The Internal Rate of Return (IRR) is the discount rate at which the net present value of an investment's cash flows equals zero — in other words, the annualised compound return generated by an investment from inception to exit, taking into account both the timing and magnitude of all cash flows. It is the primary performance metric used by private equity funds to measure and compare the returns of their portfolio investments.

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In an LBO context, the IRR is driven by three levers: operational value creation (EBITDA growth during the holding period), multiple expansion (selling at a higher multiple than the entry multiple), and leverage (the compounding effect of equity returns amplified by debt repayment). A typical mid-market PE fund targets a net IRR of 20–25% over a 4–7 year holding period.

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The IRR is a time-weighted metric: the faster cash is returned to investors, the higher the IRR, even at the same absolute multiple of invested capital (MOIC). This is why PE funds prioritise earlier exits when possible — a 3.0x MOIC in 4 years (IRR ~32%) is far superior to the same 3.0x in 7 years (IRR ~17%). The J-curve effect reflects the early years of negative IRR as management fees and initial investments are made before value is created.

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The IRR is distinct from the Money-on-Invested-Capital (MOIC) multiple, which simply measures the total return regardless of time. Both metrics are reported together by PE funds to give investors a complete picture of investment performance.

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Example: a PE fund invests CHF 8.0 million equity in a Swiss SME LBO in Year 0. After 5 years of holding (EBITDA growth from CHF 2.0M to CHF 3.2M, entry 5x / exit 7x, net debt repaid from CHF 10M to CHF 4M), the fund exits for CHF 26.4M enterprise value, receiving CHF 22.4M equity. IRR = 23.0%, MOIC = 2.8x.

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At Hectelion, we model IRR and MOIC scenarios in our LBO structuring and exit analysis mandates, providing investors with a complete return profile under multiple scenarios.