What Is IRR and Why It Matters in Startups & Venture Capital

When founders hear about IRR, they often assume it’s a finance-only metric used by banks or private equity.

But IRR or Internal Rate of Return is a powerful tool for understanding how investors evaluate your startup’s potential over time.
Especially for VCs and angels, IRR helps answer a key question:

“Will this bet pay off fast enough to matter for the fund?”

What Is IRR?

IRR (Internal Rate of Return) is the annualised return an investor earns from an investment, factoring in both the amount invested and the time it takes to get returns.

It’s the rate at which the net present value (NPV) of all future cash flows (investment in, return out) equals zero.

In simpler terms:

IRR tells investors: “How fast is my money growing, year-on-year, over the life of this investment?”

IRR Formula (Simplified)

There’s no neat one-line formula, but IRR is the discount rate r that solves:

0 = ∑ [ Cash Flow at time t / (1 + r)^t ]

Where:

• t = time period
• r = internal rate of return
• Cash flows = investment (-) and returns (+)

Most people use Excel, Google Sheets, or tools like PitchBook to calculate it.

Example: Angel Investment in a Startup

Say an angel invests ₹10 lakh in a startup in 2020.
In 2025, she exits with ₹30 lakh.

Using an IRR calculator, this equals ~24.57% IRR over 5 years.

Compare this with:

• Bank FD (~6–7% IRR)
• Public markets (~12–14% IRR long-term)
• Real estate (~10–12%)

This is why venture investing is high-risk, high-reward: IRRs above 25–30% are expected to make up for portfolio failures.

Why IRR Matters in Venture Capital

1. VCs Have a 10-Year Fund Clock

Funds usually return capital to their LPs within a 10-year cycle.
A ₹5 crore return in Year 3 is better than ₹10 crore in Year 10 because time is money.

That’s why IRR rewards earlier exits, even if the returns are slightly smaller.

2. Speed + Size = Superior IRR

High IRR isn’t just about big returns. It’s about how quickly you generate them.

That’s why VCs may push for faster exits, IPOs, or secondary sales, even if the company could grow longer, because it boosts their fund’s IRR.

3. It Affects Follow-On Rounds

If a VC invested early at a low valuation and your next round happens at a 5x markup within 18 months, their IRR spikes.
This increases confidence internally and improves their fund performance story to LPs.

Example: Early Exit vs Late Exit

Imagine an Indian SaaS startup gets acquired by a U.S. company.

• Investor A enters at ₹10 crore valuation in 2021
• In 2024, startup is acquired at ₹100 crore
• Investor’s return = 10x in 3 years → ~116% IRR
• If the same exit happened in 2029 → still 10x, but IRR drops to ~26%

Same return multiple, very different IRRs. That’s the time value of money.

IRR Is Useful, But Not Everything

Strengths	Limitations
Captures time value	Assumes reinvestment at same IRR
Helps compare investments	Doesn’t account for capital risk
Standard VC reporting metric	Not useful for pre-revenue or very long-term ideas

IRR is one lens, not the full picture.

Key Takeaway

IRR isn’t just finance jargon, it tells the story of how fast value is created.

As a founder, knowing IRR helps you:

• Understand your investor’s mindset
• Time your raise and exit with context
• Frame your traction in a fund-returning narrative

Remember:
VCs want big, fast, fund-returning outcomes.
IRR helps measure that.