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Introduction To Alternative Investment Topic 2 Lecture 6B

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12 views

Introduction To Alternative Investment Topic 2 Lecture 6B

AI

Uploaded by

ravi gupta
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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P – Part B

MOIC Vs. IRR


MOIC stands for “multiple on invested capital.” If you invest $1,000,000 and return
$10,000,000 in 10 years your MOIC is 10x. If you invest $1,000,000 and return $10,000,000
in 3 years your MOIC is still 10x.

But IRR is different, and often more important. IRR measures your financial return in respect
to time. Investors think about IRR, because when they invest $1,000,000 with a 10 year lock
up, they are also investing the opportunity cost of everything they could have been doing
with that money during those 10 years. MOIC is often interchangeable with terms like cash-on-
cash return and multiple on money (MoM)
The IRR calculation is far more complicated. For this equation, you'll need to know your net
present value, cash flow, and time.

Gross IRR calculations do not factor in carried interest or fees, either. Adding these expenses
into your calculations will provide your net IRR.
How is MOIC different than IRR?
The main difference between IRR and MOIC is that the latter does not take time into
account. Unlike the MOIC rate, the gross IRR calculation is used to understand the yearly
rate of return.

Let's look at two scenarios to see how this plays out in practice.

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

Investment B: The investor also contributed $1,000, which grows to $2,000 in two years.
The IRR is 61.80% with a 2.0x MOIC. While the IRR suggests good future results, the MOIC is
rather low. This investment analysis would likely chase off potential investors who want to
significantly multiply the returns on their investments.
The first returns $10mm on a $1mm investment in 10 years.

The second returns $7,125,000 in 6 years.

Calculate MOIC & IRR


What is a capital call?
A capital call (also referred to as a ‘drawdown’ or a ‘capital commitment’) is the means
by which limited partners fund their investments in a private equity fund.

An LP agrees to a certain capital commitment as part of their Limited Partnership


Agreement (LPA) with a private equity fund.

General partners of private equity funds, however, are typically not able to make all of
the fund’s intended investments at once, so they will notify the LPs when investments
are about to be made and request a portion of the LP’s commitment to be delivered.
What's the difference between a commitment and a contribution?

A commitment is an investor's legally binding obligation to make contributions of capital to a fund.


A contribution is the satisfaction of that commitment.

Contributions are the actual $ amounts transferred from an investor to a fund. Contributions normally happen over time as
capital is called by a fund. (Some funds also call all capital at the outset.

Example:
You subscribe to Reliable Returns, LP today for a commitment amount of $1M.
The fund accepts and closes your commitment for $1M today.

At the end of today, you have a legal obligation to contribute $1M to the fund -- but you haven't contributed anything yet.
Most funds have an initial drawdown. This is a capital call that's due when an investor is accepted into the fund. For the sake
of the example, say this initial capital call is for 25% of your commitment.

You wire $250k next week to satisfy this initial capital call. This $250k is a contribution.
After your wire is completed next week, you'll still have the same commitment of $1M but will now have made a single
contribution of $250k.

The fund then calls 50% of capital after 6 months and the final 25% of commitments after 1 year. After you've wired the
$500k and the final $250k, you'll have contributed the total $1M of your $1M commitment.
A Capital Call Example
An example of how capital calls might work is shown in the table below.
Investor Commitment: $100,000

Year 1 2 3 4
Capital Calls $25,000 $32,000 $18,000 $25,000
Total Paid-in $25,000 $57,000 $75,000 $100,000
Capital
Remaining $75,000 $43,000 $25,000 0
Commitment Or
Contribution
FAQ
How often do capital calls occur?
GPs make capital calls as needed to fund their investments during the investment phase of
a fund, which can be up to 5-7 years. Capital calls are issued as needed to buy target assets
and can therefore occur at irregular intervals.

How are investors notified?


Investors are notified of capital calls in writing with 7-10 days to comply. They can also
monitor their capital calls through online platform of PE.

What happens if an investor fails to meet a capital call?


The consequences for defaulting on a capital call are explained in the Investor Agreement
associated with each fund and can include loss of equity and rights in the fund, interest
charges, sale of the investor’s stake to third parties.
DISTRIBUTION
Distributions, the means by which private equity funds return capital to investors, are paid
when fund managers realise their investments in underlying companies or assets.

Some capital will usually start flowing back to investors within the first 1.5 to 4 years, with
larger distributions typically following later in the fund life
DISTRIBUTION - Timeline
Formation – The period prior to launch of a fund, during which the partnership is created,
the strategy determined, offering documents are created, and initial target companies are
identified.

Investment – The period during which the fund makes investments in target companies,
issues capital calls to investors, and works with the target companies to maximise the
potential return to investors.

Harvesting –The period during which the manager arranges exits from target companies
and makes distributions of capital back to investors.

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