# Preferred Return

The **preferred return** (also called the **hurdle rate** or **pref**) is the minimum annualized return LPs must earn on their contributed capital before the GP is entitled to any [carried interest](/waterfall-and-distributions/carried-interest.md). It protects LPs by ensuring the GP only profits once LPs have earned a minimum acceptable return on their investment.

## Standard Terms

* **Rate**: 8% per annum is the industry standard for buyout and growth equity funds. Some credit funds use lower hurdles (5–6%); some venture funds have no hurdle at all.
* **Compounding**: typically compounded annually, though some LPAs specify simple interest.
* **Basis**: accrues on each LP's contributed capital from the date that capital is contributed.

## How It Accrues

The preferred return clock starts for each unit of capital on the date the LP wires it:

```
Preferred return accrued on a contribution =
  Contribution amount × annual rate × (days from contribution date to distribution date / 365)
```

For a fund with multiple capital calls, each call's contribution accrues separately from its own due date.

## Role in the Waterfall

In a standard four-tier waterfall, the preferred return is Tier 2:

```
Tier 1  Return of capital     LPs receive 100% until all paid-in capital returned
Tier 2  Preferred return      LPs receive 100% until accrued 8% p.a. earned   ← here
Tier 3  GP catch-up           GP receives until carry split restored
Tier 4  Residual profits      80/20 LP/GP
```

Under a [European waterfall](/waterfall-and-distributions/waterfall-european.md), Tier 2 is measured fund-wide across all LPs. Under an [American waterfall](/waterfall-and-distributions/waterfall-american.md), it is measured per-deal.

## Net vs Gross Preferred Return

The preferred return in the LPA is stated as a gross figure — it accrues on contributed capital regardless of management fees paid. From the LP perspective, the net preferred return (after fees) is lower. This is expected: the hurdle compensates for the time value of capital called, not for fees.

## Preferred Return vs IRR

The preferred return is a *threshold* — a binary gate (cleared or not). The fund's [IRR](/reporting-and-metrics/irr.md) is a continuous measure of time-weighted return. A fund can have an IRR well above the hurdle rate (good performance) or below (poor performance). LPs evaluate both.

## How Gildi Tracks It

Gildi maintains a running preferred return balance per LP, per capital call tranche. Each balance is the sum of all contributions minus any return-of-capital distributions received, multiplied by the accrual from each contribution date to the current reporting date. The Tier 2 hurdle is cleared when the cumulative distributions to an LP equal their paid-in capital plus total accrued preferred return.


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