Tuesday, February 2, 2010

MBA Mondays - ROI vs. IRR

Fred Wilson, Venture Capitalist over at avc.com is starting a great series on Business School lessons for those new to business terminology.  He got the inspiration for the series from the comments he got on this post about the difference between Return on Investment (ROI) and Internal Rate of Return (IRR). 

I am reminded of David M. Livingston's 1998 paper, "The Business of Commercializing Space."  In the paper, David survey's 600 venture capital firms asking them about about their expectations when completing an investment.  This quote from David's paper should give you an idea of the kind of IRR these VC's are looking for:
"Ten to one returns as a minimum; Returns ranging from >30% to >100% IRR; Greater than 30% IRR; Time period of 3-6 years needed; Hundreds of times the return of a normal business."
What I love from Fred's lesson on IRR - Fred actually imbeds his spreadsheets (complete with formulas).  I firmly believe you understand the concept better after you have built the formulas.  I am considering doing the same spreadsheet imbedding for some of my upcoming posts.  Great idea Fred!

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