How does a capital call affect IRR? (1 min)

A capital call is when a portfolio company needs to go back to their investor(s) to ask for more equity investment. This could be to finance an add-on acquisition or a new growth strategy. A capital call may also occur if the company is simply low on cash and needs more capital to stay afloat and pay off interest expense and mandatory principal repayments and to not breach covenants.

Since the existing private equity investor(s) and any investors from management need to put up additional capital, this represents a cash outflow and it increases the amount of equity in the company. Since IRR effectively compares cash outflows to equity investors (eg. buying the company or capital calls) vs. cash inflows to equity investors (selling the company, dividend recapitalization), a capital call decreases IRR. It increases the equity and therefore dilutes it.

In the long run, if the cash raised from the capital call is invested into a profitable project or acquisition, it may earn enough of a return that the IRR will ultimately be higher. However, in the short run, IRR is reduced until these results can be realized.