What Is IRR (Internal Rate of Return)?

Internal rate of return (IRR) is the annualised rate at which the net present value of an investment's cash flows equals zero. In practical terms: it is the compound annual return an investment generates over its holding period, accounting for the timing and size of every cash flow in and out.

IRR is one of the primary return metrics in private equity, venture capital, real estate, and corporate finance. It answers a single question: if this investment produces these cash flows, what annualised return does that represent?

How IRR Works

IRR is calculated by finding the discount rate that brings the net present value (NPV) of all cash flows — initial investment plus all returns — to zero.

The calculation starts with an outflow (the investment), followed by a series of inflows over time (dividends, distributions, sale proceeds). IRR solves for the growth rate that connects the initial outlay to the final result, adjusted for when each cash flow occurred.

The IRR formula

IRR solves the following equation for the discount rate:

0 = CF₀ + CF₁/(1+IRR)¹ + CF₂/(1+IRR)² + ... + CFₙ/(1+IRR)ⁿ

Where:

• CF₀ = initial investment (negative)
• CF₁...CFₙ = cash flows in subsequent periods (positive or negative)
• IRR = the discount rate that brings NPV to zero

There is no closed-form solution. IRR is solved iteratively — in practice, using Excel's =IRR() function, a financial calculator, or portfolio software.

IRR vs NPV: the key difference

NPV and IRR are related but answer different questions:

MetricWhat it answersNPVDoes this investment create value at a given discount rate?IRRWhat annualised return does this investment generate?

NPV requires you to set a discount rate first. IRR produces the rate itself, which makes it useful for comparing investments without needing to agree on an assumed cost of capital in advance.

What Counts as a Good IRR?

There is no universal threshold. What constitutes an acceptable IRR depends on the asset class, the risk level, and the investor's hurdle rate — the minimum return required to justify the investment.

Asset classTypical IRR targetPrivate equity (buyout)20–30%Venture capital25–35%+Real estate (core)7–12%Real estate (value-add)13–20%Infrastructure8–15%Corporate capital projectsAbove WACC

WACC (weighted average cost of capital) is the standard corporate benchmark. If a project's IRR exceeds the company's cost of capital, it should in theory create value for shareholders.

Where IRR Is Used

Private equity and venture capital

IRR is the primary return metric for private equity and venture capital funds. These investments involve irregular capital calls over multiple years, followed by distributions at exit. An annualised percentage return is far more informative than a simple gain figure when cash flows are uneven.

A fund with a 25% IRR on a five-year cycle has compounded investor capital at 25% per year, adjusting for exactly when each capital call was made and each distribution was received.

Real estate investing

Real estate investors use IRR to compare projects with different holding periods, financing structures, and cash flow profiles. A development project with a two-year build phase looks different from a ten-year income property. IRR converts both into a comparable annual rate.

Corporate capital budgeting

Finance teams apply IRR to rank competing capital projects: equipment purchases, facility expansions, acquisitions. The decision rule is straightforward — fund projects where IRR exceeds the hurdle rate and pass on those where it does not.

Limitations of IRR

IRR is useful but incomplete when used in isolation.

The reinvestment rate assumption. Standard IRR assumes that interim cash flows are reinvested at the same rate as the IRR itself. For high-IRR investments, this overstates realistic returns. Modified IRR (MIRR) corrects for this by applying a more conservative reinvestment rate.

Multiple solutions. When cash flows change sign more than once — an investment that returns capital midway, then requires further contributions — the IRR equation can produce multiple valid solutions. The result becomes ambiguous.

Size blindness. A £50,000 investment with a 40% IRR creates less absolute wealth than a £5 million investment with a 20% IRR. IRR must be read alongside MOIC (multiple on invested capital) to give a complete picture of absolute return.

Holding period distortion. A two-year investment with a 30% IRR is not directly comparable to a seven-year investment with a 25% IRR. The compounding effect over time matters. Comparing IRR across different holding periods requires care.

For investors managing private market positions alongside listed assets, tracking IRR manually across separate spreadsheets introduces errors with every new cash flow. Platforms like Findex consolidate holdings across asset classes into a single portfolio view, giving investors a cleaner picture of how each position is performing.

FAQ (Frequently Asked Questions)

What is IRR in simple terms?

IRR is the annual return rate an investment generates based on its cash flows over time. If you invest £10,000 today and receive £14,693 in five years with no interim cash flows, your IRR is 8% — the same as compounding at 8% per year for five years.

What is a good IRR for a private equity investment?

Buyout funds typically target 20–30% IRR. Venture capital targets are higher, often 25–35% or more, reflecting greater early-stage risk. The relevant threshold is the hurdle rate: the minimum return required given the risk of the investment.

How is IRR different from ROI?

ROI measures total percentage gain without accounting for time. A 100% ROI over one year is fundamentally different from 100% ROI over ten years. IRR converts total return into an annualised rate, which makes time-adjusted comparison accurate.

Can IRR be negative?

Yes. A negative IRR means the investment returns less than was originally invested, after adjusting for the time value of money. Negative IRR signals capital loss.

What is MIRR and when should I use it?

Modified internal rate of return (MIRR) addresses the reinvestment rate assumption in standard IRR. It applies a realistic reinvestment rate — typically the cost of capital — to interim cash flows. MIRR is more conservative and more accurate for investments with significant interim distributions.

Why do private equity funds report IRR rather than simple return?

Private equity investments involve irregular capital calls and distributions over multi-year periods. A simple percentage return would ignore the timing of when capital was deployed and returned. IRR accounts for every cash flow's timing, making fund-to-fund comparison consistent.

How do I calculate IRR in Excel?

Use =IRR(values, [guess]). Enter the initial investment as a negative number, followed by expected cash flows in chronological order. For investments with irregular timing between cash flows, use =XIRR(values, dates) instead.

What is the relationship between IRR and NPV?

They are two sides of the same calculation. NPV tells you the value an investment creates at a given discount rate. IRR tells you what discount rate makes NPV equal to zero. If IRR exceeds your required return, NPV at that required return will be positive — both tests agree on whether an investment is acceptable.