Funding Law – Know Your IRR

It has been said a million times already on this blog — a CEO, especially one which is seeking funds from private equity investors, needs to understand finance. Often a basic knowledge of sources and uses and cash flow analysis is enough, but in many early stage investment rounds, savvy investors expect the CEO to know the company’s internal rate of return (IRR) – and why it matters.

I meet many entrepreneurs from the Indiana tech sector and beyond who have served as VPs or middle managers before embarking on their entrepreneurial dream. There is a key difference between the way a VP or manager looks at finance and the way a CEO looks at finance: VPs look at margins; CEOs look at cash flows.

The IRR is the time-weighted rate of return of future cash flows. More specifically it is the NPV of invested dollars, distributions to owners and unrealized investments. This is a key tool in valuing companies and for investors to determine the expected return of their investment. Venture capitalists and private equity firms understand IRR well – and most will use a discounted cash flow method (utilizing an IRR) to value companies in considering investment opportunities.

Attorney David Castor concentrates his practice on advising and serving Indiana information technology companies and broad-based other businesses and their owners through their legal matters including Indiana technology trends. Mr. Castor’s practice is focused largely on Indiana technology services, representing SaaS and Internet based companies as general counsel.

David Castor
Name: David Castor
Company: Alerding Castor Hewitt LLP
E-mail: dcastor@alerdingcastor.com 
City: Indianapolis
State: Indiana