IRR
LBOThe annualised compound return on an investment, the primary measure a private equity fund is judged on.
Also written: internal rate of return
IRR is the discount rate at which the net present value of an investment's cash flows equals zero, which in plain terms is the annualised rate at which the money compounded.
It is time sensitive, which is its great virtue and its great weakness. Doubling your money in three years is roughly 26%; doing it in five is roughly 15%. The same profit, a very different result, which is why exit timing matters as much as exit price.
That sensitivity can be gamed. A dividend recapitalisation early in the hold, or a quick partial exit, lifts IRR substantially without changing the total profit, which is precisely why funds report MOIC alongside it.
It also assumes interim cash flows are reinvested at the IRR itself, which is rarely realistic, and it can produce multiple or meaningless answers where cash flows change sign more than once.
Worked example
330 of equity invested, 950 returned after five years. That is 2.88 times money.
IRR is 2.88 to the power of one fifth, less one, so about 23.6%.
Return the same 950 after three years instead and the IRR jumps to about 42%, with identical profit. That time sensitivity is why funds report MOIC alongside IRR, and why an early dividend recapitalisation flatters the headline return.