Sign inWhat is IRR in private equity?
IRR is the annualised discount rate that makes a deal's cash flows net to zero. It is time sensitive, so the same multiple earned faster produces a higher IRR.
IRR solves for r where the net present value of all cash flows equals zero.
How practitioners use it
Internal rate of return is the standard headline metric in private equity because limited partners fund commitments over time and care when cash comes back, not only how much of it comes back.
The consequence is that IRR rewards speed. A 2.0x return earned in three years is a materially better IRR than the same 2.0x earned in six, even though the multiple is identical. This is why sponsors care about early dividend recapitalisations and quick partial exits.
Because it is sensitive to timing, IRR can be flattered by short holds and small early distributions. That is exactly why nobody quotes it alone.
Worked example with round numbers
01
Invest 500 of equity at entry and return 1,000 at exit.
02
Over five years that is a 2.0x multiple, which converts to roughly a 15% IRR.
03
Compress the same exit into three years and the IRR rises to roughly 26% with no change to the multiple.
Where people get it wrong
- Quoting IRR without stating the hold period, which makes the number unverifiable.
- Comparing a gross deal IRR to a net fund IRR, which is after fees and carry.
- Assuming a higher IRR always means more money returned. It does not.
Learn it by using it
Definitions stick once you have run the numbers yourself. The desk below is free and needs no signup.
Open the IRR calculator