Preferred return
Last updated
Quick Answer
The preferred return is the return limited partners must receive on contributed capital before the general partner participates in profits.1,2
What it is
It is a distribution threshold written into the partnership agreement, expressed as an annual percentage on contributed capital. It is frequently called the hurdle rate. It is not a guarantee of return and not a discount rate — it determines the order in which money is paid out, not what the fund earns.1,2
Operational context
What good looks like
Why It Matters
It is a payment threshold rather than a promised return, and confusing the two is how a limited partner comes to believe the fund owes a yield it never guaranteed.1
Term Family
Related concepts
Related Questions
How does 20% carried interest work?
A 20% carry entitles the general partner to 20% of the fund's profits once the limited partners have been returned their contributed capital and their preferred return, with the remaining 80% going to the limited partners.
Is hurdle rate the same as IRR?
No — the hurdle rate is a threshold and IRR is a measurement, and the confusion is common enough to be worth stating plainly.
What does charge 2 and 20 mean?
"2 and 20" is market shorthand for a 2% annual management fee and a 20% carried interest, not a defined term with a standard-setter behind it.
What is a European waterfall?
A European, or whole-of-fund, waterfall pays carried interest only after limited partners have received back all contributed capital plus their preferred return across the entire fund.
Frequently Asked Questions
What is Preferred return in venture capital?
It is a distribution threshold written into the partnership agreement, expressed as an annual percentage on contributed capital. It is frequently called the hurdle rate.
Why is Preferred return important for startups?
Understanding Preferred return is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Sources & References
- 1.ilpa-model-lpa-wof-ts — ILPA Model LPA Term Sheet — Whole-of-Fund Waterfall Version (July 2020)ILPA Model LPA Term Sheet — Whole-of-Fund Waterfall Version (July 2020)ILPA(The preferred return is the return limited partners must receive on contributed capital before the general partner participates in profits.)primary · T1 · waterfall-models · term
- 2.ilpa-principles-3 — ILPA Private Equity Principles 3.0 (2019)ILPA Private Equity Principles 3.0 (2019)ILPA(The preferred return is the return limited partners must receive on contributed capital before the general partner participates in profits.)primary · T1 · waterfall-models · term
- 3.metrick-yasuda — Metrick & Yasuda, *The Economics of Private Equity Funds* (Rev. Fin. Stud. 2010)Metrick & Yasuda, *The Economics of Private Equity Funds* (Rev. Fin. Stud. 2010)Wharton / Rodney White Center(The preferred return is the return limited partners must receive on contributed capital before the general partner participates in profits.)secondary · T2 · waterfall-models · term
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