IRR for a PE fund

Friends, I have a very basic question regarding IRR.

If a private equity fund infuses let say $10 mn in a company having Market Cap of $100 mn, how would one go about calculating the IRR for a 3rd year exit?

  • Would we take the cash outflows to be 10 % of the Net Income of the company?
  • For example if the net income figures for 3 years are 50, 60, 60 then would it be right to say that the cash flows to find IRR would be: -10, +5, +6, +6
  • Therefore, IRR equals 31 % for a 3rd Year exit?

How to Calculate Internal Rate of Return

To answer OP’s question, Certified Private Equity Professional – 1st Year Analyst @DonMunich" offers the following:

If you assume 100% of net income per year goes to the shareholders then 5,6,6 is fine (the scenario is more realistic for public companies not private). But don't forget: you're selling your 10% stake in the company as well in year 3. Your cash flow in year will be 6 + X, where X equals the cash paid for your 10% stake in year 3.

Common Investment Time Horizon for PE Funds

The thread also brought up the question of what is the common investment period for most PE funds. WSO users offer their input:

From WSO user @hiit"

A 5 year investment period is pretty common (at least in the mid-market funds I looked at). Maybe it's fundamentally different for those mega-funds, but that would surprise me since most funds lasted for ~10 years give or take. Either way, read up on the j curve if you're interested in PE return characteristics.

From Certified Private Equity Professional – 2nd Year Associate @HarvardOrBust"

Majority of funds have a 10-year life. Fund performance is dictated by the J-curve. It is better to compare across funds from each vintage rather than try to use an absolute figure (for example, 2007 vintage funds are going to perform much worse than a 2010 vintage). Also, performance figures are generally usable after 3-5 years into the fund life.

From Certified Private Equity Professional – Principal @CompBanker"

I'm not sure what the exact investment period is for megafunds, but generally it is 5-years to invest the capital and 10-years (total) to return the capital (with the option for two, one-year extensions). While hold periods can vary drastically from one investment to another, 5-years is generally used as the expected length of each investment.

Recommended Reading

 

Also how do we make a data table similar to below http://willprice.blogspot.com/2007/06/irr-multiplication-table.html

I am trying to sensitize by the exit multiple and exit period option. Taking row as the various exit multiples and column for the exit year. Which function would be suitable to let me sensitize by Exit peiod? IRR functiondoes not seem to work.

 

Some of these funds aren't even through the investment period. I'd be careful sharing this data as I suspect that most people on this board will misunderstand how to interpret it.

CompBanker’s Career Guidance Services: https://www.rossettiadvisors.com/
 
CompBanker:

Some of these funds aren't even through the investment period. I'd be careful sharing this data as I suspect that most people on this board will misunderstand how to interpret it.

Just curious, what would be the investment time horizon for most of these funds? I wouldn't be surprised if it varies, but what would be a ball park figure?

Man made money, money never made the man
 

I don't know about that... a 5 year investment period is pretty common (at least in the mid-market funds I looked at). Maybe it's fundamentally different for those mega-funds, but that would surprise me since most funds lasted for ~10 years give or take. Either way, read up on the j curve if you're interested in PE return characteristics.

http://www.calpers.ca.gov/index.jsp?bc=/investments/assets/equities/pe/…

 
Best Response
RE Capital Markets:
CompBanker:

Some of these funds aren't even through the investment period. I'd be careful sharing this data as I suspect that most people on this board will misunderstand how to interpret it.

Just curious, what would be the investment time horizon for most of these funds? I wouldn't be surprised if it varies, but what would be a ball park figure?

Majority of funds have a 10-year life. Fund performance is dictated by the J-curve. It is better to compare across funds from each vintage rather than try to use an absolute figure (for example, 2007 vintage funds are going to perform much worse than a 2010 vintage). Also, performance figures are generally usable after 3-5 years into the fund life.

 

Exactly. I'm not sure what the exact investment period is for megafunds, but generally it is 5-years to invest the capital and 10-years (total) to return the capital (with the option for two, one-year extensions). While hold periods can vary drastically from one investment to another, 5-years is generally used as the expected length of each investment. That means a 2008 vintage fund will have probably liquidated only 20% of its investments by now and will still be holding 20% of its investments at cost. This is one of the reasons why the funds at the top of the list, on average, appear to be doing so much worse than the funds at the bottom of the list.

Also note that the IRRs listed are "Net" rather than "Gross."

CompBanker’s Career Guidance Services: https://www.rossettiadvisors.com/
 

Would also assume that returns and valuations shown at some of these funds' LP meetings (if that's where some of this data came from) can be very lumpy (i.e. my HF plays in the distressed space and we make internal assesments of some of those investments' values on a monthly/quarterly basis based on your standard public comps / precedent transactions / DCF type analysis). These practices can inflate valuation and leave you with book losses when the investments are actually monetized (i.e. what's about to hit the HD Supply investors now that it will see a bad public market valuation vs. perhaps rosier valuations shown to their investors historically). Similarly with a private company, a couple of good quarters can move the needle on your valuation models very favorably.

All that being said, it wouldn't surprise me if your average vintage from this era ultimately returned 10-20% gross IRR with a skew towards the lower half of that range, just given how some of these buyouts actually panned out.

  • Toys "R" Us - $6.1bn - minimal equity return; canceled IPO a couple of months ago because no one shops there anymore lol.
  • SunGard - $10.8bn - not much equity value left; have been trying to IPO for years - thankfully were able to recap recently.
  • TXU - $44.4bn - equity value is basically 0; 2017 Sr. Sec. TL trades at ~71.
  • Freescale - $17.5bn - IPO'd at a 50% discount to the purchase multiple and the stock's traded down 20% from there; this investment represented ~10% of a few of the sponsor's funds, IIRC, just having been around the name the last few years. Know a BX partner lost his job for this.
  • Caesars - $27.6bn - Sr. Secured Debt trades at 60 today. Believe they've taken some dividends over the years, but not going to be a wonderful return.

Apax Partners (as a firm) - just from this last fund has blown multiple multi-billion dollar investments to 0; Cengage and Hibu are coming to mind off the top of my head. They've started firing folks / closing offices now as well.

Reality ultimately sides with this data, for the PE guys in this thread trying to sugarcoat this stuff; huge amounts of these large funds were invested in cos. that have either generated effectively -100% book returns to date or at least negative returns based on public market valuation. Basic math should tell you that it takes a lot of winners to overcome such big losers, and there just weren't enough over the past few years.

What's scarier is when you think about how much of these returns were beta driven (leverage, etc. - prob. 75-85%) and how much were alpha driven (wagering pretty minimal). Nice work.

 

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