Split the profit at NAV, then split the IRR at par: the two answers differ, and the gap tells you where the risk in a secondary sits.
Split the profit at the reported NAV: everything up to NAV is the discount, everything above it is appreciation. On an interest bought at 82 for a NAV of 100 that returns 128, the discount is 18 of 46 of profit, or 39.1 per cent, but it is 9.0 of the 18.8 points of IRR, or 47.6 per cent, because it is earned on the first day rather than spread across the hold.
Worked in full in The Private Equity Secondaries Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The question matters because the two sources of return behave differently. The discount is known at signing and is captured provided the NAV is real. Appreciation depends on the companies, the exits and the timing, and it is where a diligence budget earns its keep. A buyer who cannot say how much of a projected return is which cannot say where the risk sits.
| Input | Value |
|---|---|
| Reported NAV at purchase | 100 |
| Price paid (an 18 per cent discount) | 82 |
| Distribution, year 1 | 20 |
| Distribution, year 2 | 35 |
| Distribution, year 3 | 40 |
| Distribution, year 4 | 33 |
| Total value returned | 128 |
Profit = total returned − price = 128 − 82 = 46
Discount component = NAV − price = 100 − 82 = 18
Appreciation component = total returned − NAV = 128 − 100 = 28
Discount share of profit = 18 ÷ 46 = 39.1%. Appreciation share = 60.9%.
In multiple terms: the interest returns 1.56x on the price paid. Had the buyer paid par, the same cash would have returned 1.28x. The 0.28x difference is the discount, and the rest is the portfolio.
The multiple split ignores time. The IRR split does not, and it gives a different answer. Compute the IRR twice on the same distributions: once at the price paid, once at par. The difference is the discount's contribution.
IRR at 82: 18.8%. In Excel, with −82 in B2 and the four distributions in B3:B6, =IRR(B2:B6).
IRR at par, −100 in B2: 9.9%.
Discount contribution = 18.8 − 9.9 = 9.0 points, or 47.6 per cent of the IRR.
The discount is worth more in the IRR than in the profit because it is all received at time zero, in the form of a smaller cheque, while the appreciation arrives with the distributions over four years. Front-loaded value always weighs more in a rate of return than in a multiple.
Scale the four distributions up or down, keeping their shape, and the split moves sharply. The discount's contribution in points barely does.
| Total returned | Multiple | IRR at 82 | IRR at par | Discount, IRR points | Discount share of IRR |
|---|---|---|---|---|---|
| 100 | 1.22x | 7.8% | 0.0% | 7.8 | 100.0% |
| 110 | 1.34x | 11.9% | 3.7% | 8.2 | 69.3% |
| 128 | 1.56x | 18.8% | 9.9% | 9.0 | 47.6% |
| 145 | 1.77x | 25.0% | 15.4% | 9.6 | 38.5% |
Read down the fifth column. Between a portfolio that only returns its NAV and one that returns 145, the discount contributes between 7.8 and 9.6 points. It is the stable part of the return. Everything that makes the deal good or bad is in the IRR at par, which runs from zero to 15.4 per cent across the same rows. That is the case for spending diligence on the companies rather than on squeezing another point off the price.
The discount's contribution is not fixed in time. Push every distribution back by a year, same 128 in total, and the IRR at 82 falls to 13.1 per cent while the IRR at par falls to 7.0. The discount now contributes 6.1 points instead of 9.0. A discount is a fixed amount amortised over the life of the cash flows, and a longer life thins it.
Repricing for a one-year slip: to keep the original 18.8 per cent with every distribution a year later, the buyer would have to pay 69.0, a 31.0 per cent discount instead of 18. Duration risk in secondaries is priced in discount points, and the conversion rate is steep.
The common shortcut is to treat the discount as a return in itself: buy at 82, receive 100, so the discount "earns" 22.0 per cent. That figure is a multiple, not a rate. Spread over the actual timing of this portfolio it adds 9.0 points of IRR, and 6.1 if the exits slip a year. The second mistake is the mirror image: presenting the 39.1 per cent multiple split to an investment committee as the source of return when the IRR split, the one the committee is underwriting, is 47.6 per cent. Both are correct answers to different questions; state which one you are using.
Run the IRR twice, at the price and at par, and report the difference. If most of the projected IRR is discount, the deal depends on the NAV being real and the timing holding. If most of it is appreciation, it depends on the companies, and that is where the work belongs. The deal model in the free workbooks for this book makes the same split on its own worked case. For how fees and carry then cut a gross return, see why net IRR is lower than gross IRR.
No. Buying at 82 for a NAV of 100 is a 22.0 per cent gain on paper, but that is a multiple, not an annual rate. Spread over a four-year distribution profile it adds 9.0 points of IRR, and only 6.1 points if every distribution arrives a year later.
Because it is received at time zero as a smaller cheque, while appreciation arrives with distributions over the hold. In the worked case the discount is 39.1 per cent of the profit but 47.6 per cent of the 18.8 per cent IRR.
In the worked case, keeping an 18.8 per cent IRR with every distribution a year later requires a price of 69.0 instead of 82, a 31.0 per cent discount to NAV rather than 18. Duration is priced in discount points, and the exchange rate is steep.
The same split, entry discount against company appreciation, is built into the chapter 8 and 9 deal model of The Private Equity Secondaries Investor. 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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