Equity multiple hurdle vs IRR hurdle for a waterfall
Under what circumstances would an equity multiple hurdle make more sense than an IRR hurdle in a waterfall? What kind of deals or investors would an equity multiple hurdle make more sense for, or does it never make more sense?
The equity multiple hurdle is more profit driven than the IRR hurdle. For example, if an investment is purchased for 1M, and sold for 1.5M in year 3, (imagine no CF), you achieve a 1.5x multiple (500k profit) and a ~22% IRR. If you sold this same asset for 1.22M in year 2, you achieve a 1.22x multiple (220k profit), but still the 22% IRR. Thus, some LPs are more interested in profits than IRR, as profits feed families and IRR is more a measure of efficiency/timing. This is especially the case in shorter hold period deals where you can manipulate the IRR heavily based on exit timing. On the debt side, there is often a minimum early repayment multiple which is to ensure the profit earned on the loan is above a certain amt, no matter when the Sponsor repays.
Our fund is MOIC based. Our investors are largely FOs and endowments who are more profit driven, and we as developers are in a much better position with a MOIC based promote given probability of delays etc.
Equity multiple does not consider time. Returns + short time horizon = IRR better for promote. Returns + long time horizon = EM better for promote.
You can do a simple goal seek in excel to see the breakeven point.
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