Equity Multiple & IRR Correlation
Could you all please provide me your insights on the correlation between IRR & Equity Multiple? I had somebody tell me that by looking at a 20% IRR over 3 years, that you could calculate the EM to 1.6x
Is there a chart out there that explains this theory? Can you look at an IRR and investment length and say that’s a “X multiple” confidently?
We know that equity multiple doesn’t include the NPV or the “time value”.
There isn’t a fool proof method to come up with it on the fly. Understanding that the two while being return metrics they don’t measure the same thing (IRR accounts for TVM while EM is pure cash return). That being said two projects both with a 2.0x multiple one is a 3 year hold and the other is a 6 year hold, the shorter hold will have a higher IRR.
In their simplest form your IRR is the average annual rate or return and equity multiple is you ROI. If you have an irr of 20% over 3 years then you’re saying in each year you’re making 20% on your money. Add 20% up over three years and you get 60%, or your 1.6x multiple.
It’s back of the napkin math but that’s how most MD’s with look at a deal high level. Getting really good at quick back of the napkin math goes a long way when talking through deals at a high level with your superiors.
Wouldn't that be a 0.60x equity multiple since you didn't receive your initial money back?
The 60% is on your investment. It implies that you’ve received your return of equity. You wouldn’t have a positive IRR without a return of equity.
There is no quick and loose way to convert it properly as it depends on timings. A better way to phrase it is that an IRR of 20% over 3 years is a minimum of 1.6x EM.
E.G. 1m invested today with a terminal value (and no income) of 1.73m at the end of year 3 produces a 20% IRR but a 1.73x EM.
That’s not even true. Totally dependent on timing of cash flows. For example, an investment with cash flows timing -100 in period 0, +85 period 1, 0 period 2, and +50 period 3 equals a 20% IRR and only 1.35x MOIC. Granted that’s an odd cash flow stream for a real estate investment, but it illustrates that IRR doesn’t necessarily correlate with multiple.
Yeah especially if you're doing a refi or supplemental loan a few years into a longer investment, that can juice the IRR while still having a low EM. The IRR formula assumes you can reinvest earnings at the same rate throughout the investment
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