Knowing now how IRRs are calculated, we need to differentiate between company IRRs and investor IRRs. Investor IRR should be calculated specifically as it is one of those key figures you will get asked for and you will want to not only sensitivity test it, but also reverse engineer it to a degree that it will be somewhere in the ball park for a potential investors appetite. Simply put, you show the IRR between the investors current share of the company and her future share of the company. Given that the investment amount required is more or less fixed by necessity, the flexibility lies in awarding the investor a larger or smaller share of the company. By increasing the share of the company given a static investment amount the investor’s IRR will increase, provided all other assumptions remain unchanged. A smaller share has an opposing effect.
In reality, fast growing startups usually need more than one round of investment and that means that the early stage investors will likely get diluted significantly. Obviously, this dilution has a negative impact on the early stage investors’ IRR and especially if your model’s multi stage growth plan requires significant follow-on investment you might want to show an investor IRR that can survive this kind of dilution. There are two ways to deal with this: Either you aim to show an IRR, which is simply much larger than 100% or your make sure to account for the dilution of subsequent investment rounds. For the latter approach, you will have to express the dilution in terms of number of shares issued and then evaluate how much a specific round’s share of the exit valuation will be.