Internal rate of return is the discount rate that makes all of an investment's cash flows — including the initial outlay and all subsequent distributions — sum to zero in present value terms. It's the performance metric that private equity firms use because it captures not just how much money was made but how quickly it was made, rewarding investments that return capital fast and allowing meaningful comparison between deals with completely different sizes, durations, and cash flow patterns. But IRR can also be gamed, misrepresented, and misinterpreted, which is why private equity professionals who understand it deeply look at multiple metrics together — IRR plus MOIC (multiple on invested capital) plus distributed to paid-in (DPI) capital — rather than IRR alone.
IRR Manipulation and Its Limits
IRR can be artificially inflated through fund-level credit lines (subscription credit facilities) that delay capital calls while the fund buys assets. By calling capital 6 to 12 months after acquisitions begin (funding from the credit line during the delay), the fund shortens the apparent investment period, which mechanically increases IRR without improving actual returns to investors.
The practical illustration: a fund achieves $100M in exits on $80M of investments made in month 1. If capital was called in month 1, the IRR over 4 years is 5.7%. If a subscription credit facility delayed the capital call to month 9, the IRR over 3.25 years is 7.2%. Same deals, same economics — 1.5 percentage points of manufactured IRR improvement from the delay. This is why sophisticated limited partners track DPI (distributed to paid-in capital — how much has actually been distributed) alongside IRR, and why IRR without MOIC is insufficient information for evaluating fund performance.