Multiple on Invested Capital (MOIC)

Unrealized vs. Realized MOIC: What is the Difference?

When evaluating overall fund performance, i.e. multiple assets in a portfolio, the formula uses different inputs, but the core concepts remain the same.

The classification of MOIC can be expressed on either an unrealized or realized basis.

• Unrealized MOIC → The return is inclusive of investments in the portfolio not yet sold, i.e. the expected profits post-sale are not certain (and still at risk of fluctuations).
• Realized MOIC → The return calculation is composed only of “realized” investments in the portfolio, where the profits have been locked-in.

MOIC vs. IRR: What is the Difference?

The multiple on invested capital (MOIC) and internal rate of return (IRR) are the two most common performance metrics used in the private equity industry.

• MOIC → The ratio between an investment’s ending (future) value to the initial investment size.
• IRR → The annualized rate of return earned on the investment.

MOIC measures the amount earned, whereas the IRR considers not only the total earnings from the investment, but also the time required.

A higher MOIC ratio implies a more profitable investment, whereas a lower MOIC indicates the investment is less profitable.

One notable distinction between MOIC and IRR is the consideration of time, i.e. the holding period of the investment.

While MOIC may require less time and financial data to calculate, the metric simply focuses on the gross return earned on the date of the exit, regardless of when that exit occurred.

The fact that the MOIC metric neglects the concept of time is the reason the internal rate of return (IRR) – i.e. a returns metric that considers the duration of the holding period – must be calculated as well to generate a complete picture of investment performance, inclusive of the passage of time.

In contrast, an investment’s IRR can vary substantially under different exit date assumptions, as longer holding periods tend to cause returns to decline (and short exits can misleadingly increase the IRR).

The sensitivity of the IRR to the exit date is one drawback to the metric, which reflects again the importance of using more than one metric to understand the full picture.

Private equity investors must therefore pay close attention to both the MOIC and IRR, as the two are not mutually exclusive.

MOIC to IRR Table

For those preparing for private equity interviews – especially for the paper LBO – it is highly recommended to memorize the most common MOIC to IRR approximations.

MOIC Calculator

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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1. LBO Model Entry Assumptions

Suppose a company underwent an LBO acquisition on 12/31/21, marking the end of 2021.

In order to acquire the target company, the private equity firm (or financial sponsor) needed to contribute $100 million in cash, i.e. the sponsor’s equity contribution.

Our LBO returns schedule must reflect the initial cash outlay of $100 million in Year 0 – which, for illustrative purposes, was formatted with red as the font color.

• LBO Transaction Closing Date = 12/31/21
• Sponsor Equity Contribution (and Initial Cash Outlay) = $100 million

The MOIC metric has its limitations and must be used in conjunction with the IRR, so we’ll calculate the two return metrics side-by-side.

2. LBO Returns Analysis Schedule

The “Cash Inflow / (Outflow)” is determined by our “% Recovery of Initial Investment” assumption in the LBO holding period, i.e. the five-year forecast period.

The recovery percentages are assumed to be 100% in Year 1, followed by an annual increase of 50% each year until Year 5, the end of the holding period.

Therefore, the net cash inflows (and outflows) are as follows.

• Year 0 = –$100 million
• Year 1 = $100 million
• Year 2 = $150 million
• Year 3 = $200 million
• Year 4 = $250 million
• Year 5 = $300 million

Except for Year 0 – the date of the LBO – all the other years represent net positive values to the sponsor.

Hence, the IRR is 0% and MOIC is 1.0x in Year 0, which means the return was neutral and the full initial investment was recouped.

In reality, transactions such as LBOs can easily accumulate incremental fees for M&A advisory fees from investment banks and legal fees, so the 1.0x MOIC would most likely have been a net loss of capital for the firm after taking into consideration any expenses.

3. MOIC Calculation Example

The process of calculating the internal rate of return (IRR) in Excel involves using the “XIRR” function, wherein the first array is a row of dates (Row 8) and the second array is the “Cash Inflows / (Outflows), net” (Row 5).

The multiple on invested capital (MOIC) is calculated by adding the cash values received during the holding period, starting from Year 1.

The next step is to divide the sum from above by the initial investment amount, with a negative sign placed in front of the initial investment value (to convert it to a positive value).

For example, the MOIC assuming a Year 1 exit is 1.0x.

The completed returns schedule from our hypothetical LBO scenario is as follows.

4. MOIC Returns Analysis Example

Assuming the financial sponsor exited the investment in Year 5, the estimated IRR is 24.6% while the MOIC is 3.0x.

• Implied Internal Rate of Return (IRR) = 24.6%
• Multiple of Invested Capital (MOIC) = 3.0x

The implied returns reflect favorable results to the private equity firm, in which its initial equity contribution tripled in value over the five-year period, i.e. the 3.0x MOIC.