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

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