IRR
Internal Rate of Return. The annualised return on an investment accounting for the timing of cash flows. PE funds target IRRs typically in the high teens to mid-twenties percent for buyouts.
Why IRR matters in interviews
IRR is the number private equity is measured and paid on, so interviewers test whether you understand its mechanics and its weaknesses. The most revealing follow-up is why a fund would take a lower-IRR deal — because it exposes whether you know that IRR is time-sensitive and MoIC is not.
How it works in practice
IRR is the discount rate at which the net present value of all cash flows equals zero — the annualised compound return on invested capital, accounting for when cash comes back.
Because it is time-weighted, an early exit flatters it dramatically. Turning $100m into $200m in two years is a 41% IRR; the same 2.0x over five years is about 15%. This is why sponsors pursue early dividend recapitalisations even when they do not change total proceeds.
Approximation ladder for five-year holds: 1.5x ≈ 8%, 2.0x ≈ 15%, 2.5x ≈ 20%, 3.0x ≈ 25%, 4.0x ≈ 32%. Interviewers expect you to work from these rather than compute.
What candidates get wrong
- Treating IRR and MoIC as interchangeable. A 3.0x over ten years is a mediocre 12% IRR; a 1.6x over eighteen months is an excellent one.
- Forgetting that IRR assumes interim cash flows are reinvested at the IRR itself — an assumption that rarely holds and which MIRR exists to correct.
- Not being able to explain why a fund might prefer a lower-IRR, higher-MoIC deal: absolute dollars of profit, deployment of a large fund, and carry generation all argue for it.
IRR: frequently asked questions
What is the difference between IRR and MoIC?
MoIC is total cash returned divided by cash invested and ignores timing entirely. IRR is the annualised rate that sets net present value to zero and is highly sensitive to timing. A deal can have a strong MoIC and a weak IRR if it takes a long time, or the reverse if capital returns quickly.
What is a good IRR in private equity?
Funds typically target 20-25% gross IRR at the deal level, which nets down after fees and carry. The preferred return threshold above which general partners earn carry is conventionally 8%, so returns below that generate no incentive compensation for the sponsor.
Go deeper
This term comes up constantly in private equity interviews and on the desk.
Private Equity interview prepRelated Private Equity terms
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