Finance & Accounting
Definition
A hurdle rate is the minimum acceptable rate of return on an investment before a company or investor will proceed. It represents the opportunity cost of capital — if an investment cannot beat the hurdle rate, capital is better deployed elsewhere. In private equity and venture capital, the hurdle rate is the preferred return threshold LPs must receive before the GP earns carried interest.
For corporate capital allocation, the hurdle rate is typically set at or above WACC — often adding a risk premium for project-specific uncertainty. A company with a WACC of 8% might set a 12% hurdle rate for acquisitions to account for execution risk. In private equity, the hurdle rate (usually 8%) is the annual return LPs must receive before the GP participates in profits through carried interest. If the fund returns 8% or less annually, the GP receives only management fees. Above the hurdle, profits are split (typically 80/20 after a catch-up provision). Hurdle rates create discipline in capital allocation: requiring projects to clear a minimum return threshold prevents companies from investing in marginally positive or value-destroying activities. The appropriate hurdle rate depends on the risk profile of the investment, cost of capital, and competitive alternatives.
Setting an appropriate hurdle rate is one of the most important capital allocation decisions a company makes. Too high, and you pass on good projects; too low, and you destroy value with mediocre investments. A financial advisor or fractional CFO can help establish hurdle rates by investment type, model project returns against them, and build a disciplined capital allocation framework.