TL;DR: The internal rate of return (IRR) is the annualised rate of return that makes the net present value of an investment's cash flows equal to zero. It is a standard measure investors use to compare the profitability of investments over time, accounting for both the size and the timing of cash flows.
IRR expresses the return on an investment as a single annual percentage, taking into account when cash goes out and when it comes back. Because money received sooner is worth more than the same amount received later, IRR weighs the timing of cash flows, not just their total. An investment that returns capital quickly will show a higher IRR than one that returns the same total amount over a longer period.
Formally, IRR is the discount rate at which the present value of all cash inflows equals the present value of all outflows, so the net present value is zero. In practice it is calculated with a spreadsheet or financial tool rather than by hand.
Suppose an investor puts in $1M and receives $1.5M back. If that return arrives after one year, the IRR is 50%. If the same $1.5M arrives only after three years, the IRR is roughly 14%. Same total profit, very different annualised return, because timing matters. This is why IRR is central to how venture capital and other investors evaluate and compare opportunities.
For founders, understanding IRR clarifies how investors think about the cost and urgency of capital, and why exit timing affects investor returns so heavily. For Flow Capital's own investors, IRR is one lens on the performance of the firm's lending strategy. It is best read alongside other measures, since a high IRR over a very short period can represent less total value created than a steadier return over a longer horizon.
What is the difference between IRR and a simple return? A simple return ignores timing. IRR annualises the return and accounts for when cash flows occur, which makes it more useful for comparing investments of different durations.
Is a higher IRR always better? Not on its own. IRR favours speed and can overstate the appeal of short-duration outcomes. It is best considered together with the absolute amount of value created and the holding period.
Related terms: Unit Economics · Equity Dilution · Growth Capital · Venture Debt
