LBO returns attribution

Key takeaways

• The equity gain in a buyout equals the change in enterprise value plus the reduction in net debt, less entry fees and costs funded with equity.
• EBITDA growth and multiple change overlap; the cross term goes to whichever driver is measured second, so the ordering convention must be stated.
• In the Linwood deal, under the EBITDA-first convention, the $619.9m gain is $366.0m EBITDA growth, $68.3m multiple expansion, $220.6m debt paydown and minus $35.0m fees.
• Leverage shrinks the equity check, so it raises IRR proportionally more than MOIC whenever the IRR is below 1 / (n - 1), which is 25 percent for a five-year hold.
• Early distributions such as dividend recapitalizations raise IRR even when they lower MOIC.
• With a single entry and exit, 2.0x in five years is a 14.9 percent IRR and 3.0x in five years is 24.6 percent.

Why attribute returns

A general partner raising its next fund presents a track record deal by deal. Limited partners (the pension funds, endowments and family offices that invest in the fund) ask how each gain was made. A return driven by EBITDA growth suggests the firm can improve businesses. A return driven by multiple expansion may reflect skill in buying well or simply a rising market. A return driven by debt paydown mostly reflects the leverage available at the time. Attribution turns a single number into a story that can be tested.

Inside the firm, the same bridge disciplines the investment case before a deal is approved. If the model only clears the fund's target return with a higher exit multiple than the entry multiple, the committee knows the deal depends on the market rather than on the plan.

The drivers used here are the common practitioner set. Some firms split EBITDA growth further into revenue growth and margin change, or separate debt paydown from other cash effects such as dividends. The principle is the same: every dollar of gain is assigned to exactly one driver, and the drivers add up to the total.

The bridge identity

Start from the definitions. Equity at exit is exit enterprise value less exit net debt. Equity at entry, the sponsor's check, is entry enterprise value less entry net debt plus the fees and costs funded at closing, because the sponsor paid for those too without receiving any enterprise value in return. Subtracting one from the other gives the gain as three pieces: the change in enterprise value, the fall in net debt, and the fees.

The change in enterprise value is then split into EBITDA growth and multiple change. Because EV is EBITDA times a multiple, and both factors change, there is no unique split. The product of the two changes, the cross term, has to be assigned somewhere.

Attributing the Linwood gain

Linwood was bought at 10.0x LTM EBITDA of $100.0m and sold after five years at 10.5x EBITDA of $136.6m. Net debt fell from $540.0m after closing (debt of $550.0m less $10.0m cash) to $319.4m. Fees of $35.0m were funded with equity. The equity gain was $619.9m.

The EBITDA-first convention, used below, values EBITDA growth at the entry multiple and multiple expansion on exit-year EBITDA. It is the more common presentation because it asks a natural question first: if the business had sold at the price paid, how much would the operating improvement alone have been worth?

Ordering matters

Measure the multiple change first, on entry EBITDA, and EBITDA growth second, at the exit multiple, and the same deal tells a different story. The cross term, $36.6m of EBITDA growth times half a turn of multiple, $18.3m, moves from multiple expansion to EBITDA growth.

Neither answer is wrong. They are different conventions for a quantity that has no unique split. The difference grows with the size of both changes: a deal that doubled EBITDA and added three turns of multiple has a very large cross term, and a sponsor could present it as mainly operational or mainly market-driven by choosing the order. When comparing attributions across firms or funds, confirm they use the same convention.

Why leverage magnifies IRR more than MOIC

Leverage does not create enterprise value. It changes how much equity is needed to own that value. Buying Linwood with no debt would have required $1,030.0m of equity (the $1,000.0m price, $20.0m of transaction fees and $10.0m of cash, with no financing fees). The business would have paid no interest, so it would have accumulated more cash and generated a larger dollar gain. But that gain would sit on twice the equity.

For a single investment and a single exit after n years, IRR equals MOIC to the power 1 / n, less one. Differentiating shows that a 1 percent relative increase in MOIC produces a relative increase in IRR larger than 1 percent whenever IRR is below 1 / (n - 1). For a five-year hold that threshold is an IRR of 25 percent, equivalent to a MOIC of about 3.05x. Linwood, at 17.6 percent levered and 11.9 percent unlevered, sits below it, so the leverage that lifts its MOIC lifts its IRR proportionally more.

Timing sharpens the effect. IRR rewards cash returned early; MOIC does not care when cash arrives. A dividend recapitalization, where the company borrows more mid-hold to pay the sponsor a dividend, pulls cash forward. It adds interest cost, so total value returned usually falls slightly, but IRR rises.

Sensitivity: exit multiple and holding period

The base case is one path. The investment committee sees a grid: IRR for a range of exit multiples and exit years. Each cell uses the model's actual EBITDA and net debt at the end of that year, sells at the stated multiple and solves the IRR on the sponsor's two cash flows.

The grid shows a pattern worth understanding. At the lowest exit multiple, 9.0x, holding longer raises IRR, because another year of debt paydown and EBITDA growth outweighs the time cost of waiting. At high exit multiples, selling earlier is better, because the multiple gain is earned over fewer years. At 9.5x the three holding periods give almost the same IRR, and at the entry multiple of 10.0x IRR falls gradually as the hold lengthens and EBITDA growth fades.

Benchmarks: translating MOIC into IRR

Practitioners carry a few conversions in their heads, because a MOIC and a holding period are often all that is quoted. With one investment and one exit, the conversion is exact. The two most quoted: 2.0x in five years is about a 14.9 percent IRR, and 3.0x in five years is about 24.6 percent. Both are verified below.

Real funds and deals have many cash flows, so these benchmarks are approximations for them. Fees and carried interest at the fund level also separate deal-level gross returns from the net returns an investor receives; the fund performance topics cover that distinction.