Private Equity Returns
Greetings,
I'm having some trouble understanding how PE companies calculate returns for their LP's considering that their investment horizons tend to be medium to long term. I understand that the liquidity and transparency is less than that of the equity markets making it more difficult to visualize returns at any given moment.
Imagine a company invests $10 M into a private company in Y1. How does the private equity company calculate returns at the end of Y1, Y2, Y3, etc for their LP's? Obviously when they exit their position at the end of the holding period they would know their exit multiple and can calculate the returns but my question is with respect to the early years of the holding period.
Might be a basic question but I can't seem to find it anywhere. Appreciate the help.
The same way you value any other company
that is incredibly worthless, thank you so much for your help!
But it's not wrong lmao. Just done on a quarterly basis and you compare that to the equity value at close
Returns are primarily calculated using internal rate of return / IRR. If a company has invested $x to purchase y% of a company in year zero, there are two components to their return in years 1, 2, 3, etc. which are realized and unrealized cash flows. Realized cash flows come in the form of management fees, dividends, and any other distributions to the investors while unrealized returns consist is the equity value built up in the companies. Typically a PE fund will value their portfolio on a quarterly basis using market-based comparable transactions, then use an external firm to value the businesses on an annual basis. The equity value in the company + realized cash flows are the drivers of returns until the business is sold. Once the business is sold, it’s all realized. Gross IRR is before fees and carried interest while net IRR is after.
Great response, that is very useful. I appreciate you taking the time to explain this one for me.
Well said. I will add, we spend a lot more time thinking about MOIC (capital returned / capital invested) than we do about IRR at my firm (and think this is the case at most PE firms on the GP side). Once you are beyond the hurdle rate. Carry is only paid on the actual capital gain after all.
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