Normally we care about the IRR for the equity investors in an LBO – the PE firm that buys the company – but how do we calculate the IRR for the debt investors?

For the debt investors, you need to calculate the interest and principal payments they receive from the company each year.

Then you simply use the IRR function in Excel and start with the negative amount of the original debt for “Year 0,” assume that the interest and principal payments each year are your “cash flows” and then assume that the remaining debt balance in the final year is your “exit value.” 

Most of the time, returns for debt investors will be lower than returns for the equity investors – but if the deal goes poorly or the PE firm can’t sell the company for a good price, the reverse could easily be true.