What Is Multiple on Invested Capital?

Private equity firms frequently use Multiple on Invested Capital (MOIC) to determine the gross multiple of the amount of money they have made relative to the amount of money they have invested. Notable is the fact that MOIC considers both realized and unrealized gains on investments.

What Is Multiple on Invested Capital (MOIC)?

Multiple on Invested Capital (“MOIC”) is a metric commonly used in private markets to describe the value or performance of an investment relative to its initial cost. MOIC is one of the most important metrics to evaluate during fund due diligence, and it is also commonly known as Equity Multiple.

MOIC is expressed as the total value (realized and unrealized, see below) of all fund shares divided by the initial investment.

Since the individual securities held by a fund will have exit transactions at different times, the MOIC of the fund at any given time combines the value of sold securities (i.e., realized proceeds) with the value of active securities (i.e., unrealized value). The unrealized value consists of stakes in (public or private) companies that have not yet been liquidated. This logic is applied to individual assets and companies’ portfolios in a private market fund.

Net MOIC utilizes values after deducting fees; expenses are borne by limited partners (“LPs”) and carried interest. The gross MOIC does not account for these costs in its calculation.

How to Calculate MOIC?

The multiple on invested capital (MOIC) metric measures the investment’s return relative to its initial investment.

The formula for calculating the MOIC of an investment and is typically the net cash return (“cash inflows“) divided by the initial cash contribution (“cash outflows”).

MOIC is synonymous with the multiple-on-money (MoM) and the cash-on-cash return.

The multiple on invested capital essentially represents the returns per dollar of initial investment contributed.

High MOIC Higher MOICs on investments are viewed favorably due to the implication that the investments are profitable.

Lower MOICs are viewed negatively because they indicate an unprofitable investment (and investors are at risk of not receiving their target return or even recouping their initial capital).

Following is the formula for calculating the MOIC of an investment.

MOIC = Total Cash Inflows minus Total Cash Expenditures

Cash Inflows: In the context of a leveraged buyout, cash inflows result from events such as the completion of a dividend recapitalization and a liquidity event, such as a sale to a strategic buyer or IPO (IPO).

Outflows of Cash: The outflows of cash consist of a single major item: the initial equity contribution required to complete the buyout. Frequently, the outflows component will appear as a negative number in Excel; therefore, an additional negative sign must be placed before the formula can function, i.e., convert to a positive number.

Consider that a private equity firm invested $20 million to finance the acquisition of an LBO target.

If the post-exit return at the conclusion of the holding period, Year 5, is $80 million, the investment’s MOIC is four times.

MOIC = $80 million ÷ $20 million = 4.0x

During the five-year period, each dollar of invested capital increased to four dollars.

Why Are So Many Founders Concentrated on MOIC?

One reason could be that when founders raise rounds of financing, they give investors liquidation preferences based on MOIC rather than IRR. Therefore, they are more concerned with mitigating MOIC downside risk.

Also unknown is whether founders will be able to find another high-growth opportunity following the sale of their company. An IRR beyond that sale is not assured, and their calculation could look like this:

And finally, the MOIC ethos is frequently more seductive. When considering growth, it is often necessary to weigh patience and stability against an attractive and high IRR opportunity.

It is essential to recognize that the growth rate is influenced by various external factors, not all of which are beneficial to the organization but sometimes unavoidable.

What Does The Internal Rate of Return (IRR) Indicate?

In financial analysis, the internal rate of return (IRR) is a metric used to estimate the profitability of potential investments. In a discounted cash flow analysis, the IRR is the discount rate that makes all cash flows’ net present value (NPV) equal to zero.

IRR is calculated using the same formula as NPV. Keep in mind that IRR is not the project’s actual dollar value. The annual return is what causes the NPV to be equal to zero.

Generally speaking, the higher an investment’s internal rate of return, the more desirable it is. As IRR is the same for all types of investments, it can be used to rank multiple prospective investments or projects fairly evenly. When comparing investment options with other similar characteristics, the investment with the highest IRR is likely to be regarded as the best.

What Function Does The Internal Rate of Return Serve?

Various initiatives are undertaken by businesses to increase revenues or reduce expenses. Investing in the development of a new product, for instance, may be required by a novel business idea.

In capital budgeting, senior executives are interested in the estimated return on these investments. Internal rate of return is one method for comparing and ranking projects based on their anticipated yield. Typically, the investment with the highest internal rate of return is chosen.

Internal Rate of Return is widely used in analyzing investments for private equity and venture capital, which involve multiple cash investments over the life of a business and a cash flow at the end through an initial public offering (IPO) or sale of the business.

In order to select the optimal investment, a thorough investment analysis requires the analyst to consider the net present value (NPV), the internal rate of return, and other indicators such as the payback period. Since it is possible for a very small investment to generate a very high rate of return, investors and managers may choose an opportunity with a lower percentage return but a higher absolute dollar value.

In addition, it is essential to have a thorough understanding of your own risk tolerance, the investment needs of a company, its risk aversion, and other available options.

What Distinguishes MOIC From IRR?

The primary distinction between IRR and MOIC is that the latter disregards time. The gross IRR calculation is used to determine the annual rate of return, unlike the MOIC rate. In this instance, the time horizon is crucial, as the IRR measures the change in the value of money over time.

Despite the fact that MOIC is simpler to calculate and comprehend at a glance, investors typically use both calculations to evaluate the potential value of an investment. Typically, investors are attracted to a higher IRR, but a higher MOIC indicates a lower investment churn rate, which is also valuable.

Let’s examine two examples to see how this works in practice.

The investor has contributed $1,000 to Investment A. The fund has grown to $11,000 after five years with a 199.17% IRR and an 11.0x MOIC. Both metrics are high, indicating that the investment is profitable.

Investment B: The investor contributed an additional $1,000, which grew to $2,000 after two years. The IRR is 61.80%, and the MOIC is 2.0x. While the IRR indicates promising future outcomes, the MOIC is quite low. This investment analysis is likely to discourage potential investors who wish to significantly multiply their returns.

Consequently, a high IRR is typically, but not always, accompanied by a high MOIC. If your organization has a low MOIC despite a high estimated IRR, you may need to make a case for why it is a worthwhile investment.

When Should MOIC vs. IRR Be Considered?

Those with a limited amount of capital to invest or are concerned about liquidity may want to pay closer attention to IRR, as it will help them understand the potential returns over a finite time period. Institutional investors or individuals with excess capital that must be invested on a long-term basis might pay more attention to MOIC. IRR is the most important metric for the average person to consider.

MOIC and IRR are not flawless forecasts or assurances, and they are a snapshot of the analysis conducted by investment professionals. MOIC and IRR indicate the expected performance of these investments, but there is always a risk. Indeed, there would be no returns without risk.

What Does TVIP Stand For?

TVPI means “total value to paid-in” capital.

It is a simple formula that attempts to calculate the total value, including realized profits and unrealized future profits, that a fund has generated for investors in relation to the amount of money contributed.

TVPI attempts to respond to the investor to the question, “How much profit have I made relative to my initial investment, based on the fund’s current value?”

Since an investor (also known as a “limited partner” or “LP”) of a venture fund cannot simply cash out at any time, TVPI incorporates an element of future perceived value until the fund is fully realized. Investors switch to DPI, which will be covered later in this article once the fund has been fully realized.

MOIC Versus TVPI: What Is The Distinction? 

TVPI versus MOIC is a denominator difference. Multiple Invested Capital (MoIC) is determined by dividing the fund’s cumulative realized and unrealized value by the total amount of capital invested.

TVPI measures investment performance near the end of a fund’s existence. Typically, this ratio represents the minimum rate of return that investors can anticipate from their investments in a fund.

MOIC and TVPI are interchangeable performance measurements that do not account for time.

MOIC or TVPI = (DPI + RVPI) / Total Investment Dollars

DPI is the acronym for Distributions to Paid-in-Capital. Investors receive distributions from private equity managers as investments mature, most notably when a manager sells an investment and thus realizes its value.

Remaining Value to Paid-in-Capital is the abbreviation for RVPI. This is also known as unrealized value or the fund’s Net Asset Value (NAV).

Example: If an investor invests $100 and the fund’s total value is $300, the MOIC or TVPI is 3.0x. The multiple does not take into account when the return is realized but rather the value of the invested capital. The $300 may be returned in either three or five years. When the MOIC is held constant, the holding period has an effect on the IRR.

Why Do Investors Utilize The TVPI?

Consider the advantages and disadvantages of TVPI as a performance metric.

Pros:

A straightforward and easily calculable unit of measurement. In contrast to IRR (internal rate of return), TVPI is simple to calculate.

More difficult to manipulate. TVPI’s simplicity makes it more difficult for the fund manager to manipulate (a common criticism of IRR).

Cons: 

Does not take the time value of money into the account. Due to the time value of money, a TVPI of 2.0x at a venture fund’s five-year and ten-year marks has very different implications for investors. The first indicates that an investor doubled their money in five years, while the second indicates that they did so in ten years. When comparing TVPI, it is essential to consider the time period being reported.

Frequently, it is motivated by unrealized gains. The residual value portion of TVPI is an estimate of fair value that may differ significantly from the value realized when the investments are liquidated and distributed to investors. The greater the residual value proportion of the total value, the more volatile the TVPI.

When using TVPI to evaluate a fund’s performance, consider the following:

At what point in the lifecycle of the fund do I measure TVPI?

What proportion of the total value consists of distributions, and what proportion is residual value?

Do I have faith in the fund’s valuation method used to determine the remaining value?

How does this TVPI compare to other investments during the same time period?

What’s A Good TVPI?

It is essential to consider the age of the fund when comparing TVPIs. When determining whether a particular TVPI is “good” or not, we must ensure that we are comparing apples to apples, i.e., funds with comparable vintage years.

According to data from Cambridge Associates, the median TVPI for US venture capital funds established in 1995 was 2.68x as of June 30, 2020, while the median TVPI for those established in 2018 was 1.01x.

Nevertheless, the data are not uniform. For example, Cambridge data indicates that the median TVPI for 1999-vintage funds was 0.81x.

In other words, it is difficult to determine whether a particular TVPI is good or not. It depends on the performance of other funds of the same vintage year and may be affected by market conditions.

MOIC in Investments

MOIC is an excellent metric for determining your general partner’s skill when investing in a private fund; however, it is not the best indicator of your (or a generic limited partner’s) performance in a fund. Alternatives include:

TVPI (or Total Value to Paid-In Capital) estimates the impact of fees on future distributions.

DPI (or Distributions to Paid-In Capital), which only counts distributions from the fund, is an alternative measure.

You will also (obviously) want to compare the IRR or internal rate of return to your other investments. Multiples are a good source of bragging rights, but the IRR enables comparisons with theoretical alternatives.

Why Is MOIC Important in Private Equity?

MOIC provides investors and industry professionals with an easy-to-understand and straightforward-to-calculate metric based on reported figures. In addition, MOIC is a useful metric for comparing private equity funds and gauging the investment expertise of a general partner.

MOIC, at different points in time, can also provide limited partners with a measure of the quarterly or annual growth of the fund’s value.

Limitations of MOIC

MOIC does not produce time-weighted returns and therefore does not consider the timing of capital calls or distributions, nor does it consider the portfolio’s net asset value at any time other than the specified valuation date.

In addition, investors should be aware of whether they are comparing gross MOIC or net MOIC to ensure accurate comparisons.

Conclusion

Together, MOIC and IRR can help evaluate performance in a more accurate manner. MOIC depicts the total return of an investor’s capital over the duration of an investment. In contrast, IRR takes into account the time value of money. With constant IRR, additional time permits a greater MOIC. When MOIC is held constant, a shorter time period results in a higher IRR. Investors can evaluate both metrics when determining whether to use MOIC or IRR to evaluate private equity performance. These performance techniques have advantages and disadvantages. These are widely used to measure the performance of alternative assets, and investors must have a fundamental comprehension of each. It is also essential to utilize both together to obtain a complete picture of an investment’s performance. When investors comprehend the benefits and drawbacks of each, they are able to make more informed decisions that, ideally, result in higher returns.