PREFERRED RETURN
Back to GlossaryDefinition
The threshold return that the limited partners of a private equity fund must receive prior to the PE firm receiving its carried interest.
Summary
A preferred return is like a 'first priority' profit guarantee for investors in private equity funds. Think of it as a hurdle rate - typically 8% annually - that limited partners (the investors who provide the money) must earn before the general partners (the PE firm managers) can take their performance fee, called carried interest. It's essentially a way to ensure investors get a minimum return before the fund managers get their bonus, aligning interests and protecting investor capital.
Usage Context
Critical when studying private equity fund structures, compensation mechanisms, and alignment of interests between fund managers and investors. Essential for understanding investment terms and evaluating PE fund attractiveness.
Common Confusions
- Thinking preferred return is guaranteed profit rather than a priority threshold
- Confusing preferred return with management fees
- Believing it applies to gross returns rather than net returns after fees
- Assuming it's calculated on committed capital rather than invested capital
- Mixing up preferred return with the fund's target return
