IRR Hurdle

An IRR (Internal Rate of Return) hurdle refers to a specified rate of return that a project or investment must achieve before the profits are shared in a particular way, usually between the general partner (GP) and limited partners (LPs) of a fund. This is commonly used in the context of private equity funds, venture capital funds, or real estate investment structures.

These hurdle rates are often used in conjunction with a "waterfall distribution" model. Here's an example to illustrate how it works:

First, the initial investment is returned to the LPs.

Then, any additional returns up to the "IRR hurdle" (let's say 8%) might also go to the LPs. This is often referred to as the "preferred return."

Once the IRR hurdle is achieved, the GP starts to share in the profits. For instance, profits might be split 80/20 (LP/GP) until a higher IRR hurdle is achieved.

If the investment does extremely well and exceeds the second IRR hurdle, the profit split might change again, say to 50/50. This incentivizes the GP to maximize the investment's performance.

Remember that the actual details of how and when profits are shared can vary greatly depending on the specifics of the partnership agreement.