Net Internal Rate of Return (Net IRR)

Definition

Net internal rate of return (Net IRR) is the internal rate of return on an investment after accounting for fees, carried interest, and other deductions. It represents the discount rate at which the net present value (NPV) of all net cash flows (outflows and inflows after fees) equals zero. Net IRR is expressed as a percentage and is used to assess an investment’s realized performance.

How Net IRR differs from IRR

• IRR measures the discount rate that equates gross cash outflows and inflows (before fees and carried interest).
• Net IRR measures the same concept but uses cash flows net of fees and carried interest, giving a more realistic view of what investors actually receive.
• Because fees can materially reduce returns, net IRR typically understates gross IRR but better reflects investor outcomes.

How it’s used

• Comparing investment funds or projects on an after-fee basis.
• Evaluating private equity and other alternative investments that have multiple capital calls followed by one or more exits.
• Assessing whether a fund’s performance meets required or expected return thresholds.

Calculation (conceptual)

Net IRR is the rate r that satisfies:
sum_{t=0}^{T} (CF_t) / (1 + r)^t = 0
where CF_t are the net cash flows (contributions negative, distributions positive) after management fees, carried interest, and other charges. In practice this is solved numerically (built-in IRR functions in spreadsheets or financial software).

Typical calculation steps:
1. List all net cash flows (investor contributions as negatives, distributions as positives).
2. Use an IRR function or numerical root-finding to find r such that NPV = 0.
3. Report r as the Net IRR.

Example: private equity

Private equity funds commonly use Net IRR because investors make multiple capital contributions over time and receive returns in a later exit (IPO, sale, or merger). Because fund managers charge fees and may take carried interest on profits, reporting Net IRR shows investors the return after those deductions.

Regulatory note: including capital invested by the general partner (GP commitment) in Net IRR calculations can inflate reported performance since GP capital may not incur the same fees. Regulators expect clear disclosure of both gross IRR and net IRR and transparency about whether GP commitments are included.

Limitations and considerations

• Timing sensitivity: IRR is highly sensitive to the timing of cash flows; small timing changes can materially change the rate.
• Reinvestment assumption: IRR implicitly assumes interim cash flows are reinvested at the IRR, which may be unrealistic.
• Comparability: Funds with similar strategies may still be hard to compare if fee structures, distribution timing, or calculation conventions differ.
• Single-number view: Net IRR does not show scale of returns (use alongside multiples like MOIC—multiple on invested capital).
• Calculation conventions: Differences in whether GP capital or certain fees are included can make reported Net IRRs inconsistent across managers.

Key takeaways

• Net IRR measures investment return after fees and carried interest, giving a clearer picture of investor outcomes than gross IRR.
• It is calculated as the discount rate that makes the NPV of net cash flows zero and is typically solved numerically.
• Useful for comparing funds and projects, especially in private equity, but should be interpreted alongside other metrics and with attention to calculation conventions and timing effects.