IRR (internal rate of return) is the annualized return metric that equates the present value of all cash outflows and inflows from an investment to zero — widely used to compare venture and private equity fund performance.

How it works

Calculate IRR by finding the rate that balances capital calls (negative flows) and distributions (positive flows) over time. Returning capital quickly boosts IRR even if absolute multiples are modest; long holds with high multiples can show lower IRR. Funds report gross IRR on portfolio cash flows and net IRR after fees and carry to LPs. Early in a fund’s life, IRR reflects unrealized marks on portfolio companies — volatile and reversible. Mature IRR based on realized distributions is more credible. IRR complements MOIC (multiple on invested capital) and DPI: a fund can show strong IRR with low DPI if marks are high but exits are sparse. LPs scrutinize IRR alongside these metrics and vintage peers.

Why it matters

• LPs: Use IRR for manager selection but stress-test with DPI and TVPI. Ask how much IRR comes from realizations versus paper marks.
• GPs: IRR drives fundraising narratives; understanding its sensitivity to timing helps communicate performance honestly.

Common mistake

Ranking funds on IRR alone without cash returned. Paper IRR on marked-up positions overstates performance until distributions prove exits.

Related ideas

IRR gross, IRR net, DPI, TVPI, MOIC, and hurdle rate form the LP performance toolkit.