How to Measure Private Equity Performance: IRR vs. Multiples
Explanation
Understanding Private Equity Performance: IRR vs. Multiples
In private equity, the most commonly used performance metric is the Internal Rate of Return (IRR). IRR represents the annualised rate at which invested capital grows to match the total value of distributions received or the final fair value of the investment.
For example, if £100 is invested and £108 is received after one year, the IRR is 8%. But if £108 is received after just six months, the IRR increases to 16%, highlighting the importance of time in this metric.
Net IRR vs. Gross IRR
IRR can be reported in two ways:
- Gross IRR excludes management fees, fund expenses, and carried interest.
- Net IRR includes these costs and reflects the actual return investors receive.
For limited partners, net IRR is the more relevant figure, as it shows the true after-fee performance of their investment.
The “Times Money” (TVPI) Metric
Another key performance measure is the “times money” or TVPI (Total Value to Paid-In) multiple. This is a simple ratio of total value received or receivable divided by total capital invested. For example:
- A TVPI of 1.5x means the investor has received or will receive 1.5 times their original investment.
- A TVPI of 2x means the capital has doubled.
While easy to understand, this metric does not account for the timing of returns. For instance, a 1.2x return over six months equates to an annualised return of around 44%, whereas the same 1.2x return over five years drops to just 3.75%.
Reporting Standards and Best Practice
According to the Institutional Limited Partners Association (ILPA) guidelines, investors should receive detailed quarterly reporting. These reports generally include:
- Fund-level financials: balance sheet, income statement, cash flow summary
- Performance metrics: IRR, TVPI, DPI (Distributions to Paid-In)
- Deal-level information: cost, fair value, distributions received
- Commentary on portfolio company performance and valuation methodology
While reporting formats vary between managers, the industry standard is clear: adhere to ILPA guidelines and deliver timely, transparent, and consistent data within the deadlines defined in the Limited Partnership Agreement (LPA).
For definitions of all key performance metrics, refer to the Glossary of Investment Return Terminology (see page 22).
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The Origins and Evolution of Private Equity
Private equity (PE) has grown into a global financial powerhouse, but its beginnings can be traced back to the post-World War II era. The formation of the American Research and Development Corporation (ARDC) in 1946 marked one of the earliest institutional private equity efforts.
ARDC’s mission was to fund companies that could repurpose wartime technologies for commercial use. One of its landmark investments was in Digital Equipment Corporation (DEC). A modest $70,000 investment in DEC eventually turned into $355 million, delivering a return of over 5,000 times the original amount. This staggering success demonstrated the potential of private equity to fuel innovation and drive extraordinary financial outcomes.
The Rise of Leveraged Buyouts in the 1980s
The 1980s became a transformative decade for private equity, largely due to the emergence of leveraged buyouts (LBOs). Pioneering firms such as Kohlberg Kravis Roberts (KKR) led this movement, acquiring companies primarily through borrowed capital, implementing operational improvements, and exiting through strategic sales or IPOs. These deals often resulted in significant returns and played a key role in legitimizing private equity as a powerful tool for value creation.
Private Equity Today: A Global Asset Class
Fast-forward to today, and private equity has evolved into a multi-trillion-dollar global industry. PE firms are actively involved in reshaping key sectors, including technology, healthcare, financial services, energy, and consumer goods. The United States continues to dominate the market, but institutional investors are increasingly turning their attention to opportunities in Europe and Asia where valuations are more attractive and growth potential remains robust.
In recent years, PE has also embraced thematic and impact investing. Many funds are aligning their strategies with ESG (Environmental, Social, and Governance) principles or specific global trends, such as digital transformation, renewable energy, and health innovation. This not only broadens investor appeal but also enhances the sector’s influence on global progress.
The Dominance of Private Companies
One compelling statistic underscores the importance of private markets: approximately 83% of U.S. companies with over $100 million in revenue remain privately held. This highlights the vital role of private equity in financing, developing, and scaling enterprises outside the public markets.
In summary, private equity has evolved from a niche investment strategy to a dominant force in global finance. With its origins in innovation and a future driven by strategic investment, operational excellence, and global diversification, PE is positioned to remain a key player in shaping tomorrow’s economy.
