Internal Rate of Return (IRR) is another metric by which private equity investments can be measured. As a widely accepted measure of time-weighted returns, IRR is a traditional approach to measuring the profitability of any investment with both negative and positive cash flows over time. An IRR is essentially the single compounded rate of return that equates the present values of all the negative cash flows with those of all the positive cash flows. Essentially, that means it finds the equivalent rate of return that one would realize if the total investment were made all at once, compounded over the period in question, and liquidated at the end. MOIC tells you how the value of an investment has grown on an absolute basis, while an IRR tells you how that investment has generated returns on an annualized basis. A 2.0x MOIC over 3 years reflects an attractive annual return, equating to an IRR of c. 26%, while the same MOIC over 5 years equates to an IRR of c. 15%. As an example of how IRR differs from MOIC, the following table represents the calculations for two similar-sized investments in different funds:
Year 0Year 3Year 5 Investment A Investment Outlay$100,000 Realized Value$40,000$185,000 Unrealized value$108,000$85,000 MOIC1.5x2.7x IRR14%22% Investment B Investment Outlay$100,000 Realized Value0$245,000 Unrealized Value$120,000$75,000 MOIC1.2x3.2x IRR5%26% Learn more about private equity fund performance.