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Chapter 1 of 6 · 10 min

IRR versus MOIC

How many times the money, and how fast. The hold period ties the two together.

By the end of this chapter you can
  • Turn a multiple of money into an IRR over any hold
  • Work out the multiple a hurdle rate needs
  • Find the longest hold that still clears a hurdle
  • Explain why a fund cares about both numbers
1

The intuition

Two friends each double their savings. One took three years, the other seven. Both made 2x their money, but the first one's money was working much harder: about 26% a year against about 10%.

MOIC counts the dollars: how many came back for each one put in. IRR is the speed: the yearly rate that turns the money in into the money out. With one check in and one check out, the only thing linking them is time.

The key idea

IRR = MOIC^(1/years) − 1. The same multiple over more years is a lower IRR, and the same IRR over more years needs a bigger multiple.

2

Why it works

  • The convention here: one check in at the start, one check out at exit, nothing in between. Money returned during the hold is the dividend recap chapter.
  • IRR compounds. Growing at IRR for n years must turn 1 into the MOIC: (1 + IRR)^n = MOIC. Take the n-th root to get the IRR back.
  • The multiple a hurdle needs = (1 + hurdle)^n. A 20% hurdle needs about 2.5x over five years and about 3.6x over seven.
  • The longest hold at a given multiple = ln(MOIC) ÷ ln(1 + hurdle). Hold any longer and the IRR drops below the hurdle.
  • Funds are judged on both. IRR is what the next fundraising quotes; MOIC is the dollars that actually came back, and carry is paid on dollars. A quick 1.5x flatters the IRR but earns little; a slow 3x earns a lot but looks ordinary on IRR.
One check in, one check out
2.0x in 3 years: 2.0^(1/3) − 126.0%
2.0x in 5 years: 2.0^(1/5) − 114.9%
2.0x in 7 years: 2.0^(1/7) − 110.4%
3.0x in 5 years: 3.0^(1/5) − 124.6%
Multiple a 20% hurdle needs over 5 years: 1.2^52.49x
Longest hold at 2.5x for 20%: ln 2.5 ÷ ln 1.25.0 years

The five-year rules of thumb: 2.0x ≈ 15%, 2.5x ≈ 20%, 3.0x ≈ 25%.

3

The formulas

IRR = MOIC^(1/n) − 1

The yearly rate that turns one dollar into the multiple over n years.

MOIC = (1 + IRR)^n

The multiple a given IRR builds over n years.

n = ln(MOIC) ÷ ln(1 + IRR)

How long a multiple can take and still earn that IRR.

5 years: 2.0x ≈ 15%, 2.5x ≈ 20%, 3.0x ≈ 25%

The rules of thumb to check your arithmetic.

4

Worked example

One exit, no distributions in between. Take the root, subtract one, then check by compounding back.

Drawing the numbers…
5

See it move

Same deal. Change the multiple, the length of the hold and the fund's hurdle.

Drawing the numbers…
Try this
  • Lengthen the hold. The IRR falls and the multiple the hurdle needs rises, although the deal's multiple has not changed.
  • Raise the multiple. The IRR rises, and so does the longest hold that still clears the hurdle.
  • Raise the hurdle. The deal's IRR does not move, but the multiple needed rises and the longest acceptable hold gets shorter.
  • Set the multiple to 2.0x and the hold to 5 years. That is the 15% rule of thumb.
6

Run it backwards

Same numbers, reversed: the exit multiple is roughly fixed, whenever it happens. How long can the fund wait and still clear its hurdle?

Drawing the numbers…

Set (1 + hurdle)^n equal to the multiple and solve for n. Logarithms bring the exponent down: n = ln(MOIC) ÷ ln(1 + hurdle).

This is the question behind every exit-timing debate. A buyer offering the same price a year later is not offering the same deal: the wait costs IRR.

7

Traps

Dividing the gain by the years.
Returns compound. 2.0x over five years is 14.9% a year, not 20%.
Treating a higher IRR as always better.
A fast 1.5x can beat a slow 3.0x on IRR while making half the profit. Carry, and the LPs' wealth, are paid in dollars.
Quoting MOIC without the hold.
2.5x means little until you know how long it took. Always give both, or the years.
Forgetting a delayed exit costs IRR even at the same price.
The multiple stays put while n grows, so the IRR falls. Each extra year at a 20% hurdle needs about 20% more multiple.
Using these shortcuts when money comes back during the hold.
With a dividend in the middle, the IRR has to be solved from the dated cash flows. The root formula only works for one check in and one out.
8

Say it in the interview

The interviewer asks

“What's the difference between IRR and MOIC, and which matters more?”

Say yours out loud first, then compare.
9

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4
Drawing your questions…
Remember
  • IRR = MOIC^(1/n) − 1; MOIC = (1 + IRR)^n.
  • Same multiple, longer hold → lower IRR.
  • Longest hold for a hurdle = ln(MOIC) ÷ ln(1 + hurdle).
  • IRR measures speed; MOIC measures dollars. Funds need both.