Is IRR a Good Performance Metric in Private Equity?

Internal Rate of Return (IRR) is the worst form of private equity performance measurement… except for all the others. This twist on a Winston Churchill quote sums up the love-hate relationship investors have with IRR.

While it’s the industry’s most cited metric, IRR can be highly misleading if you don’t understand its fundamental weakness: extreme sensitivity to time.

For example:

• Doubling your money (2.0x MOIC) in 1 year = 100% IRR
• Doubling your money (2.0x MOIC) in 2 years = 41% IRR
  Same multiple, completely different IRRs.
  
  

This time-driven nature creates strong incentives for GPs to shorten the “measured” investment period—sometimes through financial engineering rather than true performance.

Two Common Tools to Inflate IRR

1. Subscription Lines of Credit – Funds borrow from a bank to make investments and delay calling capital from Limited Partners (LPs). If IRR is measured from the capital call date instead of the investment date, the clock looks shorter and the IRR appears higher.
2. NAV Loans – Funds borrow against the Net Asset Value of their portfolio to finance early distributions. This creates the illusion of quick returns, boosts IRR, and inflates another key metric: DPI (Distributed to Paid-In Capital).

Both tactics can make performance look better than it really is—and are often opaque to investors.

The Investor’s Antidote: Ask the Right Questions

During due diligence, LPs should go beyond the headline IRR and ask:

• “Can you show me the IRR calculated with and without the subscription line?”
• “Do you use NAV facilities or fund-level leverage to accelerate distributions? If so, what are the terms?”
  
  

IRR isn’t going away—but smart investors know how to ask the right questions. Real diligence means digging into the mechanics behind the metrics.