Cost of capital — private equity & credit
An 8% threshold sits comfortably above a 7.27% blended funding cost. Seventy-three basis points of headroom. Then you count the capital sitting idle, the facilities drawn early, and the fees accruing on both — and the headroom is gone.
Built by a treasury and fund finance practitioner with sixteen years across Oaktree, Citco and KPMG — not a consultancy pyramid.
What the hurdle rate misses
Illustrative, on the five-component v1.2 model. Every input — source mix, days idle, drawdown timing, fee basis — is yours to set. See the full calculation, or start with the plain-English glossary if the terms are unfamiliar.
The invisible 140
We call them invisible because nobody invoices for them. A bank bills you for interest and it lands in the accounts; nobody bills you for the profit you failed to make while capital sat waiting. Both are real money. Only one gets counted — and the uncounted ones arise from timing rather than pricing, which is why a hurdle rate set once at fund formation cannot possibly capture them.
LP preferred return, subscription line and NAV facility, blended by their real share of the next drawdown. Conventional, well understood, and comfortably below a typical 800bps hurdle.
Preferred return compounds from the call date, not the deployment date. Ninety days of idle capital costs EUR 4.2m gross — EUR 2.5m after deposit interest, and only if the LPA permits placement at all.
On an AuM basis, fees accrue on capital that has been called but is doing nothing. On a commitment basis they do not. The model switches between the two rather than assuming one.
Facilities drawn ahead of deployment cost you the interest on the borrowing and the return that capital was not earning. Treasury systems capture the first because someone invoices for it. Nobody invoices for the second.
The discipline argument
EUR 60m drawn seventy-five days ahead of deployment. The interest on that borrowing is invoiced, booked and visible — EUR 641,096. The return that capital was not earning while it sat there is neither invoiced nor booked, and it is nearly three times larger. Both are real. Only one shows up.
Where ICC sits
ICC does not replace your valuation work. It sits earlier — a gate before IC approval, and an audit trail afterwards.
Delivery
The sequence is fixed because each stage depends on the one before it. Discovery sets the inputs; the build encodes them; the pilot proves them against live deals.
Capital structure mapping across LPA, credit agreements and hedging policy. Deployment pattern and idle capital audit.
ClarityStack™ calibrated to your fund. Capital source decision matrix integrated into the treasury playbook. IC memo template with an ICC field.
Live test across three to five deals. Variance analysis against your existing hurdle and against realised cost.
Quarterly reporting, annual policy refresh, and LP-facing materials where capital allocation rigour is worth demonstrating.
Engagement
On the worked example above, the invisible 140 basis points represent roughly EUR 5.6m of cost across a EUR 400m deployment window. The pilot costs a fraction of one basis point of that.
Calibrated ICC model, IC memo template, three-deal pilot against defined success criteria.
Everything in the pilot, plus treasury playbook integration, scenario modelling and LP reporting materials.
Policy updates, scenario work on live deals, and recalibration as facility terms change.
Fit
Worth establishing early. A short call is usually enough to tell which side you are on.
Next step
Thirty minutes, your numbers, no preparation needed. We calculate the marginal ICC on a deal you are actually looking at and compare it to the threshold you would otherwise have used. If the gap is not material, that is a useful answer too.
Book a diagnosticClarityStack™ v1.2 — five-component methodology
Nothing here is a black box. Every input has a stated source, every component has visible logic, and the two judgement variables are labelled as judgement variables. This is the working model, run on an illustrative EUR 500mm fund.
This page is written for finance specialists, but the underlying idea is simple and worth understanding without the vocabulary. Here is the whole thing in ordinary language, followed by definitions of every term used elsewhere on the site.
| Term | In this example | What it means |
|---|---|---|
| LP capital | 60% at 8.00% | Money from the fund's investors — pension schemes, insurers, wealthy families. "LP" means limited partner. They are promised a minimum return, called the preferred return, before the fund manager earns anything. Here that promise is 8% a year. It is the most expensive money in the mix. |
| Subscription line | 30% at 5.20% | A bank loan secured against investors' unfulfilled promises to pay. Cheap, short-term, and used to move quickly on a deal before asking investors for cash. Sometimes shortened to "sub line". |
| NAV facility | 10% at 9.10% | A bank loan secured against the companies the fund already owns. "NAV" is net asset value — what those holdings are worth. More expensive than a subscription line because the bank is taking more risk. |
| Term | What it means |
|---|---|
| Measurement | |
| Basis point (bps) | One hundredth of one percent. 100 bps = 1%. Used because in finance the difference between 8.00% and 8.68% matters enormously, and "68 basis points" is clearer than "nought point six eight percent". |
| Annualised | A cost expressed as if it ran for a full year, so figures covering different periods can be compared. A 90-day cost is annualised by scaling it: 90 ÷ 365. |
| Marginal cost | The cost of the next unit, rather than the average across everything so far. It matters because decisions are always about what to do next, and the next euro can cost quite a lot more than the average euro already spent. |
| The decision | |
| Hurdle rate | The minimum return an investment must promise before the fund will consider it. Traditionally a fixed number set when the fund launched — typically 6% to 8% — and left unchanged for years. |
| ICC | Internal Cost of Capital. What this model produces: the true, current, all-in cost of deploying the next euro. It replaces the fixed hurdle rate with a figure that reflects what is actually happening in the fund today. |
| IRR | Internal rate of return — the annualised profit a deal is expected to make, as a percentage. If a deal's IRR is 14.2% and the ICC is 8.68%, the deal earns 5.52 percentage points more than the money costs. |
| Spread | The gap between two rates. Here, the deal's expected return minus the cost of the capital funding it. A positive spread means the deal creates value; a negative one means it destroys value however profitable it looks in isolation. |
| Investment committee (IC) | The group inside the fund that approves or rejects proposed investments. The ICC figure is designed to go into the paperwork they review. |
| The costs the hurdle rate misses | |
| Drag | A cost that reduces returns without anyone deciding to incur it. It arises from timing — money sitting still, borrowed too early, or charged fees while doing nothing — rather than from the price of anything. |
| Invisible cost | Our term for drag that never appears on an invoice or in an accounting system, and so is rarely counted. Nobody bills a fund for the profit it failed to make while capital sat waiting, but that failure is as real as any interest payment. In the worked example these costs total 140 basis points — about a sixth of the fund's true cost of capital. |
| Called capital | Money the fund has formally requested from its investors and now holds. From the moment it is called, the 8% preferred return starts accruing — whether or not it has been invested in anything. |
| Idle capital | Called capital that has arrived but not yet been invested. It is costing 8% a year and earning perhaps 3.4% in a deposit account. The difference is pure loss, and it is the largest of the invisible costs. |
| Deployment | Actually investing the money in a company. "Undeployed" means the cash is sitting in an account rather than working. |
| Commitment fee | A small charge banks levy on the unused portion of a loan facility — payment for keeping the money available. Here 0.50% a year. |
| Facility interest | The interest paid to a bank on borrowed money during the period before it is put to work. Real, invoiced, and usually the only part of the waiting cost anyone records. |
| Carried interest | Confusingly, "carry" in private equity means something else entirely: the fund manager's share of the profits, typically 20% of gains above the preferred return. It is not a cost of capital and plays no part in this model. Mentioned here only so the term is not mistaken for facility interest. |
| Opportunity cost | The value of the thing you did not do. If capital sat in an account for 75 days instead of earning 14% in an investment, that forgone 14% is an opportunity cost. It never appears in the accounts, which is precisely why it gets ignored. |
| Fund mechanics | |
| LPA | Limited partnership agreement — the contract between the fund manager and its investors. It sets the preferred return, the fees, and what the manager may do with cash that is waiting to be invested. |
| Management fee | An annual charge, here 1.50%, paid to the fund manager for running the fund. Charged either on the total investors committed, or on the value of what the fund currently holds. |
| Commitments vs AuM basis | Two ways of calculating that fee. On a commitments basis it is charged on the full amount investors promised, so it does not change with deployment. On an AuM basis (assets under management) it is charged on current holdings, which means the fund pays fees on capital sitting idle. Only the second creates drag. |
| GP | General partner — the firm managing the fund and making the investment decisions. The client for this work. |
| Hedging / FX | Protecting against currency movements when investing abroad. A euro fund buying a US business can either borrow dollars directly or borrow euros and use a currency contract. The two routes cost different amounts, and the model picks the cheaper. |
ClarityStack calculates the marginal cost of deploying the next unit of capital, for use as a pre-approval gate at investment committee. It replaces a static 6–8% hurdle rate with a live, audit-trailed threshold.
| Condition | What must be confirmed | Where |
|---|---|---|
| Multi-currency draw | The credit agreement supports drawing in the target currency, at transparent per-currency pricing. | Credit agreement |
| Idle cash placement | The LPA permits called-but-undeployed capital to be held in interest-bearing accounts. | Limited partnership agreement |
Twenty-three inputs, each labelled with the document it comes from. Where a figure is a judgement rather than an observable rate, it says so. The worked example below is an illustrative EUR 500mm fund.
| Input | Value | Unit | Basis / source |
|---|---|---|---|
| 1 Fund parameters | |||
| Fund size (commitments) | 500,000,000 | EUR | LPA / final close documentation |
| Fund base currency | EUR | LPA | |
| 2 Capital source mix | |||
| LP capital — mix % | 60.0% | % | Deployment plan / treasury forecast |
| LP capital — cost (pref rate) | 8.00% | % | LPA preferred return |
| Sub line — mix % | 30.0% | % | Deployment plan / treasury forecast |
| Sub line — all-in cost | 5.20% | % | Credit agreement: SOFR/EURIBOR + margin |
| NAV facility — mix % | 10.0% | % | Deployment plan / treasury forecast |
| NAV facility — all-in cost | 9.10% | % | NAV facility agreement |
| Mix check | 100.0% | % | If this is not 100%, weighted cost is under- or overstated |
| 3 Idle capital | |||
| Called capital sitting idle | 200,000,000 | EUR | Treasury cash position report |
| Days idle | 90 | days | Call date to expected deployment date |
| LP preferred return rate | 8.00% | % | LPA preferred return |
| Commitment fees on undrawn facilities | 0.50% | % | Credit agreement commitment fee |
| Overnight / term deposit yield | 3.40% | % | Treasury sweep rate at measurement date |
| Toggle: LPA permits idle cash placement? | YES | Y/N | Must be confirmed against the LPA. Set NO if unconfirmed. |
| 4 Drawn but undeployed capital — new in v1.2 | |||
| Amount drawn, not yet deployed | 60,000,000 | EUR | Facility drawdown log vs deployment log |
| Days drawn and undeployed | 75 | days | Drawdown date to actual deployment date |
| Facility interest rate on drawn amount | 5.20% | % | Credit agreement: all-in rate on the facility actually drawn |
| Forgone deployment return | 14.00% | % | Judgement input: fund target IRR or realised portfolio IRR |
| 5 FX sourcing | |||
| Foreign-currency deployment amount | 40,000,000 | EUR eq. | Deal funding requirement in non-base currency |
| Proportion of deployment requiring FX | 0.0% | % | Set to 0% if the deal is base-currency only |
| Toggle: multi-currency facility available? | YES | Y/N | Must be confirmed in the credit agreement. Set NO if unconfirmed. |
| Path A — native-currency tranche rate | 5.65% | % | Credit agreement: target-currency tranche pricing |
| Path B — base-currency tranche rate | 5.20% | % | Credit agreement: base-currency tranche pricing |
| Path B — forward points (annualised) | 0.68% | % | FX forward quote; embeds cross-currency basis |
| 6 Management fee | |||
| Toggle: fee basis | AUM | AUM/COMMIT | AUM = fees on invested and idle capital. COMMIT = on commitments. |
| Management fee rate | 1.50% | % | LPA management fee provision |
| 7 Drag allocation basis | |||
| Total expected deployment over drag period | 400,000,000 | EUR | Capital expected across all deals in the measurement window |
| 8 Deal assessment | |||
| Deployment amount for this deal | 75,000,000 | EUR | Proposed investment size |
| Expected deal IRR (gross) | 14.20% | % | Deal team underwriting model |
| Required spread over ICC to proceed | 1.00% | % | House policy: minimum ICC clearance margin |
Each component states its own logic. The two memo lines exist to show what the calculation would have missed under a simpler method — the gap between them is the argument for doing this properly.
| Component | Value | Unit | Logic |
|---|---|---|---|
| Component 1 — Weighted cost of next unit deployed | |||
| LP capital contribution | 4.80% | 480 bps | 60.0% of funding × 8.00% preferred return = 4.80%. The largest single cost, because LP capital is both the biggest slice and the most expensive. |
| Subscription line contribution | 1.56% | 156 bps | 30.0% of funding × 5.20% all-in rate = 1.56%. Cheaper than LP capital, which is why sub lines are drawn first. |
| NAV facility contribution | 0.91% | 91 bps | 10.0% of funding × 9.10% all-in rate = 0.91%. The most expensive source per euro, but only a tenth of the mix. |
| Component 1 | 7.27% | 727 bps | 4.80% + 1.56% + 0.91%. An annual rate: the blended cost of holding this funding mix for a year. |
| Component 2 — Net idle capital drag · measured over 90 days | |||
| Gross idle drag | 4,191,781 | EUR | EUR 200m idle × (90 ÷ 365) × (8.00% preferred return + 0.50% commitment fee) = EUR 4,191,781. The preferred return accrues to LPs from the day capital is called, not the day it is invested — so 90 days of waiting costs real money. |
| Less: interest earned on placement | (1,676,712) | EUR | EUR 200m × (90 ÷ 365) × 3.40% deposit rate = EUR 1,676,712. Earned only where the LPA permits idle cash to be held in interest-bearing accounts. If it does not, this line is zero and the drag more than doubles. |
| Net idle drag | 2,515,068 | EUR | EUR 4,191,781 − EUR 1,676,712. What 90 days of idleness actually costs the fund. |
| Component 2 | 0.63% | 63 bps | EUR 2,515,068 ÷ EUR 400m total expected deployment = 0.63%. A one-off cost per euro deployed, not an annual rate. |
| Component 3 — FX sourcing cost (optimised) | |||
| Path A — direct native-currency draw | 5.65% | % | Native-currency tranche rate |
| Path B — base-currency draw + hedge | 5.88% | % | Base tranche rate + forward points |
| Selected path cost | 5.65% | % | Lower path, only where multi-currency draw is confirmed |
| Memo: saving vs hedged path | 0.23% | 23 bps | What the optimisation is worth when FX is in play |
| Component 3 | 0.00% | 0 bps | Selected path × 0% FX proportion — nil on this deal |
| Component 4 — Management fee drag · measured over the same 90 days | |||
| Fee drag on idle capital | 739,726 | EUR | EUR 200m idle × (90 ÷ 365) × 1.50% management fee = EUR 739,726. On an AuM basis the fee is charged on capital that has been called but is not yet working, so the fund pays to manage money that is doing nothing. On a commitment basis the fee does not vary with deployment and this line is zero. |
| Component 4 | 0.18% | 18 bps | EUR 739,726 ÷ EUR 400m total expected deployment = 0.18%. A one-off cost per euro deployed. |
| Component 5 — Drawn capital opportunity cost · measured over 75 days — new in v1.2 | |||
| Combined annualised rate | 19.20% | 1,920 bps | 5.20% facility interest rate + 14.00% forgone deployment return. You pay interest on the borrowing and lose the return the money would have made if invested. |
| Drawn capital opportunity cost | 2,367,123 | EUR | EUR 60m drawn × (75 ÷ 365) × 19.20% = EUR 2,367,123. The 75 days run from the drawdown date to the date the money was actually deployed. |
| Memo: facility interest alone | 641,096 | EUR | EUR 60m × (75 ÷ 365) × 5.20% = EUR 641,096. This is the only part the bank invoices for, and the only part most treasury systems record. |
| Component 5 | 0.59% | 59 bps | EUR 2,367,123 ÷ EUR 400m total expected deployment = 0.59%. A one-off cost per euro deployed. |
| Marginal ICC — total | |||
| Marginal ICC | 8.68% | 868 bps | Sum of components 1–5 |
| Typical static hurdle (reference only) | 8.00% | 800 bps | The proxy this framework replaces — shown for contrast, not used in any calculation |
| ICC vs static hurdle | +0.68% | +68 bps | Positive = the static hurdle understates true cost of capital |
The output tab is written to be pasted. It gives the committee a recommendation, the attribution behind it, and an audit trail of every condition that was assumed — so the assumptions can be challenged in the room rather than discovered later.
| Measure | Value | Note |
|---|---|---|
| Deployment amount | 75,000,000 | Proposed investment size |
| Marginal ICC | 8.68% | Live cost of deploying the next unit of capital |
| Expected deal IRR (gross) | 14.20% | Deal team underwriting model |
| Spread over ICC | 5.52% | Deal IRR less marginal ICC |
| Spread over ICC (bps) | 552 | Same figure in basis points |
| Required spread (house policy) | 1.00% | Minimum ICC clearance margin |
| Recommendation | PROCEED | Proceed only where spread over ICC meets or exceeds house policy minimum |
| Component | Contribution | Share of total ICC |
|---|---|---|
| 1 Weighted cost of next unit deployed | 7.27% | 83.8% |
| 2 Net idle capital drag | 0.63% | 7.2% |
| 3 FX sourcing cost (optimised) | 0.00% | 0.0% |
| 4 Management fee drag | 0.18% | 2.1% |
| 5 Drawn capital opportunity cost | 0.59% | 6.8% |
| Total | 8.68% | 100.0% |
| Condition | Setting | Note |
|---|---|---|
| Drag allocation base | 400,000,000 | Fund-level drags spread across this, not this deal alone |
| Multi-currency facility draw available? | YES | Must be confirmed in the credit agreement |
| LPA permits idle cash placement? | YES | Must be confirmed in the LPA |
| Management fee basis | AUM | AUM-basis funds incur fee drag on idle capital |
| Forgone deployment return | 14.00% | Not a market-observable rate. Defaults to fund target IRR; confirm the house basis. |
Next step
Thirty minutes, your numbers. We set the inputs from your LPA and credit agreement, calculate the marginal ICC on a deal you are actually looking at, and compare it to the threshold you would otherwise have used.
Book a diagnostic