Private equity runs on metrics. Yet many professionals still miss the basic question: what are we measuring, and why? IRR and MOIC dominate pitch decks and quarterly reports. Both are useful. Both get misinterpreted. And both can be shaped by financing tools that change optics more than fundamentals.
Keep it simple. IRR measures speed. It shows how fast capital gets recycled. MOIC measures scale. It shows how much wealth gets created per dollar at risk. Neither metric captures portfolio risk, cash flow quality, or the operating work that produced the outcome. Both can be influenced by fund-level tools that affect timing and presentation.
The industry knows this. Yet headline numbers still drive allocations. That is why it pays to dissect what IRR and MOIC actually say, where they fall short, and how to read through the effects of subscription facilities, dividend recaps, NAV financing, and continuation funds.
IRR answers one question. How efficiently does capital compound each year? Technically, it is the discount rate that sets the net present value to zero across all cash flows. In practice, it reflects when LP capital goes out and when it comes back. It includes residual NAV as if it were paid at the end of the period.
IRR matters when capital recycling and pacing are central. Allocators who manage liquidity care about the time profile of calls and distributions. A higher IRR, all else equal, means cash returns sooner.
MOIC measures total value created per dollar invested. It is total proceeds divided by cost. It does not consider time. It is useful when the focus is long-horizon wealth creation. A high MOIC that takes too long may still be less attractive than a lower MOIC realized quickly, but MOIC by itself will not tell you that.
Fund tools affect both metrics. Subscription credit lines change the measured holding period of LP capital. Dividend recaps pull forward cash distributions. NAV financing creates distributions at the fund level. Portfolio company debt can amplify MOIC if execution works. It can also destroy equity if it does not. These tools shape cash flow timing and reported returns while leaving the asset’s operating trajectory unchanged.
Carry is paid on realized gains. That shapes behavior and reporting. Waterfalls pay when cash hits thresholds. So managers often favor steps that accelerate realizations and crystalize carry. Dividend recaps, NAV financing, and continuation funds all can serve this purpose. They convert appreciation into cash flow, which can pull forward economics for the GP.
This improves optics for DPI and often for IRR. It can also create timing mismatches. Risks that follow added debt or extended hold periods show up later. The GP may have already booked carry on earlier distributions.
Continuation funds fit this pattern. In these GP-led secondaries, assets move from an older fund into a new vehicle. The selling fund realizes gains and distributes proceeds. The manager can earn carry. The new fund takes over the asset at a fresh basis. LPs are often shown a smooth story across both vehicles. The economics for the manager are separate in each fund. Read that carefully. See how value is split, how fees reset, and how the governance will work in the new vehicle. For an overview of exit mechanics, check out this post on private equity exit strategies and market trends.
None of this is improper. It reflects contract design. It does mean headline IRR and MOIC can include a meaningful share of financial timing rather than operating alpha.
IRR assumes interim distributions get reinvested at the same rate. That is rarely feasible in private markets. IRR is also sensitive to timing. Small shifts in exit dates can move it by several hundred basis points. IRR can even be undefined for certain cash flow patterns with multiple sign changes. Analysts know how to work around these issues. Still, these quirks complicate manager comparisons.
MOIC ignores duration. A 2.0x in three years versus eight years is not the same outcome. MOIC also rides on the accuracy of year-end marks for unrealized assets. That means subjectivity can matter most late in the holding period, when stakes are highest.
Risk. You need loss ratios, downside protection, and dispersion to see the full picture. A strategy that avoids large losses compounds better than one with occasional big wins and frequent write-offs, even if both report similar headline IRR.
Subscription facilities are now common. These lines bridge capital calls and allow GPs to fund deals quickly. When the line is repaid with LP capital later, performance reporting shows LP capital invested for a shorter period. The asset performance did not change. The fund’s timing did.
Here is a simple illustration. Assume a manager buys an asset on day one and exits in year three at 1.3x. If LP capital funded the deal on day one, the net IRR might be roughly 9%. If the manager used a subscription line for the first 12 months and called LP capital only to repay the line, the measured holding period for LP money is closer to two years. Reported IRR rises even though the asset outcome is identical.
Industry analysis estimates credit line usage can lift net IRR by 100 to 300 basis points depending on draw patterns and hold periods. That gap can move quartile rankings.
LPs can address this with one simple ask. Request “with facility” and “without facility” performance. Use both. The difference is the effect of timing.
Dividend recaps distribute cash to equity from new company-level debt. DPI rises. IRR often rises. The enterprise value did not improve from that distribution alone. If the asset continues to grow, fine. If the incremental debt reduces flexibility or adds stress later, the early metrics overstated progress.
NAV financing borrows against fund-level asset values. The fund can use proceeds to fund follow-ons, support portfolio companies, or distribute cash. That can help returns if it bridges to a strong exit. It increases fund-level leverage in the capital stack. If the portfolio softens, debt service can absorb cash flows and reduce flexibility.
These tools are not inherently harmful. They have a cost and a benefit. The key is to separate operating performance from financing-driven timing.
Ask for IRR and DPI both with and without the effect of subscription facilities and NAV financing. Request a simple reconciliation. Measure how much of DPI comes from operating cash flows and exits, and how much from fund-level or company-level financing.
IRR needs context. A 20% IRR over 18 months is very different from a 20% IRR over six years. Track capital-weighted duration and time to cost recovery. Both tie IRR to opportunity cost and risk exposure.
Track the percentage of cost in positions under 1.0x and the depth of write-offs. Track how quickly capital returns to par after a downturn. These measures show how the manager handles risk and compounding across a cycle.
Use public market equivalents (PME) to benchmark against passive exposure. PME anchors performance to what public markets would have delivered over the same time frame. It is a useful filter for separating market beta from manager skill. For a refresher on how this connects to discounting and valuation math, see this overview of discounted cash flow analysis. Want to turn theory into hands-on experience? Take a look at my DCF financial model. It is built to level up your financial modelling skills.
Reconcile TVPI between realized distributions and the quality of remaining NAV. Persistent high multiples with aging portfolios may reflect slow exits or optimistic marks. DPI provides stronger evidence than unrealized appreciation. Understand the valuation policy and exit prospects for top holdings.
Focus on facility-adjusted IRR, time to break-even, and sources of DPI. Favor portfolios that generate distributions from operating cash flow, asset sales, and debt paydown progress. Set thresholds for financing-driven DPI as a share of total distributions. Review covenant cushions, interest coverage, and refinance plans. Track how often the fund used dividend recaps and why.
Emphasize MOIC potential, capital efficiency, and loss minimization. Accept longer duration if the path to value creation is clear and capital intensity is manageable. Underwrite revenue growth, margin expansion, and path to cash generation. Limit reliance on multiple expansion to hit targets.
Prioritize DPI, duration-adjusted returns, and the quality of underlying governance. Target discounts to NAV that reflect real catalysts and exit visibility. Avoid structures where headline IRR stems from deferred purchase price or short-dated flips that mask fundamental progress.
Traditional metrics are less informative in power-law portfolios. Focus on fund-level MOIC potential and position sizing. Track write-off discipline and partial liquidity events. Review reserves policy and follow-on pacing.
Expect more standardization. The SEC adopted private fund adviser rules in 2023 that included quarterly statement requirements and disclosures on fund-level borrowing. In 2024, the Fifth Circuit vacated those rules. Even so, many large managers are moving toward clearer reporting given LP requests and consultant guidance.
Several items are becoming common asks. Facility-adjusted performance. A clear split between financing-driven and operating-driven DPI. Consistent calculation of net IRR and TVPI. Cross-checks using PME. Transparent methodologies for year-end marks and exit timing. Clear description of any carried interest triggers and crystallization events. If you want a refresher on mechanics, review the distribution waterfall.
Adopting these measures does not slow managers down. It reduces noise. It helps LPs compare strategies with different pacing, capital intensity, and use of fund finance. It also reduces the influence of accounting timing on manager selection.
IRR and MOIC are necessary but incomplete. They help screen managers, compare fund vintages, and frame pacing. They do not tell you about underwriting discipline, portfolio construction, or risk control. To move from reports to decisions, focus on sources of return and timing of cash flows.
Pair IRR with duration. Pair MOIC with loss ratios. Stress returns with and without facilities. Tie realized outcomes to operating KPIs. And keep the vocabulary consistent across managers. The more consistent the frame, the stronger the selection decisions.
Finally, remember the reinvestment assumption embedded in IRR. Ask how the manager redeploys cash. The ability to turn distributions into new high-return deals matters for compounding. That is hard work. It does not show up in a single metric.
Two funds each return 2.0x TVPI after seven years. Fund A distributed 1.0x by year three through exits and operating cash flow. Fund B distributed 1.0x by year three through dividend recaps and a NAV distribution. Which is stronger?
Fund A likely shows higher facility-adjusted IRR, lower financing-driven DPI, and healthier portfolio companies entering years four to seven. Fund B may show a higher early IRR. The later years carry more financial risk. The headline TVPI is identical. The risk is not.
This is why committees should request facility-adjusted performance and a split of DPI by source. The added context often changes conclusions about manager selection and pacing for the next commitment.
Measure speed and scale, but do not stop there. IRR and MOIC are inputs, not conclusions. Adjust for facilities. Tie returns to operating sources. Add duration, loss ratios, and PME. When the data is presented this way, manager skill becomes clearer. So do the trade-offs between speed of cash return and depth of value creation.
