A preferred return — also called a hurdle rate — is the minimum annualized return a fund must first pay its limited partners before its general partner becomes entitled to any carried interest at all.
Like the management fee, the preferred return is set out in the fund’s own limited partnership agreement rather than by any Canadian statute — the same Canadianized ILPA fund formation documents CVCA publishes are where a Canadian GP and its LPs negotiate and record the rate. Two structural choices sit underneath the number itself. First, whether the hurdle is tested fund-wide (a “European” waterfall, where the GP earns carry only after LPs have gotten back all contributed capital across every investment plus the preferred return on it) or deal-by-deal (an “American” waterfall, where carry can flow to the GP investment by investment, before every other investment in the fund has returned capital). Second, whether the LPA gives the GP a “catch-up” — a provision that, once the preferred return has been paid, directs a larger share of the next dollars of profit to the GP until it has caught up to its full agreed share of total profit measured from dollar one, rather than only on profit earned after the hurdle was cleared.
To illustrate the mechanics only — the rate itself is a drafting choice, not a benchmark — suppose Fund III’s LPA sets a 7% annually compounded preferred return on a European, whole-fund waterfall. LPs have contributed $50 million; by the time the fund starts realizing investments, that capital plus the compounded 7% works out to $58 million owed to LPs before a dollar of carried interest is paid to the GP. If the fund has so far returned only $52 million from early exits, the GP receives nothing on those distributions — the hurdle has not been cleared — even though the fund is already profitable on a cost basis.
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