Internal Rate of Return (IRR)
Annualized return a buyer projects on their investment. It's the main decision criterion for financial buyers — if the IRR doesn't meet their target at the asking price, the offer will be revised downward.
Definition
The internal rate of return (IRR) measures the annualized return on an investment, taking into account the timing and size of each cash flow. In an acquisition context, it’s the annual rate of return a buyer projects between the day they buy the business and the day they sell it or get their investment back.
In French-language Quebec documentation, you’ll see TRI (taux de rendement interne) used for the same concept.
Concretely, if a buyer invests $1 million in equity and projects getting back $3 million (including distributions and resale) over five years, the IRR on that investment would be roughly 25% per year. The higher the IRR, the more attractive the investment for the buyer.
Why IRR matters in a business sale
IRR is the compass of financial buyers — private equity funds, venture capital firms, and institutional investors. These buyers have non-negotiable return thresholds, typically between 20% and 30% per year.
Every dollar above their IRR target is a dollar they could accept to pay you. Every dollar below is a dollar they’ll take off their offer.
For you as a seller, that means price isn’t only a question of EBITDA multiples. The financial buyer models their cash flows, applies their growth and resale assumptions, then checks whether the resulting IRR hits their target.
If it doesn’t at the price you’re asking, they won’t negotiate based on comparables or emotion — they’ll simply adjust their offer down until their IRR works.
That’s also why financial buyers place so much weight on growth potential. A business that can double its EBITDA in five years delivers a much higher IRR than a stable one, even if their current EBITDA is identical.
If you can show a credible growth trajectory, you raise the buyer’s IRR — and with it the price they’re willing to pay.
What every seller should know
- Financial buyers typically target an IRR of 20% to 30% — that’s the primary filter that determines whether they’ll move forward with an offer.
- IRR is sensitive to the holding period: a buyer who plans to sell again in three years will demand a lower purchase price than one with a seven-year horizon, all else equal.
- Leverage (debt financing) amplifies IRR — that’s why a business with stable cash flows able to support a meaningful level of debt is more attractive to a financial buyer.
- Understanding your buyer’s IRR target lets you structure a smarter offer — for example, by proposing a vendor take-back that improves their return while securing a better total price for you.