Internal rate of return
The annualised rate of return that reflects when cash goes in and comes out.
IRR rewards returning money early, so it can be flattered by short holding periods and subscription lines. That is why LPs read it together with multiples such as TVPI and DPI.
IRR is the discount rate at which the present value of all cash flows into a fund equals the present value of all cash out, including the current net asset value for unrealised investments. Gross IRR is measured before fees and carry, and net IRR is what LPs actually earn.
Because IRR weights early returns heavily, a quick small win can show a very high IRR that adds little real money. LPs therefore read IRR together with TVPI, DPI and the size of the investments, and often ask for IRR with and without a subscription line.
Worked example
An investment of $10M that returns $20M after two years has an IRR of about 41.4 percent. The same $20M returned after six years gives an IRR of about 12.2 percent. Both have a 2.0x multiple, which is why IRR and a multiple are always shown together.
Common questions about IRR
What is a good IRR for a venture capital fund?
It depends heavily on vintage and strategy. Net IRRs in the high teens or above are generally considered strong over a full fund life, but LPs compare against funds of the same vintage rather than a fixed number.
What is the difference between gross and net IRR?
Gross IRR measures the return on investments before management fees, expenses and carried interest. Net IRR is after those costs, which is what LPs actually receive.