In today’s private equity landscape, characterised by increasingly complex fund structures and more demanding limited partners, clarity and precision in performance metrics are essential. Asset managers must not only generate returns but also communicate them with rigour and credibility. This is where MOIC (Multiple on Invested Capital) and IRR (Internal Rate of Return) become strategic indicators.
Understanding MOIC: Simplicity, Strengths and Common Misconceptions
What is MOIC? Formula and Interpretation
MOIC measures the total value of realised and unrealised assets divided by the capital initially invested. It is a straightforward metric that does not account for the time factor. For instance, a MOIC of 2.0x indicates that the investment has doubled in nominal terms, while a MOIC of 1.5x indicates a 50 percent gain on the invested capital.
When Does MOIC Provide Real Value to General Partners and Limited Partners?
MOIC is particularly relevant for early-stage investments, where exits have not yet occurred. In such cases, time-sensitive metrics like IRR are less meaningful. Due to its simplicity, MOIC is often used in quarterly reports where transparency is critical. It is also useful for comparing investments with similar holding periods, such as two venture deals exited after five years.
What Are the Limitations of MOIC in Time-Sensitive Strategies?
MOIC does not reflect the time value of money, which can distort performance comparisons. A MOIC of 2.0x over three years is far more attractive than the same MOIC over ten years. Therefore, in short-duration or high-turnover strategies such as venture debt or credit underwriting, IRR is generally a more relevant metric.
Decoding IRR: Annualised Returns and Modelling Complexity
What Is IRR and How Is It Calculated?
IRR is the annualised rate of return that sets the Net Present Value (NPV) of all cash flows, both inflows and outflows to zero. Unlike MOIC, IRR considers both the amount and the timing of cash flows. This makes it a dynamic yet complex performance indicator. IRR is particularly useful for comparing investments with different durations, such as a two-year growth investment and a seven-year buyout. It also highlights the speed of returns, which is often a key consideration for limited partners.
Why Does IRR Remain the Industry Standard Despite Its Biases?
IRR is widely used to measure private equity performance. However, its limitations are often overlooked. It assumes that interim cash flows are reinvested at the same rate of return, which is rarely the case. It is also highly sensitive to the timing of cash flows. A slight delay in distribution can significantly alter the IRR. In addition, IRR can be misleading. A fund showing an IRR of 25 percent may appear to be outperforming, but if it is based on a few small and early exits, the MOIC might reveal a much more modest performance.
What Are the Distortions and Assumptions Behind IRR?
IRR is based on strong assumptions that may not align with actual market conditions. The assumption of reinvestment at a constant rate is particularly problematic in volatile interest rate environments. Its extreme sensitivity to timing makes IRR especially unstable in the early life of a fund, when limited data is available. At the portfolio level, if IRRs are aggregated without a rigorous consolidation method, the results can be confusing and unreliable.
MOIC and IRR: Choosing the Right KPI Based on Strategy
How Does the Relevance of MOIC and IRR Vary Between Venture Capital and Growth Equity?
In venture capital, capital is typically deployed gradually and exits are unpredictable. As a result, MOIC is often the primary metric used during the early stages of a fund’s life. As the fund matures and liquidity events reshape the return profile, IRR becomes more relevant. In contrast, in growth equity strategies, where holding periods are shorter and exits are more predictable, IRR tends to become the preferred metric earlier in the fund’s lifecycle.
How Do Timing, Exit Profiles and Liquidity Affect Metric Selection?
For illiquid or long-term assets such as infrastructure or buyout deals, MOIC offers a clearer view of value creation. On the other hand, shorter-cycle deals such as secondaries or private credit benefit from IRR, which captures the speed at which value is generated. The best practice is to use both metrics in tandem. MOIC provides a measure of absolute value creation, while IRR reflects time efficiency.
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FAQs
Which Is the Most Relevant Metric: MOIC or IRR?
The answer depends on the investment context and strategy. MOIC is easier to calculate and interpret, making it a preferred choice for assessing the overall long-term performance of an investment. IRR, on the other hand, incorporates the timing of cash flows and provides insight into the speed of return on investment.
Can MOIC Be Misleading?
Yes. MOIC does not take into account the time dimension. As a result, a MOIC of 2.0x over two years is treated the same as a 2.0x over ten years. IRR is better suited for short-duration strategies where the timing of returns is critical.
How Do Limited Partners Assess MOIC and IRR During Fundraising?
Limited partners generally rely on both metrics. MOIC offers a high-level view of value multiples, while IRR helps assess the pace and timing of distributions. LPs typically expect fund managers to report both.
Should MOIC or IRR Be Prioritised in Reporting?
MOIC should be used for unrealised gains or early-stage portfolios, while IRR is more appropriate for mature funds. MOIC shows absolute performance, whereas IRR reflects efficiency. Using both metrics is now considered standard practice.
