Glossary - Hurdle Rate
A hurdle rate is the minimum rate of return that investors or managers require before they invest in a project or a venture. It is a benchmark for the expected rate of return necessary to justify the risk associated with the investment. The hurdle rate typically includes the cost of capital with an additional risk premium.
Also known as
- Minimum Required Rate of Return
- Minimum Acceptable Rate of Return
Use cases examples
- Limited Partnership Agreement: All limited partners are entitled to receive an annual return of 8% on their invested capital before the general partner receives any performance fees, as defined by the hurdle rate in this agreement.
- Venture Capital Term Sheet: The fund requires a hurdle rate of 20% IRR, ensuring that the investors will prioritize projects expected to exceed this threshold, in accordance with the terms outlined in the term sheet.
Considerations for investors
- Investors need to set a hurdle rate that accurately reflects the risk and the opportunity cost of investing in the venture, ensuring that the rate is competitive and achievable.
- Adjusting the hurdle rate might be necessary for different stages of investment, reflecting the changing risk profile as a company matures.
Considerations for founders
- Founders should understand that a high hurdle rate can make it more challenging to secure investment, as it sets a higher expectation for the return on the venture.
- It is important for founders to negotiate the hurdle rate realistically, taking into account their business model and growth projections, to avoid overly burdensome financial commitments.
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