The hurdle rate is a minimum annual return that a fund must generate before the General Partner (GP) becomes eligible to earn carried interest—their share of the fund’s profits. Commonly used in private equity and venture capital, the hurdle rate is a core mechanism for aligning incentives between fund managers and investors (Limited Partners or LPs).

By ensuring that LPs receive a baseline return—typically 8–10% per annum—before any profit-sharing occurs, the hurdle rate acts as both a performance benchmark and a risk mitigator. It guarantees that GPs only participate in upside gains once investors have first achieved an acceptable return on their capital.

Once the fund exceeds the hurdle rate, the excess profits are distributed according to the carried interest structure defined in the Limited Partnership Agreement (LPA). This design incentivizes GPs to deliver outperformance, while also protecting LPs from paying performance fees on subpar results.