The Internal Rate of Return (IRR) is the discount rate at which the net present value (NPV) of all cash inflows and outflows from an investment equals zero. In practical terms, it measures the annualised effective compounded return on invested capital, accounting for the exact timing of each capital call and distribution.
IRR is the most widely used performance benchmark in private equity and venture capital. A net IRR (after fees and carry) above the fund's hurdle rate is necessary for the GP to earn carried interest. IRR is sensitive to the timing of cash flows — a quick win early in the fund's life boosts IRR disproportionately, while a large unrealised position with no distributions can suppress it. For this reason, IRR is best read alongside TVPI and DPI multiples.