Preferred return
A guaranteed minimum return to certain members before others share in profits.
Definition
A preferred return gives specific members (typically passive investors) a guaranteed annual return on their capital contribution before any other members share in profits. Common in real estate LLCs and venture-capital partnerships. The preferred return is paid out of LLC profits to the preferred members first; remaining profits then flow per the agreed waterfall.
Context
Preferred returns are specified in the Operating Agreement's distribution waterfall. Typical preferred returns range 6-10% annually.
Example
A real estate LLC has investors who contributed $1M with 8% preferred return. Each year, the first $80,000 of LLC profit goes to investors as preferred return. Profits above that flow per the rest of the waterfall.
Common pitfalls
- Compounding vs simple preferred-return calculations make a substantial difference over multiple years.
- Catch-up provisions for preferred returns can complicate the waterfall.