Which is more important: IRR vs. MOIC
Hey everyone, university student here. I recently spoke about investment strategy with an alum at a fairly well-known PE firm. When discussing returns analysis, he said that in most cases his firm cares about MOIC more so than IRR. Maybe I'm taking an academic approach, but I would think IRR is more important in most transactions since time horizon is considered.
I was wondering what the industry standard is in measuring returns? Do most PE firms use one metric over the other? Do GPs and LPs have different preferences between IRR and MOIC? I know both are usually considered, but I'm curious to see if there is a common theme across the Street regarding importance. All input is appreciated.
From Marcus_Halberstram
Key thing you need to zero in on in comparison questions is what the third variable that needs to be considered. In most comparison questions, there is an indifference point at a given third variable.
In this case, the third variable is time.
There are 3 things to keep in mind when answering this question:
So the answer is it depends. What is the time horizon. With that third variable answered, you can properly make a decision.
This makes a lot of sense. I guess the best way for me to understand it would be that a specific IRR (say 40%) is more impressive over a longer period of time, while a specific MOIC (say 3X) is more impressive over a shorter period of time. This should take into account the time factor.
Makes sense that PE firms look at both metrics, considering the typical investment period is 5-7 years (happy medium between "long" and "short" holding periods). Thanks for the help!
All firms look at both IRR and multiple.
Multiple is looked at more heavily on longer term holds because the IRR is going to appear low on those (due to time value of money.)
Exactly. It's cynical, but when hold periods extend beyond the usual 5-7 years you'll see a lot more talk of the MOIC. When the exit is within or before 5-7 years, the investor will talk up the IRR.
But IRR is the most important one, and definitely the most important metric for a fund (vs. an individual investment). You buy your groceries, so to speak, with the IRR, not the MOIC.
Use the the modified IRR- that is, IRR where distributions are reinvested at some other rate that's pegged to an outside source. For instance, if you know that your firm as a whole has a historical IRR of X%, you can assume proceeds from any given investment will be reinvested at that rate. This really only matters though when you are comparing two good opportunities and can only choose one.
Modified IRR? The IRR calculation works as you describe it, not exactly sure what you are getting at.
A "Public Markets Equivalent" (PME) analysis can be pretty insightful: https://en.wikipedia.org/wiki/Public_Market_Equivalent
It will essentially show you on an actual cash flow out/in basis how you would have done against an index vs. a PE investment or fund.
See this link for an explanation of the difference between IRR and MIRR and why I generally prefer the latter: https://www.investopedia.com/terms/m/mirr.asp
IRR for carry hurdles, cash on cash for actual $$$.
This. The reason your guy cares about MOIC is because most funds have an 8% hurdle rate. If his fund is consistently over the hurdle rate...the only thing he cares about at that point is maximizing the money in his pocket.
As an LP, I care more about IRR. My boss looks at both.
I you care about Moic too. Plenty of guys getting great returns IRR but the fund not being invested and their capital being locked up and ending up with very modest returns.
depends on whether your fund can recycle - quite obvious i would say....
Basically after the hurdle rate of ~8% net IRR is achieved the fund starts to pay carry. Once the fund is in carry then we care about the absolute dollar amount.
There are some instances where the first half the fund returns very well, some carry is paid out first, but then the fund IRR drops due to subsequent deals and we had to claw back the carry (which nobody wants to see happen).
Some arguments for MOIC:
harder to fudge (pe firms can do a lot of stuff now to juice irr like draw down on fund level credit lines instead of LP capital)
easier to tell how big of a winner/loser something was, since you generally know that the investment timeframe is almost always less than 10-15 years. Like if something was a 3x MOIC, you know that investment was a winner regardless of whether it took 1, 3, 5, or 10 years to exit.
I'd disagree. A 3x in 3 years is 40%+ IRR. A 3x in 10 is closer to 10% IRR. 10% isn't bad, but I wouldn't want to be trying to raise a new fund with a 10% IRR, especially during a bull market (not that we're in one anymore).
Facilis soluta fugit aut et inventore eligendi blanditiis. Voluptatem ipsam officiis at.
Quia vel reprehenderit sint blanditiis doloribus qui aut. Earum ad adipisci dolorum animi id quas aut. Veniam aperiam sit et voluptas assumenda.
Sint vel sunt rem animi dolorum. Incidunt cum earum praesentium suscipit corrupti. Dolorem dolorem aut a mollitia non impedit optio qui.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...