How the model works
The fund pays an enterprise value equal to EBITDA times the entry multiple. Debt covers part of the price, and the rest is the equity cheque. Over the hold period EBITDA grows at a steady rate and a fixed amount of debt is repaid each year. At exit, the company sells for exit EBITDA times the exit multiple, remaining debt is repaid, and the rest belongs to the fund.
Entry equity = EBITDA x (entry multiple - debt multiple). Exit equity = EBITDA x (1+g)^years x exit multiple - remaining debt. MOIC = exit equity / entry equity. IRR = MOIC^(1/years) - 1, which holds because there are no cash flows between entry and exit. The model leaves out fees, interim dividends and taxes.
A worked example
A fund buys a company with $50 million of EBITDA at 9x, so the price is $450 million. It borrows 5x EBITDA, or $250 million, and puts in $200 million of equity. EBITDA grows 6% a year, $30 million of debt is repaid each year and the fund sells after five years at the same 9x.
| Entry | Exit | |
|---|---|---|
| EBITDA | $50.00 | $66.91 |
| Enterprise value | $450.00 | $602.20 |
| Debt | $250.00 | $100.00 |
| Equity | $200.00 | $502.20 |
MOIC is $502.20 / $200 = 2.51x and IRR is 2.51^(1/5) - 1 = 20.2%. Of the $302.20 million gain, $152.20 million comes from EBITDA growth at the entry multiple, nothing from multiple change and $150 million from paying down debt. Change the exit multiple to 8x and the MOIC falls to 2.18x with an IRR of 16.8%.
What leverage does
Run the same deal with no debt and the fund pays $450 million for equity that is worth $602.20 million at exit. MOIC is 1.34x and IRR is 6.0%, which is simply the EBITDA growth rate because the multiple did not change. Borrowing lifts the IRR to 20.2% because the fund controls the same company with less of its own money, and the debt repayment accrues to equity.
The same leverage works against a fund when things go wrong. If the exit multiple drops far enough, or EBITDA falls, the remaining debt can absorb the whole exit value. The calculator floors the MOIC at zero in that case and shows an IRR of -100%. It also refuses a structure where debt equals or exceeds the purchase price, because there would be no equity cheque to earn a return on.
Mistakes that cost points
- Computing returns on enterprise value instead of equity. The fund's money is the equity cheque.
- Using the IRR formula MOIC^(1/n) - 1 on a deal that pays dividends along the way. It only fits a single entry and a single exit.
- Assuming the exit multiple will equal the entry multiple without saying so. Multiple expansion is the weakest source of return to rely on.
- Forgetting that the debt left at exit is repaid first.
- Ignoring fees, which usually cut the returns the fund's investors actually receive.
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