Internal Rate of Return (IRR) – annual rate of return an owner receives from his or her investment, averaged over the life of investment. IRR is calculated on the basis of market value of equity share in the business. It reflects total return to the owner from both the growth in equity value and dividends received.

Why IRR is important for business owners:

1. Financial benchmark. Shows the return generated from investment in the company’s equity;
2. Comparison of alternatives. Allows the owner to compare the actual or expected return from the business with other asset classes – other stocks, bonds, real estate, bank deposits;
3. Decision-making. Helps assess the benefit of continuing to develop business over outright sale (locking in the results) and reinvest capital in other assets;
4. A common benchmark for owners and investors. Used by financial and strategic investors as a key criterion for assessing investment attractiveness. It enables the owner to negotiate with potential investors “in the same language.”

IRR is best used in:

• Corporate strategies – to choose between (a) growth strategies and investments in business expansion, or (b) dividend distribution;
• Private Equity and Venture Capital – the main criterion for entry and exit decisions;
• M&A transactions – to assess the acquirer’s expected return in case of a future exit from the investment;
• Owner’s personal financial planning – to forecast the future value of the business owner and family wealth.

For a business owner, IRR is the average annual return from owning and developing the business: as if they bought it today at market value, received dividends over a certain period, and sold business at the end of that period.

How can an owner practically apply IRR calculation in a strategic decision-making process – to develop or to sell the business?

1. Assess current equity value of the company;
2. Build a 5-year growth strategy and financial model;
3. Estimate equity value of the company in 5 years;
4. Calculate IRR based on the chosen strategy (specialized software or Microsoft Excel can be used in this process).

Period	0	1	2	3	4	5
Equity Value	10,0					12,0
Dividends		1,0	1,0	1,0	1,0
Shareholder Cash Flows (CF)	(10,0)	1,0	1,0	1,0	1,0	12,0
IRR	11,6%
Formula in MS Excel	= IRR (Shareholder CF)

5. Compare the computed IRR with the expected rates of return for alternative assets:

• If IRR is higher (or equal) than the expected returns from alternative investments (real estate, other stocks, bonds, deposits), then the decision should be to hold and develop this business;
• If IRR is lower, the owner should consider either selling business now and investing the proceeds in higher-yielding assets, or rethinking the strategy and following the steps 2 – 5 once again.

Consider an entrepreneur who owns a growing business. The company’s market is becoming saturated, competition is increasing, and it is expected that within the next five years the business will reach maturity and slow down – entering a plateau.

Assume that due to current market growth potential, the company is valued at 7.0x EV/EBITDA in 2025, or ₽3.8 b, based on an estimated EBITDA of ₽750 m in 2025 and net debt of ₽ 1.5 b.

In 2025, the business owner needs to choose between two options:

• Option 1. Hold, and continue to receive dividends for the next five years, selling the company in 2030 – but at a lower EBITDA multiple of 5.5x. The multiple is expected to decline due to market saturation and slower business growth amid rising competition, both leading to shrinking profitability;
• Option 2. Sell the company now and invest the proceeds in other assets – for example, a diversified portfolio of marketable securities (stocks and bonds), real estate, bank deposits, and so on.

At first glance (see the table below), given the company’s growth, holding and selling the company in the future (2030) may appear to be justified.

However, Option 2 – selling the business in 2025 – may actually be the preferable, even though the company’s financial metrics in 2030 are higher than in 2025.

The business owner must take into account not only EBITDA, but also:

• the EV/EBITDA multiple at which it would realistically be possible to sell the business in the future; and
• IRR.

IRR helps determine whether it is more profitable to continue owning the business and earning income, or to sell it and invest in assets with higher expected returns.

When selling the company in 2030 (holding period – 5 years) at a 7.0(x) EV/EBITDA multiple, its equity value is expected to reach ₽3.8 b. Taking into account the assumed dividend payout ratio of 40% in 2026–2029, the forward-looking IRR will be 9.6%.

To make an informed decision, the business owner should compare this scenario with the alternative – selling the company in 2025 and investing the proceeds in a diversified bond portfolio.

Key assumptions of the company development scenario for 2025–2030:

• Market saturation limiting the company’s growth rate;
• Entry of new competitors reducing profitability;
• Unified dividend policy: 40% of net profit distributed as dividends in 2026–2029;
• Reduction of leverage from 2.0(x) Net Debt / EBITDA to 1.0(x).

Option 1.
Company Valuation and Cash Flows to Shareholders for 2025-2030

EBITDA and EV/EBITDA Multiples of the Company, ₽ m

Company Valuation and Dividends for 2025-2030, ₽ b

Notes:
EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization
Equity - Value of own capital
Net debt - Net Financial Debt, calculating as the sum of bank loans, bonds less Cash and cash equivalents

In this scenario, the business owner sells the company in 2025 (period 0) at a 7.0(x) EV/EBITDA multiple, or ₽3.8 b for 100% of the Equity.

The proceeds from the sale are invested in a diversified portfolio of securities, including high-quality corporate and government bonds, ETFs, and other reliable fixed income assets. For simplicity, we will consider a portfolio composed of AAA-rated corporate bonds, in which the owner invests over a five-year horizon.

The assumption is made that the funds are invested in bonds with coupon income reinvested over the five-year period. Under these conditions, the investment portfolio delivers an IRR of 14.9%, which is significantly higher than in the “hold the business until 2030” scenario – 9.6%. The future value of the portfolio by 2030 amounts to ₽7.5 billion, which is 42.1% higher than the equity value of the company in Option 1.

Option 2.
Selling the Company in 2025 and investing in the fixed income portfolio

Fixed income portfolio growth, ₽ b

Option 1 and Option 2 comparisons in 2030, ₽ b

Notes:
[1] FV или Future Value – the Future Value of the investment portfolio and the Company’s Equity in 2030;
[2] Weighted average time to maturity or Macaulay duration;

Key assumptions of the fixed income portfolio (simplified approach):

1. The business owner invests the proceeds in bonds included in the Moscow Exchange Corporate Bond Index (RUCBTR3A5YNS) with an average duration of about 4 years;
2. After the initial 4-year period, the investor reinvests the proceeds for one additional year into a new combination of similar corporate bonds;
3. The interest rate level remains unchanged throughout the 5-year investment horizon, and the YTM stays at 14.9%. Thus, with a conservative strategy, the business owner effectively “locks in” a return of 14.9% over the entire period.