IRR (Internal Rate of Return) is the discount rate that makes NPV = 0. It represents the project's expected annualized return. If IRR > your required return (hurdle rate), the project is worth pursuing. VCs typically seek IRR > 25-35%.
IRR Definition
0 = Σ [CF_t / (1+IRR)^t] - Initial Investment
Solve for IRR. Usually done iteratively (Excel: =IRR function).
VCs target 25-35% IRR on their portfolio. Individual deals must target 50-100%+ IRR to compensate for the many failures.
Key Takeaways
- IRR = the discount rate that makes NPV = 0.
- IRR > hurdle rate → invest.
- VCs need 50-100%+ IRR per deal to achieve 25-35% portfolio IRR.
- IRR and NPV usually agree — use both for validation.
Frequently Asked Questions
If a project has an IRR of 40% and the hurdle rate is 20%, should you invest?▼
Answer: Yes — IRR exceeds the hurdle rate
IRR > hurdle rate means the project's return exceeds your minimum required return. Invest. (NPV will also be positive in this case.)
What does a negative IRR mean?▼
Answer: The project never returns the initial investment
Negative IRR means the total cash flows never exceed the initial investment — you lose money overall.
Why do VCs need individual deals at 50-100% IRR?▼
Answer: Because most deals fail — portfolio IRR must compensate for losses
In a typical VC portfolio, 60-70% of investments fail or return < 1x. The winners must return 10-50x to achieve 25-35% portfolio IRR.