Internal Rate of Return (IRR) is the default performance reporting metric for many private market assets, from real estate to private equity and venture capital. Unfortunately, IRR is complex to calculate and not an intuitive metric for most investors, so calculators/spreadsheets are a must to determine and compare both gross IRR and net IRR.

Nearly all investments incur expenses and so there is a difference between gross and net performance. Gross IRR does not include expenses and represents performance before expenses, while net IRR includes expenses and thus represents performance after expenses. Investors evaluating any type of performance should compare gross vs net performance, including gross IRR vs net IRR.

## Gross IRR

Technically, IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. Gross IRR considers the cash flows before the deduction of expenses, so the cash flow inputs and resulting IRR are higher than with net IRR.

### Gross IRR Calculation & Example

The IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

Using an online calculator, Excel, or Sheets, we can input the below cash flows and determine that the IRR is 17.5%.

Initial Investment | $100,000 |

Year 1 Cash Flow | $10,000 |

Year 2 Cash Flow | $20,000 |

Year 3 Cash Flow (final distribution) | $125,000 |

IRR | 17.5% |

## Net IRR

As stated above, IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. Net IRR considers the cash flows after the deduction of expenses, so the cash flow inputs and resulting IRR are lower than with gross IRR.

### Net IRR Calculation & Example

As mentioned above, the IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

The main difference when calculating net IRR vs gross IRR is that we’ll have to adjust the amounts of the cashflows. In the below example, we will add a 10% performance fee (carry/promote/incentive) to the cash flows of the above example. Therefore, the cash flows will only be 90% of the cash flows in the gross IRR example above.

Using an online calculator, Excel, or Sheets, we can input the below cash flows and determine that the IRR is 13%.

Initial Investment | $100,000 |

Year 1 Cash Flow | $9,000 |

Year 2 Cash Flow | $18,000 |

Year 3 Cash Flow (final distribution) | $112,500 |

IRR | 13.0% |

## Gross vs Net IRR: Calculation Differences

As the above examples show, the main difference between gross IRR vs net IRR calculations is the impact of expenses on the cash flow inputs used in the calculation. The calculation remains the same, but the inputs need to be adjusted beforehand. Common adjustments include:

- Upfront or one-time fees at the fund level
- Upfront or one-time fees at the asset level
- Expenses (such as legal, accounting, audit, etc.)
- Management fees
- Performance fees (carry, promote, incentive, etc.)
- Exit/disposition fees

There may be others, but these are the ones that I observe most frequently.

## Gross vs Net IRR in Private Equity

Although IRR is a common reporting metric, there is variation in how it’s reported. Some default to reporting gross IRR, while others default to net IRR.

The most common practice seems to be reporting net IRR at the fund level. All fund expenses and investor-level fees are deducted, with the caveat that the performance of any single investor will vary.

There are a few reasons that investor-level returns deviate from fund -level returns. Different investors often pay different fees (and reporting a multitude of individualized net IRRs is not feasible). Early investors often receive discounts and larger investors qualify for fee breakpoints.

Reporting an investor -level IRR is further complicated by the fact that investors may have invested at different points in time. Even if there are equalization terms and catch-up interest is paid, there are timing differences that could impact an investors IRR. Additionally, it is not uncommon for equalization to adjust the equity or NAV for investors, but allow early investors to keep the income distributions that they already received.

Some sponsors report gross IRR and some may report IRR that is net of non-fee expenses and gross of fees. Still others might report non-IRR performance metrics like MOIC or TVPI or not report anything at all! Even if IRR is reported though, it is important that investors understand if it is gross IRR, net IRR, or some hybrid IRR, as well as how it is derived.