What is a hurdle rate in a VC fund?

A hurdle rate (also called a preferred return) is a performance threshold built into a VC fund's LP agreement. It specifies the minimum annualized return that LPs must earn on their capital before the general partners can begin taking their 20% carried interest. The most common hurdle rate is 8% per year.

Here's how it works mechanically. Suppose a fund raises $100M and returns $150M after ten years. LPs first receive their $100M back. Then the 8% hurdle must be satisfied — meaning LPs must receive an 8% annualized return on their capital before any carry is taken. If that threshold is met, the GP then catches up (often 100%) to their pro-rata share of profits in a "catch-up" provision, and thereafter the remaining profits split 80/20.

The hurdle rate protects LPs from paying a performance fee on mediocre returns. Without a hurdle, a fund that barely beats inflation would still pay GPs 20% carry. With an 8% hurdle, GPs only earn carry once they've delivered genuinely strong risk-adjusted returns.

Not all funds have hurdle rates. In venture capital (as opposed to private equity), hurdles are less universal than in buyout funds. Many top-tier VC funds skip the hurdle entirely — their brand is strong enough that LPs accept the terms. When a fund does have a hurdle, it's often accompanied by a "catch-up" provision where the GP receives 100% of profits (up to their full carry entitlement) until their share of total profits equals 20%.

For LPs evaluating a new fund, the presence and structure of a hurdle rate is one of several economic terms to scrutinize. A fund without a hurdle, charging 2% management fees, is asking for a lot of trust — it better have a track record to match.