IRR may lead to a misalignment of interests between the GP and the LP
- GP’s interests: to maximize IRR as a track record to raise more follow-on funds
- LP’s interests: not always to maximize IRR
An example
Invest $100M, two exit options
- Option 1: Receive $150M after one year, IRR: 50%
- Option 2: Receive $200M after two years, IRR: 41%
Unlike GP, LP may prefer option 2
- Option 2 provides a 41% IRR over two years, equivalent to 50% in year 1 and 33% in year 2
- 33% IRR is still superior to other investments