Hurdle Rate: Definition, Formula and How to Set One

A hurdle rate is the minimum return an investment must be expected to earn before a company or investor will commit capital to it. It is also called the minimum acceptable rate of return (MARR). Companies usually set it at their cost of capital plus a risk premium. If a project's expected return (its IRR) is below the hurdle rate, it is rejected. If it is above, it goes forward for a decision.

The term has a second, narrower meaning in private equity and venture funds. There, the hurdle rate (or preferred return) is the annual return investors must receive before the fund manager earns carried interest. Nearly 80% of private equity funds set it at 8%, according to Goodwin's fund terms data.

This guide covers both meanings, with a worked example of each.

What is a hurdle rate?

The hurdle rate is a threshold, not a forecast. It answers one question: what is the lowest return that justifies the risk and the capital?

The two meanings work the same way but serve different people:

For a founder, the corporate meaning matters inside the business. The fund meaning matters when you are raising from, or selling to, a private equity or venture fund, because it shapes what that fund needs your company to return.

Hurdle rate formula

There is no single formula. The common starting point is:

Hurdle rate = WACC + risk premium

• WACC is the company's weighted average cost of capital (WACC): the blended return its lenders and shareholders require.
• The risk premium covers what WACC does not: forecast optimism, execution risk, and the fact that capital and management time are limited.

Some companies set the hurdle without reference to WACC, as a round number the board is comfortable with, such as 15%. That works, but it drifts out of date when interest rates move. Anchoring to WACC keeps it honest.

To test a project against the hurdle, calculate its net present value at the hurdle rate:

NPV = Σ [ Cash flow in year t ÷ (1 + hurdle rate)^t ] − initial investment

If NPV at the hurdle rate is positive, the project's IRR is above the hurdle rate. The two tests give the same accept-or-reject answer for a single project with a normal pattern of cash flows (one investment up front, returns after).

Why hurdle rates sit above the cost of capital

In textbook finance, a company should take every project that returns more than its cost of capital. In practice, almost none do. Companies set hurdle rates well above it, and the gap is large.

• A survey of U.S. CFOs found an average hurdle rate of about 15%, against an average cost of capital of about 8% (Jagannathan, Matsa, Meier and Tarhan, Journal of Financial Economics, 2016). The authors trace the gap mainly to operational constraints, such as limited managerial time and skilled staff, rather than to difficulty raising money.
• Across 7,000 observations from 3,000 firms in 20 countries, drawn from company conference calls since 2001, discount rates averaged 3 percentage points above firms' own estimate of their cost of capital (Gormsen and Huber, NBER Reporter, 2025 No. 3). For U.S. firms the gap widened from 3% in 2002 to 5% in 2020, in part because the cost of capital fell while discount rates were slow to adjust.

That second finding is the practical warning. Hurdle rates are sticky. A rate set when capital was cheap, or expensive, keeps running long after conditions change.

The premium over WACC does three jobs:

1. It absorbs forecast optimism. Project forecasts are written by the people who want the project. A premium is a blunt correction.
2. It rations scarce capacity. A team can only run so many initiatives well. A high hurdle funds the best ones first.
3. It prices in risk the WACC misses. WACC reflects the average risk of the existing business. A new product or new market is usually riskier than average.

Worked example: one project, three rates

A company with a 13.6% WACC (the U.S. worked example in our WACC guide) is considering a $1,000,000 expansion project. It sets its hurdle rate at WACC plus 3 points: 16.6%.

The project returns $1,510,000 over five years on a $1,000,000 investment. Its IRR is 14.9%.

The project creates value on paper. It returns more than capital costs. But it does not clear the hurdle, so it does not get funded as proposed.

This is the hurdle rate working as designed. The 1.3-point cushion between 14.9% and 13.6% is thin enough that one optimistic assumption, such as a year-one ramp that arrives six months late, wipes it out. The right next step is not to lower the hurdle. It is to re-scope the project: cut the upfront cost, phase the investment, or find the assumption that would lift the return, and build that into the financial model.

The honest cost of a high hurdle is the reverse case: if the forecast is accurate, rejecting this project leaves $33,550 of value on the table. Every company that sets a hurdle above WACC accepts that trade.

Hurdle rate vs IRR vs WACC

The three numbers are often confused because they are all expressed as percentages and all appear in the same investment memo.

The order should normally be WACC < hurdle rate. A project is funded when IRR > hurdle rate. If a company's hurdle is below its WACC, it can fund projects that lose money for its investors.

One caution on IRR: when comparing projects of different sizes or lengths, rank them by NPV at the hurdle rate, not by IRR. A small project with a 40% IRR can create less value than a large one at 20%.

Hurdle rate in private equity and venture capital

In a fund, the hurdle rate is a term in the limited partnership agreement. Investors (limited partners, or LPs) get their capital back plus the hurdle return before the manager (the general partner, or GP) receives any carried interest, typically 20% of profits.

Goodwin's analysis of its Terms Database for Private Investment Funds (November 2023) found:

• More than 50% of funds have a hurdle rate of 8%. The second most common rate, used by 16% of funds, is 7%.
• Nearly 80% of private equity funds have an 8% hurdle.
• About half of infrastructure funds have an 8% hurdle, but only 29% of real estate funds do.
• Credit funds typically set hurdles below 8%, mostly between 5% and 7%.
• The majority of U.S. venture capital funds have no hurdle rate at all.

The catch-up, and why the hurdle often changes less than it seems

Most fund hurdles come with a catch-up. Once LPs have received their preferred return, the GP receives most or all of the next distributions until it has "caught up" to its full 20% share of total profits. Goodwin's follow-up analysis (March 2024) found 100% catch-ups in 84% of private equity funds and 80% of venture funds; most real estate funds (86%) use a 50% catch-up instead.

Worked example. A $100 million fund draws all capital at the start and exits everything at the end of year five. It has an 8% compounding hurdle, a 100% catch-up and 20% carry. The preferred return over five years is $100m × (1.08⁵ − 1) = $46.93 million. The GP's catch-up completes once total distributions reach $158.67 million.

Figures in millions. Simplified: one drawdown, one exit, no fees.

Below the hurdle, it protects LPs completely. Above $158.67 million, a 100% catch-up means the GP ends up with exactly 20% of profits, the same as if there were no hurdle. The hurdle decides who is paid first, not how the profits are split in a successful fund. That is the difference between a soft hurdle (with catch-up, as here) and a hard hurdle, where the GP earns carry only on profits above the hurdle and never catches up.

For a founder selling to or raising from a private equity fund, the takeaway is simple: the fund needs its whole portfolio to clear 8% net of fees before its managers earn carried interest. Gross returns on each deal have to be well above that, which is why business valuation conversations with PE buyers center on the return they can underwrite, not on what the company is worth to you.

How to set a hurdle rate

1. Start with WACC. Recalculate it at least once a year and whenever your borrowing cost or funding mix changes. Our WACC guide walks through the calculation.
2. Add a premium by risk class, not by project. Group projects into three or four classes and set one hurdle for each. Letting each project owner argue for a custom rate turns the hurdle into a negotiation.
3. Write the classes down. The table below is an illustrative starting point, not an industry standard. Calibrate it to your own record of forecast accuracy.
4. Test against your pipeline. If almost nothing clears the hurdle, it is too high or your forecasts are too cautious. If everything clears it, it is doing no work.
5. Revisit it when rates move. The research above shows the most common failure is a hurdle that never changes.

Illustrative ranges for discussion. They are not drawn from a survey, and your own should reflect your data.

Common mistakes

1. One rate for every project. A single company-wide hurdle over-penalizes safe projects and under-penalizes risky ones, so the portfolio drifts toward risk.
2. Counting risk twice. If the forecast already uses a cautious case, a large premium on top rejects good projects. Adjust the cash flows or the rate, and say which.
3. Ranking by IRR. IRR says whether a project clears the bar, not which project creates the most value. Rank by NPV at the hurdle rate.
4. A hurdle below WACC. Usually the result of a stale WACC after rates rose. Every project funded in that gap loses money for investors.
5. Treating a fund's preferred return as a guarantee. It is a priority in the order of payment. If the fund does not earn it, LPs do not receive it.