Internal rate of return (IRR): how to calculate IRR, IRR vs ROI, and what “good” looks like in private equity

What is IRR?

IRR (internal rate of return) is an annualized rate of return that accounts for the timing of cash inflows and outflows from an investment.

More formally, IRR is the discount rate that makes the net present value (NPV) of all cash flows equal to zero. 

Simply put:

• Money today is worth more than money later.
• IRR is the “per year” rate that makes your starting cash outflow, and your future inflows balance out when you time-adjust them.

That timing part is the whole game. Two investments can have the same total profit, but the one that returns cash sooner is bound to have a higher IRR.

Why IRR exists (and when it’s useful)

IRR is most useful when:

• Cash flows happen over time (not just “buy” and “sell”).
• You want a single number that reflects both outcome and timing.

That’s why IRR shows up constantly in:

• Private equity and venture capital funds (capital calls now, distributions later)
• Real estate (purchase, rent, refinance, sale)
• Projects with uneven cash flows (a.k.a. real life)

But IRR is not magic. It’s a tool. And like any tool, it can be used well or it can beused to make something look shinier than it is.

The IRR formula (NPV = 0)

Here’s the math version you’ll see in textbooks and spreadsheets:

0 = t=0nCFt(1+r)t

Where:

• CFₜ = cash flow at time t (negative for money out, positive for money in)
• r = the IRR you’re solving for
• t = time period (usually years)
• n = final period

The key takeaway: you’re solving for the rate “r” that makes the equation equal zero. 

In most real cases, you don’t “solve” this by hand. You let Excel do it using iterative math.

How to calculate IRR step-by-step

Let’s walk through how to calculate IRR in a way that works whether you’re building a model or sanity-checking someone else’s.

Step 1: List every cash flow (including the negative one)

On Excel, IRR only works if your cash flows include:

• at least one negative cash flow (you invested money), and
• at least one positive cash flow (you got money back). 

Also, order matters; spreadsheets interpret cash flows in the order you provide them. 

Step 2: Decide whether your cash flows are “regular” or “irregular”

Use:

• IRR when cash flows happen at regular intervals (monthly, quarterly, yearly).
• XIRR when cash flows happen on specific dates (irregular spacing). 

Step 3: Calculate IRR in Excel (regular intervals)

Excel’s function is: =IRR(values, [guess])

• values is your range of cash flows
• guess is optional (Excel will guess if you don’t)

Step 4: Calculate IRR in Google Sheets with XIRR (irregular dates)

Google Sheets’ function is: =XIRR(values, dates, [guess])

This is specifically built for “real-world timing” where dates aren’t perfectly periodic. 

Step 5: Sanity check the result

Before you celebrate (or panic), ask:

• Are the cash flows in the right order?
• Did you accidentally flip signs (inflows should be positive, outflows negative)?
• Is the “IRR” absurdly high because you got a small distribution really fast?

Worked example: IRR vs ROI in the same deal

Here’s a simple, clean example with annual cash flows:

IRR (annualized, timing-aware)

In Excel/Sheets (assuming the cash flows are in B2:B6): =IRR(B2:B6)

That returns an IRR of ~12.8% per year for this set of cash flows.

What that means: this investment behaves like something compounding around 12.8% annually, given the timing of the returns.

ROI (total return, timing-blind)

Total cash in = 2,000 + 3,000 + 4,000 + 5,000 = 14,000
Total profit = 14,000 − 10,000 = 4,000
ROI = 4,000 / 10,000 = 40%

That’s the difference in one line:

• ROI says: “I made 40% overall.”
• IRR says: “Given when I got paid, this looks like ~12.8% per year.”

And yes, both are “true.” They’re answering different questions.

IRR vs ROI: what’s the difference?

If you only remember one thing, make it this:

• ROI measures how much you made.
• IRR measures how fast you made it (annualized) and accounts for timing.

The following is a more comprehensive look between the two:

You’ll see people argue “IRR vs ROI” like it’s a fight. It’s not. It’s more like… a screwdriver vs a wrench. Use the one that fits the problem.

IRR vs NPV: why they sometimes disagree

NPV tells you: “How many dollars of value did this create (in today’s dollars) at a given discount rate?”

IRR tells you: “What discount rate makes NPV equal zero?”

They can disagree because:

• IRR is a rate, not a dollar outcome.
• A small investment can have a huge IRR but create fewer total dollars than a larger one.

Quick intuition example:

• Project A: invest $100, get $130 in a year → 30% IRR, +$30 value
• Project B: invest $1,000,000, get $1,200,000 in a year → 20% IRR, +$200,000 value

If you’re trying to build wealth in actual dollars, NPV (and plain profit) matters. This is often why MOIC is a great metric to consider; you can learn more about it here.

Common IRR pitfalls (aka “why this number sometimes lies to you”)

IRR is useful. It’s also very easy to misunderstand or to accidentally game.

1) Early cash flows can dominate the IRR

In private funds, small early distributions can make IRR look great, even if later performance is just… fine.

CFA Institute has pointed out that IRR can overweight early cash flows and can exaggerate differences between investments with similar multiples.

2) IRR can be “sticky” once it’s high

As underscored by FT, in private markets, IRR can become effectively “fixed” early in a fund’s life. That’s one reason critics argue it can be misleading as a long-term scorecard. 

3) Multiple IRRs (yes, plural) can exist

If cash flows change sign more than once (e.g., invest → distribute → reinvest), the math can produce more than one valid IRR.

That’s why spreadsheets include the optional guess input, and why different guesses can sometimes produce different results. 

4) The “reinvestment assumption” is often misunderstood

A classic critique: IRR can implicitly assume you reinvest interim proceeds at the same rate, which may not be realistic.

One workaround is MIRR (modified internal rate of return), which uses more realistic assumptions about reinvestment and financing rates. 

5) Private-market IRR should be paired with multiples

If you’re evaluating funds, IRR alone is not enough. Many institutional conversations increasingly emphasize distributions (like DPI) because “paper gains” don’t pay bills. 

Practical takeaway: If someone shows you a beautiful IRR, ask what the multiple and distributions look like, too.

What is a good IRR in private equity?

Let’s answer the question people actually ask: what is a good IRR in private equity?

A “good” IRR depends on:

• Strategy (venture, growth, buyout, real estate, credit)
• Risk level (and how much leverage is involved)
• Fees (gross IRR vs net IRR)
• Fund age (early IRRs can be noisy)
• Vintage year (macro matters)
• Benchmark (compared to what?)

That said, we can still give useful ranges; as long as we treat them as context, not promises.

Contextual “target net IRR” ranges (illustrative)

Wellington (a large asset manager) published a helpful table framing typical target net IRR ranges by fund type, such as:

• Early-stage venture: 20%–25%
• Late-stage growth: 18%–22%
• Buyout: 15%–20% 

Carta provides additional “real-world expectation” context for venture funds, noting that LPs often expect net IRR to reach at least ~20% by the time a VC fund is fully exited, and that early-stage VC targets can be higher (often cited at ~30% net IRR). 

Meanwhile, CFA Institute commentary has argued that “headline” PE IRRs can be inflated by unrealistic assumptions and gives an example framing in which ~12% is a more realistic long-run IRR in certain contexts (and consistent with observed multiples). 

And Preqin research (e.g., comparing specialist vs. generalist PE funds across certain vintages) has reported median net IRRs in the mid-teens, depending on the market segment you’re looking at. 

A practical way to think about “good IRR”

If you want a simple mental model:

• Low double-digit net IRR can be perfectly respectable in many mature PE strategies (especially given fees, leverage, and real-world exit timing).
• Mid-to-high teens net IRR is generally strong.
• 20%+ net IRR is often exceptional, but also where you should ask the most questions (because timing effects can juice the number).

And yes, plenty of funds target “high teens.” For example, Reuters has reported specific fundraising targets in that range for major buyout funds. 

Don’t confuse IRR with the hurdle rate

Many private equity agreements include a preferred return / hurdle rate (often around 7%–8%) before carried interest kicks in. 

That hurdle is a contract term, not a market guarantee. It’s more like: “LPs get paid first up to X, then profits split.”

How to use IRR like a pro (without getting fooled)

Here’s a quick checklist you can steal:

• Confirm the cash flow schedule. IRR changes if you shift timing even slightly.
• Ask: gross or net? Net IRR (after fees) is the number LPs actually feel.
• Pair IRR with multiples and distributions. IRR can look great without meaningful cash back.
• Benchmark by vintage and strategy. Comparing a 2021 growth fund to a 2013 buyout fund is apples vs… scooters.
• Treat very high IRRs as a prompt, not a conclusion. “How did they get paid so fast?” is usually the right question.

For more robust benchmarking frameworks (especially against public-market alternatives), institutional firms like Cambridge Associates emphasize comparing private performance in context rather than relying on a single metric in isolation. 

Final thoughts

IRR is popular for a reason: it compresses messy cash flows into one clean, annualized number.

But if you’re learning how to calculate IRR, remember the bigger lesson: IRR is a timing metric, not a full truth machine.

Use it with:

• ROI (for total gain),
• multiples and distributions (for private funds),
• and a benchmark mindset (for reality checks).

If you’re exploring private-market opportunities and metrics more broadly, Augment’s marketplace, Glossary, Collective, and The Power 20 are great next stops inside the ecosystem.

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