wired to push for a fast return, which shapes how they operate your business post-close.
European vs. American waterfall
The waterfall structure determines when the GP can access carry.
The European waterfall (the more LP-friendly model) requires the GP to return 100% of invested capital across the entire fund plus the preferred return before collecting a dollar in carry. The GP waits for the fund as a whole to clear the hurdle. If early exits are profitable but later ones fail, the GP has to give carry back (clawback).
The American waterfall pays carry on a deal-by-deal basis. If a fund closes three strong exits in years four and five, the GP starts collecting carry immediately on those wins, even if the remaining portfolio hasn't been realized. LPs are exposed to clawback risk if later deals underperform.
Most institutional-grade PE funds use the European structure. Lower-middle-market funds sometimes run American waterfall terms. When Patriot Growth Capital evaluates fund structures as part of our Acquire/Mentor/Invest model, the waterfall type is one of the first questions on the due diligence list. It shapes risk allocation between GPs and LPs more than almost any other single term.
How this affects business owners selling to PE
Most business owners focus on valuation multiples. That is the wrong starting point. Valuation determines what you receive at close. The GP's hurdle rate determines how they are going to behave during the hold period, and that affects every decision made inside your business for the next four to seven years.
A GP behind their hurdle will push for faster growth, earlier EBITDA improvement, or an opportunistic add-on acquisition to boost the multiple at exit. That creates performance pressure that flows downstream to management, employees, and customers.
A GP comfortably ahead of their hurdle rate, already trending toward a 2.5x or 3x gross MOIC, may have more patience. They can afford to wait for the right exit buyer instead of taking the first offer.
Before you negotiate an enterprise value with a PE suitor, ask your advisor to pull the fund's vintage year, deployment timeline, and current DPI (distributions to paid-in capital). That data tells you whether the GP is in a hurry or can afford to be deliberate. Carry pressure is real, and it shapes behavior in ways that no letter of intent will spell out.
Calculating the preferred return
According to Goodwin Law's Private Funds Terms Database, 50% of PE funds calculate the preferred return using a compounding interest rate method. Another 38% use an IRR-based calculation. The remaining 12% use a percentage of drawn or committed capital.
The practical difference is timing and compounding convention. A compounding interest rate method accrues daily (or annually) on called capital. An IRR-based method measures the actual annualized rate of return on cash flows in and out. Because IRR already contains a compounding element, the two approaches produce similar outcomes when cash flows are modeled over a full fund life.
What matters in practice: confirm whether the hurdle compounds annually or continuously, and whether it applies to called capital net of fees or gross of fees. The inclusion or exclusion of management fees in the compounding base changes the effective return threshold materially over a 10-year fund life.
What to ask when reviewing PE fund terms
If you are an LP evaluating a commitment, or a business owner assessing a PE buyer's fund structure, here are the questions that matter:
- What is the hurdle rate, and is it hard or soft?
- What is the catch-up percentage?
- Is the waterfall European (fund-wide) or American (deal-by-deal)?
- What is the compounding base for the preferred return calculation?
- What clawback provisions apply to the GP?
- Where is the fund in its deployment timeline relative to the hurdle rate trajectory?
The hurdle rate is the GP's leash. It keeps incentives aligned — in theory. The terms around it determine whether that alignment holds under pressure. Read the LPA. Model the waterfall. Understand what environment you are entering before capital changes hands.
For more on how PE fund economics shape acquisition strategy, see our breakdown of carried interest in private equity.
