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  1. 022A private fund calls Rs 100 crore from an investor today and returns Rs 200 crore in five years, an IRR of about 14.9%. If the fund instead uses a credit line to delay the call by one year, at a borrowing cost of Rs 8 crore paid out of the final distribution, what happens to the IRR and to the multiple of money?Private and real asset mathsHardPrivate markets

    Try it first

    With the credit line, what happens?

    Show the worked solution

    The IRR rises to about 17.7% while the multiple falls from 2.00x to 1.92x. With the line, the investor pays Rs 100 crore at year 1 instead of year 0 and receives Rs 192 crore at year 5 after the borrowing cost. That is 1.92 times the money over four years, 17.7% a year, against 2.00 times over five years, 14.9%. The investor ends with Rs 8 crore less, and the reported IRR looks better.

    How can the return rise when the investor gets less money?

    Imagine lending a friend money: getting back Rs 192 after four years can be a better annual rate than Rs 200 after five, even though Rs 200 is more money. IRR measures speed, not size, so anything that shortens the time the investor's money is out raises it, even at a cost. A subscription lineA short-term loan to a private fund, secured on investors' commitments, used to delay capital calls. does exactly that. The fund's deal is identical; only the investor's clock starts a year later.

    A later call lifts the IRR while the investor ends with lessWithout credit linemultiple 2.00xIRR 14.9%Y0Y1Y2Y3Y4Y5-100 called+200With credit linemultiple 1.92xIRR 17.7%Y0Y1Y2Y3Y4Y5-100 called+192line funds year 1after -8 interest
    Without the credit line the investor pays 100 at year 0 and gets 200 at year 5, an IRR of 14.9% and 2.00x; with it the investor pays 100 at year 1 and gets 192 at year 5, an IRR of 17.7% but only 1.92x.
    The relationship
    (200100)1/5−1≈14.9%(192100)1/4−1≈17.7%\left(\frac{200}{100}\right)^{1/5}-1\approx 14.9\% \qquad \left(\frac{192}{100}\right)^{1/4}-1\approx 17.7\%
    200, 192the distribution at year 5 without and with the line, Rs crore
    1/5, 1/4one over the years the investor's money is at work
    What it says in wordsWith a single call and a single distribution, the IRR is the multiple raised to one over the years, minus one.

    Is the investor better or worse off?

    It depends on what the investor does with the Rs 100 crore during the extra year. If the idle money earns less than the Rs 8 crore the line costs, the investor is worse off even though the fund reports a higher IRR. That is why allocators look at the multiple and the IRR together, and increasingly ask for IRRs calculated both with and without the effect of credit lines. Say the limitation: this example uses one call and one distribution; real funds call and return money in many pieces, and the line's effect on IRR is largest in the early years of a fund.

    Where candidates lose it

    Candidates say both numbers fall, because the line costs money. They miss that IRR is time-weighted and rewards a later call.

    The deeper trap is stopping at the arithmetic. The interviewer on a private markets desk wants to hear that a higher IRR here does not mean a better result for the investor, and that the multiple exposes it.

    What the interviewer asks next

    • What if the line delays the call by two years at a cost of Rs 16 crore?
    • What return must the investor earn on the idle Rs 100 crore to break even?
    • Why do some investors prefer to see a fund's multiple before its IRR?