How do you fair value structured equity with a MOIC floor?

A PIK return, a 1.6x minimum multiple and four exit scenarios: why the floor turns the exit date into the biggest driver of the mark.

Julian R. Sterling · from The Private Markets Valuation Specialist

Fair value structured equity as the probability-weighted payoff of each exit scenario, where each payoff is the greater of the PIK-accreted amount and the MOIC floor, discounted at a yield calibrated to the entry price and then moved with the market. On an illustrative 100 investment with a 10 per cent PIK and a 1.6x floor, the calibrated yield is 11.36 per cent and, a year later, the position is worth 114.04 after a 150 basis point widening and a sale process that brings the likely exit forward. The PIK balance of 110.00 understates it, because under a floor an earlier exit is worth more, not less.

Worked in full in The Private Markets Valuation Specialist by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

Structured equity, the preferred or hybrid instruments growth and buyout funds use to put money into a company without fixing its equity price, has become a regular line in private fund portfolios. Its terms typically combine an accreting return with a minimum multiple of the money invested on any redemption or exit. Both features are easy to model separately and easy to get wrong together, because the floor makes the value depend on when the exit happens in a way an ordinary loan does not.

The assumptions

Illustrative instrument. Payoff at exit = max(100 × 1.10^t, 160), except in the downside.
Input	Value
Amount invested	100
PIK return, compounding annually	10%
Minimum return on exit or redemption (MOIC floor)	1.6x, so 160
Recovery in the downside scenario	50
Market yield move to the measurement date	+150 bp

Exit scenarios at entry.
Scenario	Year	Probability	Accreted	Payoff
Early sale of the company	2	25%	121.00	160.00
Planned sale	4	40%	146.41	160.00
Holder's redemption right	6	25%	177.16	177.16
Downside, restructuring	5	10%	161.05	50.00

The accreted amount overtakes the floor only after 4.93 years, so in the two sale scenarios the floor, not the PIK, sets the payoff.

The calculation, step by step

Step 1, calibrate at entry. Find the yield y at which the probability-weighted present value equals the 100 paid: 25% × 160 ÷ (1+y)² + 40% × 160 ÷ (1+y)⁴ + 25% × 177.16 ÷ (1+y)⁶ + 10% × 50 ÷ (1+y)⁵ = 100. Result: y = 11.36%. The four contributions are 32.25, 41.61, 23.22 and 2.92.

Step 2, roll forward one year at the same yield. Same scenarios, one year closer: value 111.36. This is the unwind of the calibrated yield, not a gain.

Step 3, move the yield with the market. Comparable structured and private credit yields have widened 150 basis points: discount at 12.86%. Value 107.22.

Step 4, update the scenarios. The company has launched a sale process: the early sale, now one year away, rises to 45 per cent, the planned sale falls to 25 and the redemption to 20, downside unchanged. Value 114.04.

In Excel, scenario rows with the payoff =IF(Kind="rec",Recovery,Inv*MAX((1+PIK)^T,Floor)), then =SUMPRODUCT(Prob,Payoff/(1+Y)^(T-Tm)); Goal Seek on Y at entry.

The result

From cost to fair value one year after entry.
Step	Change	Value
Cost at entry, calibrated yield 11.36%		100.00
Passage of one year	11.36	111.36
Yields wider by 150 bp	−4.14	107.22
Exit expected earlier	6.82	114.04
Fair value against cost	14.04	114.04

The fair value is 4.04 above the 110.00 PIK balance, 103.7 per cent of it, even though market yields have widened. The timing update more than offsets the yield move.

What if: the exit year

The table isolates the floor. It values a single certain exit in each year, at the 12.86 per cent measurement yield, with and without the 1.6x floor.

Value one year after entry of a single exit in the year shown; no downside scenario.
Exit year	Years away	Payoff	With floor	Plain PIK	Value of the floor
2	1	160.00	141.76	107.21	34.55
3	2	160.00	125.61	104.49	21.12
4	3	160.00	111.29	101.84	9.45
5	4	161.05	99.25	99.25	0.00
6	5	177.16	96.73	96.73	0.00

Without the floor, the exit year barely matters: the PIK rate is close to the discount rate, so value drifts from 107.21 to 96.73 over four extra years. With it, an exit next year is worth 141.76 and an exit in year six 96.73. The floor is a fixed sum paid whenever the exit comes, so its value is a bet on speed. That is why the evidence that matters most at each quarter end is not the company's EBITDA but the state of any sale or refinancing process.

The common mistake

Marking the instrument at its PIK balance, 110.00 here, on the argument that it behaves like a loan. It does not: the balance ignores both the floor and the market yield. The opposite error is marking at the floor, 160, because "the sponsor will sell within two years". That treats the most favourable scenario as certain and skips the discounting. A third, subtler one is keeping the entry probabilities unchanged for years: when a sale process starts, or stalls, the weighting must move, and the yield must be re-tested against the market as for a private credit loan when spreads widen. The calibration logic is the same as in calibrating a private company valuation to the entry price.

Takeaway

Payoff per scenario = max(accreted, floor), or recovery in the downside; value = probability-weighted, discounted at a yield calibrated to cost (11.36 per cent here).
Roll forward by moving the yield with the market and re-weighting the scenarios on current evidence about timing.
Under a MOIC floor, an earlier exit raises value: 34.55 of floor value if the exit is a year away, nothing beyond the 4.93-year crossover.

The calibration and roll-forward chain behind this method is built in the free workbooks for this case.

Questions readers ask

Why does an earlier exit increase the value of structured equity with a MOIC floor?

Because the floor pays a fixed sum whenever the exit happens. In the illustrative case a 1.6x floor pays 160 on any exit before 4.93 years, so an exit one year away is worth 141.76 at a 12.86 per cent yield while an exit four years away is worth 99.25. Without the floor the same exits are worth 107.21 and 99.25.

Can structured equity be marked at its PIK accreted value?

Only by coincidence. The accreted balance ignores the floor, the market yield and the chance of a downside. In the illustrative case the PIK balance after one year is 110.00 while the scenario-weighted fair value is 114.04, 103.7 per cent of it, even after market yields widened 150 basis points.

How do you calibrate the discount rate for a structured equity investment?

Solve for the yield at which the probability-weighted present value of the scenario payoffs equals the price paid at entry, then move that yield with comparable market yields at each measurement date. In the illustrative case 100 paid for scenarios paying 160, 160, 177.16 and 50 gives a calibrated yield of 11.36 per cent.

Read the whole case

This article is one calculation from The Private Markets Valuation Specialist. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.

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