During fundraising, managers change the hurdle rate to balance investor attraction, incentive design, and market positioning. The hurdle rate determines when the manager begins to earn carry, so shifting it is a lever that affects perceived fairness, risk allocation, and the willingness of limited partners to commit capital.
Market incentives and signaling
Fund terms are partly a market signal. When competition for capital is intense, managers may lower the hurdle rate to appear more investor-friendly and accelerate closes. Research by Paul Gompers at Harvard Business School and Josh Lerner at Harvard Business School shows that fund economics, including fee and carry arrangements, evolve with LP bargaining power and market cycles. A lower hurdle can indicate confidence in delivering returns or simply signal concession to attract cornerstone investors; a higher hurdle can signal manager conviction in their ability to outperform benchmarks.
Incentives, risk-taking, and governance
Agency theory explains another driver. Michael C. Jensen at Harvard Business School demonstrated how incentive structures influence managerial behavior. Raising a hurdle increases the portion of returns that must be generated before managers are rewarded, which can curb excessive risk-taking but may also encourage riskier bets if managers push to clear the threshold quickly. Conversely, a lower hurdle reduces the downside for managers and can dilute alignment with investors. Steven N. Kaplan at University of Chicago Booth School of Business has documented how private equity contracts adjust to align incentives while reflecting investor oversight and monitoring costs.
Cultural and territorial factors shape these dynamics. Institutional investors in different regions bring distinct norms and mandates; pension funds and sovereign wealth funds often demand stronger alignment and may insist on higher hurdles, while family offices may prioritize access and speed, accepting lower hurdles. Nuanced negotiation over hurdles reflects trust, regulatory contexts, and the economic risks of the target geography.
Consequences extend beyond the fundraising window. Adjusted hurdle rates change the fund’s risk-return profile, affect the investor base composition, and influence long-term reputation. A pattern of low hurdles may attract more capital short-term but weaken perceived managerial discipline, while persistently high hurdles can limit fundraising success or concentrate investors that tolerate higher thresholds. Documented industry shifts in terms underscore that hurdle adjustments are a tactical response to competing pressures: investor expectations, competitive markets, incentive alignment, and regional norms. Understanding those pressures clarifies why fund economics are rarely static during the fundraising process.