How do net/gross PE returns and hurdle rates work?
I understand the 2/20 concept, but when a fund reports net returns, is that net of both the 2% management fee and 20% carry allocation? Or just the carry?
I also know a lot of funds have 8% hurdle rates -- is that on net or gross IRR and does that include the 2% management fee? If so, is the effective hurdle rate really 10% because you need to account for the management fee before you start to realize carry? Sorry if these are basic questions, I just realized that I don't know how the detailed mechanics actually work.
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These are good questions.
The best place to understand the answer is by looking at the distribution waterfall in an LPA.
It will say something like:
So to answer your question, capital can be called for investments, management fees and fund/partnership expenses. If a fund doesn’t recycle capital then typically you would expect 85% of capital to be called for investments and 15% for fees and fund related expenses.
In order for the GP to earn carry, the GP has to first return the full amount called and preferred return.
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