Net IRR is the return metric that matters most to limited partners. It is the internal rate of return calculated after stripping out all fees, expenses, and carried interest paid to the general partner. Where gross IRR shows how well a GP invested, net IRR shows what LPs actually took home.
How Net IRR Is Calculated
Net IRR uses the same time-value-of-money math as standard IRR, but the cash flows reflect what LPs experience. Specifically:
- Outflows include the full amount of each capital call, which covers both investment capital and the management fee and expense components.
- Inflows include only the distributions LPs actually receive, after the GP has taken carried interest and any expense recoupment.
The result is the annualized return on the LP’s committed or contributed capital, net of all frictional costs.
The Fee Drag
The standard 2 and 20 fee structure in private equity creates meaningful drag. A fund charging 2% annually on committed capital during the investment period and 20% carry above an 8% preferred return will typically show a 500-800 basis point spread between gross and net IRR.
That spread widens for smaller funds where fixed costs represent a larger percentage of assets, and narrows for mega-funds that negotiate lower fee rates. It also compresses when a fund performs exceptionally well, since high absolute returns dilute the proportional impact of fixed management fees.
Why Net IRR Can Be Misleading
Net IRR inherits all the limitations of standard IRR, plus a few of its own:
- Subscription line effects. When GPs use credit facilities to delay capital calls, the LP cash flow timeline is compressed. This inflates net IRR without changing the actual dollars returned. Some institutional LPs now request IRR calculations both with and without subscription line adjustments.
- Fee offset provisions. Funds that offset management fees with portfolio company monitoring fees can show higher net IRRs, but the economic reality for LPs depends on how those offsets are structured.
- Unrealized holdings. For funds still in their investment or harvesting period, net IRR includes the estimated net asset value of unrealized positions. These marks can shift materially between reporting periods.
Using Net IRR in Due Diligence
When evaluating a GP’s track record, LPs typically benchmark net IRR against peer groups by strategy, geography, and vintage year using data from Cambridge Associates, Preqin, or Burgiss. A net IRR in the top quartile is generally the threshold for institutional re-ups.
But net IRR alone is insufficient. Pairing it with DPI shows how much of the return is cash in hand versus paper gains. Comparing it to TVPI reveals total value creation. And running a PME analysis benchmarks the fund against a public market alternative, stripping out the timing effects that can flatter or penalize IRR.
The most rigorous LPs evaluate net IRR across a GP’s full fund series, not just the flagship vintage, to assess consistency and repeatability of returns.
Frequently Asked Questions
What is the difference between net IRR and gross IRR?
Gross IRR measures returns at the portfolio level before any fees or carry. Net IRR is what LPs actually earn after management fees (typically 1.5-2% annually), carried interest (typically 20%), and fund-level expenses are deducted. The spread between gross and net varies but commonly runs 500-800 basis points for buyout funds.
What is a good net IRR for a private equity fund?
According to Cambridge Associates benchmark data, top-quartile buyout funds have historically delivered net IRRs above 20%. Median buyout funds typically land in the 12-16% range depending on vintage year. Venture capital shows wider dispersion, with top-quartile net IRRs often exceeding 25% while bottom-quartile funds may be flat or negative.
Why do LPs focus on net IRR rather than gross IRR?
Net IRR reflects the actual return LPs receive in their accounts. A fund with a stellar gross IRR but high fees and aggressive carry terms may deliver a mediocre net return. LPs use net IRR to compare managers on an apples-to-apples basis and to evaluate whether a GP's fee structure is justified by their performance.
