The IRR and the multiple disagree about when to exit. The marginal return of one more year of ownership settles it, and it is a calculation, not a preference.
Sell when one more year of ownership earns less than the capital could earn elsewhere. In an illustrative buyout with 190.0 of equity whose EBITDA grows 10 per cent a year for three years and 3 per cent after, the IRR peaks at 23.5 per cent at the end of year 3, at 1.88x. Year 4 adds only 9.6 per cent to the equity, so holding to year 6 lifts the multiple to 2.47x while the IRR falls to 16.2 per cent.
Worked in full in The Buyout Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A buyout's multiple of money almost always rises with time: as long as the company grows and repays debt, the equity is worth more next year than this year. Its IRR does not. Once the growth plan is delivered, each extra year adds a smaller return to a bigger base, and the annualised rate falls. The two metrics therefore give different exit dates, and arguing about which to maximise goes nowhere. The question that settles it is narrower: what does the next year of ownership return on the value the fund could take out today?
| Item | Value |
|---|---|
| Entry EBITDA, multiple | 50.0 at 9.0x |
| Fees, debt at closing | 15.0, 275.0 |
| Equity cheque | 190.0 |
| EBITDA growth | 10% in years 1 to 3, then 3% |
| Interest on opening debt, tax | 8.0%, 25% |
| Unlevered cash flow | 45% of EBITDA, all used to repay debt |
| Exit multiple, any year | 9.0x |
| Fund hurdle for redeployed capital | 15% |
The growth profile is the usual shape of a value creation plan: a burst while the operating changes land, then the company's underlying rate. The deal mechanics are those of a paper LBO solved by hand, run for eight years instead of five.
Equityt = 9.0 × EBITDAt − Debtt
MOICt = Equityt / 190.0, IRRt = MOICt1/t − 1
Marginal return of year t = Equityt / Equityt−1 − 1
Excel: =(Equity_t/190)^(1/t)-1 and =Equity_t/Equity_prev-1
With a single exit and no interim distributions, the IRR is the multiple annualised, as in how to convert MOIC to IRR.
| Exit year | EBITDA | Debt | Equity | MOIC | IRR | Return of that year |
|---|---|---|---|---|---|---|
| 1 | 55.0 | 266.8 | 228.3 | 1.20x | 20.1% | 20.1% |
| 2 | 60.5 | 255.5 | 289.0 | 1.52x | 23.3% | 26.6% |
| 3 | 66.6 | 240.9 | 358.0 | 1.88x | 23.5% | 23.9% |
| 4 | 68.5 | 224.5 | 392.4 | 2.07x | 19.9% | 9.6% |
| 5 | 70.6 | 206.2 | 429.2 | 2.26x | 17.7% | 9.4% |
| 6 | 72.7 | 185.9 | 468.6 | 2.47x | 16.2% | 9.2% |
| 7 | 74.9 | 163.3 | 510.8 | 2.69x | 15.2% | 9.0% |
| 8 | 77.1 | 138.4 | 555.9 | 2.93x | 14.4% | 8.8% |
The IRR column peaks at year 3, but it peaks because of the column beside it. The equity grows 23.9 per cent in year 3 and only 9.6 per cent in year 4, when the growth burst ends. From then on each year earns about 9 per cent on the equity, made of 3 per cent EBITDA growth geared by the remaining debt plus the paydown. A fund whose capital is expected to earn 15 per cent is, from year 4, keeping 358.0 of its investors' money in an asset returning 9.6 per cent.
Sell at year 3: 358.0, 1.88x, 23.5%
Hold to year 6: 468.6, 2.47x, 16.2%; the forward return from year 3 to year 6 is 9.4% a year
Sell at year 3 and redeploy at 15% for three years: 358.0 × 1.153 = 544.5
On those assumptions holding costs 75.9 by year 6, even though it shows the bigger multiple. The 0.58x of extra MOIC is bought at 7.3 points of IRR.
The redeployment rate is the whole argument. Late in a fund's life, with the investment period over, sale proceeds go back to investors rather than into a new deal, and the comparison becomes the investors' own alternative return. A continuation vehicle exists precisely for the case where the forward return is still attractive but the fund's clock has run out.
Reading the exit decision off the IRR column and stopping at its peak, or off the MOIC column and never stopping. The IRR is an average over the whole hold, so it falls well after the marginal return has collapsed: here the year-4 return is already 9.6 per cent while the IRR still shows 19.9. Set the next year's return against the hurdle, every year, from the date the value creation plan is delivered.
The book runs one buyout from entry to exit and sets the holding period beside the other levers of the return; the free workbooks for this case carry the holding-period sheet and the rest of the sensitivities.
The year after which one more year of ownership earns less than the fund's hurdle or its alternative use of the capital. In the illustrative buyout the equity grows 23.9 per cent in year 3 but only 9.6 per cent in year 4, so with a 15 per cent hurdle the exit falls at the end of year 3, not at the five years a model defaults to.
Because each extra year adds a smaller return to a larger equity base. In the worked case EBITDA growth slows from 10 to 3 per cent after year 3, and the equity's yearly gain falls to about 9 per cent. Averaged into the earlier years, that drags the IRR from 23.5 per cent at year 3 to 16.2 per cent at year 6 and 14.4 per cent at year 8.
Neither alone. Holding the illustrative deal from year 3 to year 6 adds 0.58x of multiple but costs 7.3 points of IRR. If the fund can redeploy at 15 per cent, selling at year 3 and reinvesting produces 544.5 by year 6 against 468.6 from holding. If it cannot redeploy, the larger multiple is real money to its investors.
This article is one calculation from The Buyout 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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