IRR vs. Cash on Cash Multiples in Leveraged Buyouts and Investments

In this IRR vs Cash tutorial, you’ll learn the key distinctions between the internal rate of return (IRR).
By breakingintowal... "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
You will also learn further distinctions on the cash-on-cash multiple or money-on multiple when evaluating deals and investments - and you’ll understand why venture capital (VC) firms target one set of numbers, whereas private equity (PE) firms target a different set of numbers.
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Table of Contents:
1:35 Why Do IRR and Cash-on-Cash Multiples Both Matter?
3:05 What Do Private Equity vs. Venture Capital vs. Other Firms Care About?
8:30 How to Use These Metrics in Real Life
11:08 Key Takeaways
Lesson Outline:
1. Why Does This Matter?
Because there are DIFFERENT ways to judge the success of a deal - 2 of the main ones for leveraged buyouts (LBOs), growth equity investments, and venture capital investments are the internal rate of return (IRR) and the cash-on-cash (CoC) or money-on-money (MoM) multiple.
Many investment firms will care a lot about one of these, but not the other, and will try to find investments that yield a high IRR or a high multiple… but not both.
The Difference: IRR factors in the time value of money - it's the effective, compounded interest rate on an investment. Whereas the multiple is simpler and ignores timing (e.g., $1000 / $100 = 10x multiple).
2. What Do Different Firms Care About?
Most venture capital (VC) firms and early-stage investors want to earn a multiple of their money back - they don't care that much about IRR, because they're going to be invested for a VERY LONG time and it's not exactly liquid… and they don't care what the stock market does.
VC firms must be able to cover their losses with “the winners”! If they get 2x their capital back in 1 year (100% IRR) and then lose everything on another investment in 5 years’ time (0% IRR), the first result is completely irrelevant because they've only earned back 1x their capital.
Perfect Example: Harmonix, maker of Guitar Hero - got VC investment in the mid-1990's, generated $0 in revenue for 5+ years, and then in 2005 released the hit video game Guitar Hero. Sold for $175 million to Viacom in 2006!
Massive multiple, but likely a pathetic IRR since it took 10+ years to get there.
Later-stage investors and private equity firms care more about IRR because the multiples will never be that high in late-stage deals, and because they are benchmarked against the public markets (e.g., the S&P 500) more.
If the firm's IRR can't beat the stock market, why should you invest?
Most PE firms target at least a 20-25% IRR depending on the economy, deal environment, valuations, etc… less when things are bad, more in frothy times.
This makes it common to do "quick flip" deals where the company is bought and then sold at a MUCH higher multiple right after - simply to get a high IRR.
Real-Life Example: Thoma Bravo (mid-market tech PE firm) bought Digital Insight from Intuit for $1.025 billion, and then sold it 4 months later for $1.65 billion to NCR.
VERY high IRR - 316%! But only a ~1.6x money multiple, assuming no debt / no debt repayment.
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3. How Do You Use These Metrics In Real Life?
How to calculate them: see the Atlassian or J.Crew models. IRR is straightforward and uses built-in Excel functions, but for the CoC or MoM multiple, you need to sum up all positive cash flows in the period and divide by the sum of all negative cash flows in that period, and flip
the sign.
In the case of Atlassian, the deal is great for Accel because they earn a 15x multiple, even though the IRR is "only" 35%... they do not care AT ALL because they are targeting the multiple, not the IRR.
For T. Rowe Price, the multiple of 1.9x isn't great, but they do at least get a 14% IRR which is probably what they care about more since they are late-stage investors.
For the J. Crew deal, both the IRR and the multiple are very low and below what PE firms typically target, so this deal would be problematic to pursue, at least with these assumptions.
4. Key Takeaways
IRR and Cash-on-Cash or Money-on-Money multiples are related, but often move in opposite directions when the time period changes.
Different firms target different rates and metrics (VC/early stage - multiples, ideally over 10x or 3-5x later on; PE/late stage - IRR, ideally 20%+).
Calculation: IRR is simple, use the built-in IRR or XIRR in Excel; for the multiple, sum the positive returns/cash flows, divide by the negative returns/cash flows and flip the sign.
Judging deals: Focus on multiples for earlier stage deals (and if you're pitching VCs to fund your company), and focus on IRR for later stage / growth equity / PE deals.

[@StayPolishThinkEnglish]

So awesome. Everything seems nicely correlated. The more I listen to you, the more insight I get from it. Thanks!

[@financialmodeling]

Thanks for watching!

[@Dylan-cr5ub]

Thanks 😊

[@financialmodeling]

Thanks for watching!

[@AlexVoxel]

Great explanation, very clear. Thank you for making this!

[@financialmodeling]

Thanks for watching!

[@frogger2359]

Great video, very helpful

[@financialmodeling]

Thanks for watching!

[@MrJasper888]

Very helpful video --many thanks for this!

[@financialmodeling]

Thanks for watching!

[@andrewmaina8899]

Excellent stuff!

[@financialmodeling]

Thanks for watching!

[@marcelo_luz]

Great, thanks to share. I have one question that is not totally related to video: can I project a PE Fund Cash Flow with MOIC, Distributions (all inflow dates stated) and amounts assumptions to match with a growth year rate by iterations that return inflows with the exact sum of all distributions on the cash flow and from that have an implied IRR output? Is this make sense for you? For exemple: MOIC=2, Contributions fixed between range dates=30.000, Distr.p1=x+Distr.p2=y+ ...+ Distr.pf=z=60.000, and the iterations will show the rate that meets this equation applied in x, y...z. Thanks again.

[@financialmodeling]

I don't think you can really do that because if you try to project distributions based on a targeted IRR or MOIC and the cash inflows, there will be multiple solutions to the equation. You could probably come up with a single set of numbers that solves it, but you wouldn't be able to say that that's the "only" solution or the "correct" solution.

[@cireracusins8335]

Thank you very much, you do a great job :)

[@financialmodeling]

Thanks for watching!

[@piotrw4629]

Hey great video! I have question regarding the sensitivity table buildup. What should be inserted in the D61???

[@financialmodeling]

A link to the IRR calculation cell in the actual model.

[@TheMackayFile]

Thank you for the video. Could you please help me to understand the following. If i use ev/ebitda multiple and find my exit value for the private equity deal, I get IRR of over 30% which looks good. But then when I use DCF, I get fair value of equity which gives me almost no upside to the price I pay, which does not look good at all. Or if I use current market multiple of, for example PE, and apply to my final year net income and then discount back to now, it gives me again no upside to the price I pay. How should I interpret these numbers? Many thanks

[@financialmodeling]

TheMackayFile Those results don't necessarily contradict each other. A DCF just tells you whether or not something is appropriately valued, whereas the IRR tells you how much you could earn each year by investing in it... so you could still earn a good amount even if a company is not undervalued. It is a bit odd that the IRR would be so high with a properly valued company, but it's not unheard of. You should probably check the implied growth rates from your terminal multiples in the DCF, and if they're too low (e.g., 0.5% for a high-growth company), maybe adjust up the multiples. Or check the assumptions that go into IRR and adjust those downward if it turns out they are too aggressive.

[@TheMackayFile]

Mergers & Inquisitions / Breaking Into Wall Street Many thanks for your assistance.

[@johnjohnson8465]

Thanks for the video! Quick question - given that the IRR decreases over time all else equal, why don't PE firms exit after 1 to 2 years to get the highest IRR? Is it because it's difficult to make meaningful operational changes and have the board / shareholders agree to such a short holding period?

[@financialmodeling]

Yes, and also, if they do that, they then need to redeploy the capital in something else that will also yield a higher IRR in a short time frame, which is quite difficult in practice. It's better to accept a lower IRR if it means a 5-7-year holding period rather than higher IRRs where fund re-allocation is required every 1-2 years, as the manpower and expenses required to do that would be substantially higher. LPs also like to see their capital relatively stable over time.

[@shrwn786]

Hey, thanks for making such great videos! Maybe it is too much to ask, but can you please also share a link to download your excel files? It will be really helpful.

[@financialmodeling]

+Shrawan Mundra Click on "Show More" and then click the Excel file link.

[@heyrram]

Great Explanation..

[@financialmodeling]

+ram murthy Thanks for watching!

[@yoelherman5344]

Thanks a lot for the great videos. Quick clarification - you mean that VC care more about the multiples than the IRR becasue they want to produce a high return to investors? that's what a IRR also does, is'nt it?

[@financialmodeling]

It's not a universal rule. It was just a general comment that some investors care more about the multiple and some care more about the IRR, depending on the stage of the firm and how LPs measure the firm. Sometimes VC firms care more about the multiple or try to highlight that more because some deals can take an extremely long time to exit (10-15+ years), so the IRR doesn't look great.

[@alphacapton4943]

Hello! I have a basic question. If you had invested 5k in a project and after two year's you sold everything for 15k cash. Most people would say, you received 3x cash-on-cash. Is it wrong to say 2x? since, the first 5k is my own cash and the additional 10k is actual profit.

[@financialmodeling]

It is a 3x cash-on-cash multiple. 2x does not make sense because the amount received at the end is always assumed to include the initial amount contributed.

[@MrJasper888]

Quick question: Is the Cash-on-Cash multiple interchangeable with the Multiple on Invested Capital (MOIC)? What's the difference? Thanks!

[@financialmodeling]

Yes, they're the same thing.

[@Kingofgtown]

Well done presentation. Is it possible to receive a copy of the excel? Many thanks in advance

[@financialmodeling]

Click "Show More". Then click the Excel link in the description.

[@Hudsonyards1978]

Thank you!

[@samuelsafaty8269]

excellent.

[@financialmodeling]

+Samuel Safaty Thanks for watching!

[@crownroyal89]

Good content and good timing! Any chance you could share this model? Or, at minimum, a PDF printout of it?

[@financialmodeling]

If you click "Show More" right above the "Published on Aug 5, 2014" below the video you can get the file there.

[@hal12b]

Mergers & Inquisitions / Breaking Into Wall Street I don't see the option to download it...?

[@financialmodeling]

hal12b Go to the link mentioned in the descriptions above. Press the right mouse button on your mouse. Go to "Save As" or "Save Target As." Then, select the location where you want to save the file...

[@zerdzub]

Great video. How would you calculate the acceptable IRR for an investment that has not been Exited yet? How would you make a valuation of the investment in the owner period if you only know the entry price?

[@financialmodeling]

You could create a "Terminal Value" for IRR rather than assuming an exit and say that the investment will grow at a constant X% after a certain period and use the normal Terminal Value formula there. You can value a company in any period, and the entry price doesn't really matter - only the company's financial metrics and future cash flows. See the DCF/valuation tutorials.

[@vijaynatarajan2790]

Too good..

[@maciekm0007]

So generally the bigger NPV the better.

[@financialmodeling]

NPV is only relevant for the IRR, not the multiple, so... kind of? Not really sure what you're asking or implying.

[@maciekm0007]

I don’t understand why do you care about multiply. You can have +IRR but -NPV and +multiply. Still you will be losing money.