A distribution threshold (also called a "hurdle" or "preferred return") is the amount of cumulative distributions that must be paid to capital-contributing members before incentive unit holders (sweat equity) start participating. Common thresholds range from 1x to 3x invested capital.
Why thresholds exist: They protect investors by ensuring they recoup their investment before service providers share in profits.
Impact on timing: A $2M threshold on a company earning $100K/year in distributable cash means you wait 20+ years. Revenue growth and margins are critical.
Thresholds typically equal 1x–2x the total capital contributed by investing members. A $2M threshold on a $1M investment is common. Thresholds above 2x invested capital should raise questions about deal fairness, as they significantly delay service providers' participation in economics.
Can I negotiate a lower threshold?
Yes, and this is one of the most impactful negotiation points. Consider proposing milestone-based threshold reductions (e.g., threshold drops 25% when company hits $3M revenue), time-decay (threshold reduces 10% per year after year 3), or catch-up provisions that accelerate your share once the threshold is met.
What if the company never reaches the threshold?
If cumulative distributions never exceed the threshold during the company's life, incentive unit holders receive nothing — even if the company was profitable. This is why the break-even timeline is critical: if projections show 15+ years to threshold, the deal may not be worth the opportunity cost.
How do profit margins affect my break-even?
Dramatically. A company with $2M revenue and 30% margins generates $600K in distributable profits (at 100% distribution rate), reaching a $2M threshold in ~3.3 years. At 10% margins, the same revenue produces only $200K/year — a 10-year path. Margin improvements accelerate break-even more than revenue growth in many cases.
What's a catch-up provision and should I negotiate for one?
A catch-up provision gives incentive unit holders accelerated distributions after the threshold is met, "catching up" to what they would have received without a threshold. For example, after the $2M threshold, 100% of the next $X goes to you until you're caught up, then normal splits resume. This is very favorable and worth negotiating.