The hurdle is a fact in the document, and three things about it are read before the rate.

A hurdle is the return the register receives before the manager shares in gain. It is stated as a rate, and the rate is what gets negotiated: eight, seven, six, a number each side has a view about and a precedent for. Three other facts about the hurdle decide what the rate is worth, and each is a clause a reader can find in the constitution and most registers do not read until the first distribution. Whether the hurdle compounds, and from what date. What it is measured on. And whether it is calculated on the whole fund or deal by deal. A fourth, the catch-up, decides whether the hurdle is a preference or a threshold. The four together are the hurdle; the rate is the part that is easiest to say, and the part a manager's counsel is happiest to concede, because the other four are where the money is.

This note sets out the four facts in turn, with the arithmetic each changes, the dates the clock runs from, the base the rate is applied to, the unit of calculation and what it does to timing, the catch-up and its forms, a worked hurdle on one fund under different terms, the land platform's hurdle and the charges, the register's reading in order, a comparison, cases, what each party holds, the sequence, questions, terms and what to read.

Compounding, and from when

A hurdle that compounds annually on capital outstanding is a different number from one that does not, and over a seven-year hold the difference is large: a simple rate accrues the same amount every year on the original capital, while a compounded rate accrues on the capital plus the unpaid hurdle, so that the holders' entitlement grows faster the longer the fund holds. The constitution says which, and says from what date the clock runs: from the drawdown of each contribution, which is the register's preferred date because its money left its hands then; from the close at which the contribution was committed, which is earlier; or from the investment of the contribution in an asset, which is later and which the manager prefers because the capital-call facility's deferral of drawdowns then shortens the hurdle's run. The date is the term most often left to a precedent and most often worth a point of rate.

The base

The rate is applied to a base, and the base decides how much hurdle accrues. A hurdle measured on capital contributed to investments is one thing; on capital contributed to investments plus the annual charge the manager draws and the fund's expenses is another, and larger, because the holders' money that paid the charge is also money they want returned with a return. A hurdle measured on commitments, drawn or not, is a third, and larger still, because it accrues on money the holders have not yet paid. A register that reads the rate and assumes the base has assumed the most generous version, and the constitution's definition of the base, usually "contributed capital" with a definition of what counts, is the clause to read.

The unit

A whole-fund waterfall returns all capital and all hurdle on every investment before the manager shares in any gain, and the manager's share arrives late and is rarely clawed back. A deal-by-deal waterfall calculates on each realisation, pays the manager's share on the first profitable exit, and relies on an escrow and a clawback to correct for the losses that come later. The unit is the difference between a share paid in year three and one paid in year eight, between a clawback that is rarely needed and one that is the main event, and between a hurdle that the holders receive in cash before the manager receives anything and one they receive position by position while the manager is paid beside them. The unit is the most consequential term in the economics and the one registers negotiate least, because the rate is easier to argue about.

The catch-up

After the hurdle, many constitutions give the manager all or most of the next tranche of gain until it has received its full share of the total, and then split the remainder. A full catch-up, in which the manager receives the whole of the gain above the hurdle until its share of all gain equals its percentage, means the hurdle is a threshold rather than a preference: once cleared, the manager's share is the same as if there had been no hurdle, and the hurdle protected the holders only in the case where it was never cleared. A partial catch-up, in which the manager receives a stated majority of the tranche, or no catch-up, in which the manager shares only in gain above the hurdle, means the hurdle is a true preference the holders keep. The rate of the hurdle, again, is not the point; the catch-up decides what the rate bought.

The dates, read closely

The clock's start is per contribution under most constitutions, so that each drawdown accrues its own hurdle from its own date, and the administrator computes a hurdle for every drawdown in the life of the fund. The clock's end is the distribution that returns the capital, and a distribution that returns part returns part of the hurdle's base. A recycling provision that treats returned capital as re-called restarts the clock on the recycled amount or does not, as the constitution says. A capital-call facility that defers drawdowns defers the clock's start, and the constitution says whether the hurdle runs from the facility's funding of the investment or from the drawdown that repaid it, because the two dates differ by the facility's tenor and the difference is the manager's gain.

Why the four facts hide behind the rate

The rate is one number and the four facts are four clauses, and a negotiation between a manager and a register is conducted by people who can argue a number in an afternoon and cannot read four clauses in one. The manager's counsel drafts from a precedent whose four facts favour the manager, because the precedent was drafted by a manager's counsel; the register's counsel reads the rate because the rate is what the register's committee asked about. The four facts are therefore agreed by default, and the default is worth more to the manager than the rate it conceded. A register's counsel that reads the four facts first has read the precedent's choices as choices, and a manager that shows the four facts in a table in the memorandum has shown the register what it is buying, which a register remembers at the successor fund.

The precedents' choices

The precedents in use in the region for private funds commonly carry: a simple or compounded hurdle at a stated rate from the drawdown date; a base of contributed capital with the charge included; a deal-by-deal or whole-fund unit according to the strategy's convention; and a full catch-up. Real estate precedents lean whole-fund; credit precedents vary; private equity precedents lean deal-by-deal in some markets and whole-fund in others. A register arriving from a market with one convention reads the other as unusual, and the manager explains the four facts to each register in its own convention's terms. The explanation is the table.

The worked example, read closely

The worked example annexed to the constitution shows the four facts working on a stated portfolio: the drawdowns with dates; the hurdle accruing per drawdown, compounded or not, on the stated base; the realisations with dates and amounts; the capital returned; the hurdle returned; the catch-up, if any; the split; and under deal by deal the escrow and the clawback position at each realisation. It shows three outcomes, a strong one, a weak one and a loss, and for each the manager's share and the holders' receipts by year. A register that reads the example has read the four facts in numbers, and an administrator that computes from it computes what the register read.

The facility and the clock

A capital-call facility lets the fund invest before it draws from the holders, and the period between the facility's funding of an investment and the drawdown that repays it is a period in which the holders' capital was not yet at work by the constitution's clock and was at work by the fund's. A constitution that runs the hurdle from the drawdown has given the manager that period free of hurdle; one that runs it from the earlier of the drawdown and the facility's funding of the investment has not. Registers have noticed, and the later constitutions run the clock from the facility's funding or cap the facility's tenor so that the deferral is short. The facility's own clean-down and the constitution's clock are read together.

Where it surfaces

At the first distribution, when the administrator's calculation shows a catch-up the register did not expect.

At the hurdle's base, when the holders' charge-paying capital returns with no hurdle on it.

At the facility's deferral, when the clock started a year after the money was at work.

At the successor fund, when the register reads the predecessor's four facts and negotiates them first.

At the land platform's contribution class, when the landowner's hurdle ran from the wrong date.

The cost of getting it wrong

A register that agreed the four facts by default has paid, over a fund's life, more in the manager's share than any rate concession returned, and it learns it at the first distribution, from the administrator's calculation. A manager that hid the four facts behind the rate has a register that reads them at the successor fund and negotiates all four. The table in the memorandum costs a page; the worked example costs a day; and both are the difference between a hurdle the register understood and one it discovered.

The land platform's hurdle

A land platform's hurdle is measured on contributed capital, and a landowner's contribution class has a contribution at a valuation rather than in cash, so the class's hurdle base is the valuation at which its units were issued, and its clock runs from the contribution's date. The hurdle is met from realised value after the charges a sale bears, the Kingdom's disposition charge among them, and after the developer's promote beneath the platform, because the platform's waterfall runs on what reaches it. A platform whose hurdle is tested on gross sale proceeds has tested it on the State's money, and a platform whose contribution class's hurdle runs from the platform's first close rather than the contribution's date has given the landowner a hurdle on a period its parcel was not in.

The register's reading, in order

A register reads the four facts in order and negotiates the rate last. First the unit, because it decides when the holders receive their capital and hurdle relative to the manager. Second the catch-up, because it decides whether the hurdle is a preference. Third the base and the dates, because they decide how much hurdle accrues and from when. Fourth the compounding. Fifth the rate. A register that negotiates in that order knows what the rate is worth; one that starts with the rate has agreed the other four by default, and the default is the precedent's.

By fact · by version	The holders' preferred	The manager's preferred	What it changes
Compounding	Compounded annually	Simple	The hurdle's growth over a long hold
Clock's start	Each drawdown's date	Investment date; or after the facility's funding	The hurdle's run on deferred drawdowns
Base	Contributed capital including the charge and expenses	Capital invested only	How much hurdle accrues
Unit	Whole fund	Deal by deal	When the share is paid; the clawback's role
Catch-up	None or partial	Full	Whether the hurdle is a preference or a threshold
Rate	Higher	Lower	Less than any of the above

A timeline, as a type

Month one: the manager proposes its economics from a precedent; the register's counsel asks for the four facts in a table before the rate. Month two: the unit is agreed as whole-fund, the catch-up as partial, the base as contributed capital including the charge, the clock as the earlier of the drawdown and the facility's funding, compounded annually; the rate is then agreed at the manager's number. Month three: the worked example is annexed on three outcomes; the administrator confirms it can compute from it. Year four: the first realisation; nothing is paid to the manager, because the whole-fund unit returns all capital and hurdle first; the holders receive the distribution. Year eight: the last realisation; the holders have received their capital and the full compounded hurdle; the manager receives its partial catch-up and its share of the remainder, computed as the example showed.

The structure paper's page

The structure paper's hurdle page carries: the four facts with the version chosen and the reason; the rate; the base's definition quoted; the clock's start with the facility's treatment; the compounding; the unit and, where deal by deal, the escrow's size and the clawback's tests; the catch-up's form; the land platform's contribution class's base and date; and the worked example. The page is the register's counsel's first reading and the memorandum's economics section in its working form.

The hurdle and the tier's disclosure

The centres' funds rules require the memorandum to disclose the manager's economics in a form the holders can understand, and a memorandum that states a rate and refers to the constitution for the rest has disclosed the rate. The regulators' reviews read the memorandum's economics against the constitution's, and a memorandum that advertised a hurdle the constitution's base and catch-up hollowed out is a memorandum the review reads as incomplete. The table of four facts is the disclosure the rules intend.

Reading the hurdle with the onshore registers

Gulf institutions read the four facts as closely as any register and have their own conventions: a preference for whole-fund waterfalls on real estate, a familiarity with compounded hurdles on contributed capital, and a reading of the catch-up as the term that decides whether the hurdle is real. The Kingdom's distributor and Kuwait's licensed person file the economics with the documents, and an intermediary whose diligence reads a full catch-up behind a low rate asks the question before the filing.

The hurdle and the side letters

A holder's side letter may vary its hurdle: a higher rate, a different base, a different clock, in exchange for a larger or earlier commitment. Each variation is a class in substance, and the most-favoured-nation clause decides whether the others may elect it. A hurdle varied by side letter for one holder and not disclosed to the others is a hurdle the others read at the first distribution, when the administrator's calculation shows two rates. The concession schedule records every hurdle variation, and the constitution says that a hurdle variation is a class rather than a letter.

The hurdle and the continuation

A continuation resets the hurdle: the old fund's hurdle is tested on the transfer price as a realisation, and the new vehicle's hurdle starts on the transfer price from the transfer date. A manager whose old-fund hurdle was cleared by the transfer price it proposed, and whose new-fund hurdle starts low because the price was low, has two hurdles that serve it in opposite directions on the same number; the continuation's process tests the price so that neither hurdle is the manager's to set.

The hurdle on a loss

A fund that loses money has a hurdle that is never met and a manager's share that is never paid, under any version of the four facts; the facts matter on a fund that makes money, and they matter most on a fund that makes a modest return, where the difference between a simple and a compounded hurdle, a full and a partial catch-up, a contributed and an invested base, is the difference between a manager paid and a manager not. A register that models the four facts on a modest outcome sees what they are worth; one that models them on a strong outcome sees a manager paid either way and misreads the facts as immaterial.

The base, read closely

The base's definition lists what counts as contributed capital: amounts drawn from the holders for investments; amounts drawn for the manager's charge; amounts drawn for the fund's expenses, formation, administration, audit, the committee's adviser; amounts drawn for a facility's interest; and amounts recycled, as the recycling provision says. Each inclusion raises the base and the hurdle on it; each exclusion is money the holders paid that returns with no return. The honest base is every amount drawn, because every amount drawn is the holders' money; the manager's preferred base is amounts invested, because the charge and the expenses are, in the manager's reading, costs and not capital. The register decides, and the constitution's definition is the decision in words.

The administrator's computation

The administrator computes the hurdle per drawdown, per holder, per class, from the drawdown's date at the stated rate, compounded or not, on the stated base, to each distribution, and it computes the catch-up on each distribution's split. The computation is a model with hundreds of lines on a fund with many drawdowns and holders, and the worked example is its specification. An administrator that cannot reproduce the example from the constitution has found an ambiguity, and the ambiguity is resolved before the first distribution rather than at it.

The hurdle as the register's protection

The hurdle exists so that the manager shares in gain only after the holders have received their capital and a return on it, and the four facts decide whether that protection is real. A compounded hurdle on contributed capital from each drawdown, whole-fund, with a partial catch-up, is a protection: the holders are paid first and the manager's share is a share of what exceeds their return. A simple hurdle on invested capital from the investment date, deal by deal, with a full catch-up, is a formula: the manager is paid beside the holders from the first realisation and the hurdle, once cleared, bought nothing. Both are called a hurdle at the same rate, and the register that reads the four facts knows which it holds.

One fund under different terms

A fund draws a stated capital in three tranches over two years and realises its portfolio over years four to eight at a total gain of a stated multiple. Under a whole-fund waterfall with a compounded hurdle from each drawdown on contributed capital including the charge, no catch-up, and a stated rate, the holders receive their capital and the full hurdle before the manager receives anything, and the manager's share is its percentage of the gain above the hurdle only. Under a deal-by-deal waterfall with a simple hurdle from the investment date on invested capital only, a full catch-up and the same rate, the manager receives a share on the first realisation in year four, the catch-up brings its share to the full percentage of all gain once the hurdle is cleared, and the holders' hurdle was a threshold that bought them nothing once passed. The rate is identical in both; the manager's share differs by a large fraction; and the difference is the four facts.

Four cases, as types

A register negotiates a hurdle rate down by two points and accepts the precedent's full catch-up, deal-by-deal unit and investment-date clock. The manager's share on the fund is larger than it would have been at the higher rate with no catch-up, and the register's counsel reads the four facts at the first distribution.

A fund's constitution measures the hurdle on capital invested, excluding the manager's charge and the fund's expenses. The holders' money that paid the charge over ten years returns with no hurdle on it, and the hurdle the memorandum advertised was on two thirds of what they paid.

A fund's capital-call facility defers drawdowns by a year, and the constitution runs the hurdle from the drawdown. The holders' hurdle starts a year after their capital was at work through the facility, and the manager's share is larger by the hurdle on that year.

A register reads the four facts first, requires a whole-fund unit, a partial catch-up, a base of contributed capital including the charge, a compounded clock from each drawdown or the facility's funding, and then accepts the manager's rate. The hurdle means what the memorandum said.

What each party holds

The manager holds the four facts it proposed, usually from a precedent, and the rate it will defend.

Counsel holds the constitution's definitions: the base, the dates, the compounding, the unit, the catch-up, and the worked example that shows them.

The administrator holds the computation of a hurdle per drawdown and the catch-up's arithmetic.

The register holds the order of reading, and the rate last.

The lender holds the facility's deferral of drawdowns and the clock's treatment of it.

The landowner's contribution class holds its own base and its own date.

The sequence

1. The unit is chosen and stated: whole fund, or deal by deal with escrow and clawback.
2. The catch-up is chosen and stated: none, partial or full.
3. The base is defined: contributed capital, with the charge and expenses included or not, in terms.
4. The clock's start is defined per drawdown, with the facility's funding addressed.
5. The compounding is stated.
6. The rate is agreed, last.
7. A worked example is annexed showing the four facts and the rate on three outcomes.

Questions a manager asks

Is a full catch-up standard. It is common and it converts the hurdle into a threshold; a register that wants a preference negotiates it down, and a manager that offers a partial catch-up has offered something the register values more than a point of rate.

Does compounding matter on a short fund. Less on a five-year fund and a great deal on a ten-year one; the land platform's term makes it matter.

What base do registers expect. Contributed capital including the charge and expenses, because that is the money they paid; a base of invested capital only is read as the manager's.

Can the clock run from the facility's funding. It can, and a register reads a clock that starts after the facility has deferred the drawdown as a year of hurdle taken from it; the constitution states which date and the memorandum shows it.

What about the landowner's class. Its base is the contribution valuation and its clock the contribution date, with the hurdle on realised value after the charges and the promote.

Is the rate really the least of the four. On a fund held ten years with a facility, a deal-by-deal unit and a full catch-up, a two-point difference in rate is smaller than any one of the four facts.

Terms used

Hurdle: the return the holders receive before the manager shares in gain.

Compounding: the accrual of hurdle on unpaid hurdle as well as on capital.

Base: the capital on which the hurdle rate is applied.

Unit: the whole fund or each realisation, as the calculation's subject.

Catch-up: the manager's receipt of gain above the hurdle until its share of all gain reaches its percentage.

Clock's start: the date from which the hurdle runs on each contribution.

What to read

The constitution's definitions of contributed capital, the hurdle, the catch-up and the manager's share; the waterfall's unit and the escrow and clawback where deal by deal; the facility's deferral of drawdowns and the constitution's treatment of the clock; the worked example. On this site, the economics room under Structures and the worked structure on seed terms.