What is considered a good IRR for private equity?
The median net IRR is between 20% and 25%. Consistent with the PE investors' gross IRR targets, this would correspond to a gross IRR of between 25% and 30%.
According to research by Industry Ventures on historical venture returns, GPs should target an IRR of at least 30% when investing at the seed stage. Industry Ventures suggests targeting an IRR of 20% for later stages, given that those investments are generally less risky.
On average, private equity firms target roughly a 20% to 25% internal rate of return (“IRR”) and a 2.5x to 3.5x multiple on invested capital (“MOIC”).
There isn't a one-size-fits-all answer, but generally, an IRR of around 5% to 10% might be considered good for very low-risk investments, an IRR in the range of 10% to 15% is common for moderate-risk investments, and in investments with higher risk, such as early-stage startups, investors might look for an IRR higher ...
Whether an IRR is good or bad will depend on the cost of capital and the opportunity cost of the investor. For instance, a real estate investor might pursue a project with a 25% IRR if comparable alternative real estate investments offer a return of, say, 20% or lower.
Private Equity Has Outperformed
As of March 31, 2022, these companies generated a gross internal rate of return (IRR) of 18.3%, and with all deals included, a gross IRR of 18.6%.
What is a good IRR for venture capital? “Since VC funds have very high risk, very high return profiles, normally anything above 30% is the target,” says Titan senior investment strategist John Bottcher.
Private equity produced average annual returns of 10.48% over the 20-year period ending on June 30, 2020. From 2000 to 2020, private equity outperformed the Russell 2000, the S&P 500, and venture capital. When compared over other time frames, however, private equity returns can be less impressive.
You want a positive IRR—a negative IRR indicates you'd lose money on the investment. Generally, an IRR of 18% or 20% is considered very good in real estate.
Hurdle rates in private equity typically range from 7% to 8% but can vary based on the fund's strategy and the agreement between LPs and GPs. Only after reaching the hurdle rate do GPs start receiving their share of the profits, often about 20% of the fund's returns above the hurdle rate.
What is the rule of thumb for IRR?
So the rule of thumb is that, for “double your money” scenarios, you take 100%, divide by the # of years, and then estimate the IRR as about 75-80% of that value. For example, if you double your money in 3 years, 100% / 3 = 33%. 75% of 33% is about 25%, which is the approximate IRR in this case.
XIRR, or Extended Internal Rate of Return, measures the annualized return on an investment portfolio. For mutual fund portfolios, a good XIRR can vary based on market conditions and individual risk tolerance. Generally, a benchmark for a good XIRR is around 15-20%.
If you were basing your decision on IRR, you might favor the 20% IRR project. But that would be a mistake. You're better off getting an IRR of 13% for 10 years than 20% for one year if your corporate hurdle rate is 10% during that period.
Internal Rate of Return (IRR)
IRR reflects the performance of a private equity fund by taking into account the size and timing of its cash flows (capital calls and distributions) and its net asset value at the time of the calculation.
If you invest 1 dollar and get 2 dollars in return, the IRR will be 100%, which sounds incredible. In reality, your profit isn't big. So, a high IRR doesn't mean a certain investment will make you rich. However, it does make a project more attractive to look into.
ROI and IRR are complementary metrics where the main difference between the two is the time value of money. ROI gives you the total return of an investment but doesn't take into consideration the time value of money. IRR does take into consideration the time value of money and gives you the annual growth rate.
The main problem with the IRR calculation is the assumption that cash proceeds are reinvested at the same IRR for the entire investment period.
A MOIC of 3x and above, which indicates that the investment has tripled the initial capital or better, is considered excellent, mainly if it's realized over a short to moderate timeframe. On average, most private equity firms target a MOIC of between 2.5x and 3.5x.
Decision Rule:
If two projects are mutually exclusive, and one has a higher NPV, but the other has a higher IRR, the project with the higher NPV must be chosen, as only NPV maximises shareholder wealth.
Higher IRR suggests a more attractive project. Conflicts between NPV and IRR arise in comparing mutually exclusive projects due to different assumptions, especially regarding the discount rate. NPV is generally preferred for its realistic assumptions and clarity on firm value impact.
Is IRR calculated on Ebitda?
Calculates the value of a business, or an internal rate of return (IRR), based on its projected EBITDA as a proxy for enterprise cash flows. Allows for either the calculation of a valuation based on an assumed discount rate or the calculation of an IRR based on an assumed value.
The TLDR; seed investors shoot for a 100x return; Series A investors need an investment to return 10x to 15x and later stage investors aim for 3x to 5x multiple of money. This translates into portfolio returns from 20% to 35% targeted IRRs.
This means the fund manager receives the next distributions until it has caught up its percentage of carried interest. So, if this were 20%, the fund manager takes distributions until profits are split 20% to the fund manager and 80% to the investors.
Public Market Indexes – including broad indexes like the S&P 500 – are commonly used benchmarks for private equity. Public Market Indexes plus a Premium – for example, the S&P 500 plus 4% to 6% – also are commonly used.
Stated as a percentage or equity multiple, preferred return is often favored by investors since the sponsor's “promote” or profits participation is subordinated up to a specific return threshold, generally 8 to 10 percent.
