Modeling Portfolio Company Returns

When To Use

• Modeling projected or realized returns for a PE/growth equity portfolio company
• Calculating IRR, MOIC, and cash-on-cash returns across holding periods
• Attributing value creation to revenue growth, margin expansion, multiple expansion, and leverage paydown
• Comparing entry vs. exit economics for investment committee memos or LP reporting
• Stress-testing return sensitivity to purchase price, leverage, and exit assumptions

Inputs To Gather

• Entry transaction details: purchase price (enterprise value), equity check size, entry EV/EBITDA multiple, transaction fees, and sources & uses
• Capital structure at entry: senior debt, subordinated debt, mezzanine, seller notes, rollover equity, management equity; interest rates and amortization schedules
• Operating projections: revenue, EBITDA, and free cash flow forecasts for the hold period (typically 3–7 years); capex, working capital, and tax assumptions
• Exit assumptions: target exit EV/EBITDA multiple, expected exit year, transaction costs at exit
• Additional cash flows: add-on acquisitions, dividend recaps, management fees, monitoring fees, or other interim distributions
• Benchmark context: comparable transaction multiples, sector median returns, or fund-level return targets for reasonableness checks

Workflow

1. Build the sources & uses table

   • Map total enterprise value, transaction fees, and financing fees on the uses side
   • Lay out debt tranches, sponsor equity, rollover equity, and any co-invest on the sources side
   • Confirm total sources equal total uses

2. Construct the operating model

   • Project revenue, EBITDA, and unlevered free cash flow year-by-year through the hold period
   • Apply working capital changes, capex, and tax assumptions to derive free cash flow available for debt service
   • If add-on acquisitions are modeled, layer in incremental EBITDA and purchase price in the relevant year

3. Model the debt schedule

   • For each tranche: opening balance, mandatory amortization, cash sweep (if applicable), interest expense, and closing balance
   • Calculate total debt remaining at each projected exit year
   • Track cumulative cash interest vs. PIK interest separately

4. Calculate exit proceeds and equity waterfall

   • Apply exit multiple to projected EBITDA at each candidate exit year
   • Deduct remaining net debt and transaction costs to arrive at equity value at exit
   • Run equity proceeds through the waterfall: preferred return hurdles, GP catch-up, carried interest splits, and management option pool dilution where applicable

5. Compute return metrics

   • MOIC: total equity distributions ÷ total equity invested
   • Gross IRR: internal rate of return on equity cash flows (entry, interim distributions, exit)
   • Net IRR: after management fees and carried interest [VERIFY fund-level fee structure]
   • Cash-on-cash: cumulative cash returned ÷ equity invested (useful for dividend recap scenarios)
   • DPI / TVPI: for fund-level context if aggregating across portfolio

6. Perform value creation bridge

   • Decompose total equity return into four drivers:
     • Revenue/EBITDA growth: EBITDA increase at constant entry multiple
     • Margin expansion: incremental EBITDA from margin improvement at constant revenue
     • Multiple expansion: delta between entry and exit multiples applied to exit EBITDA
     • Leverage effect (FCF and debt paydown): equity accretion from debt reduction over the hold period
   • Present as a waterfall chart or bridge table summing to total equity gain

7. Run sensitivity and scenario analysis

   • Two-way sensitivity tables on entry multiple vs. exit multiple and on EBITDA growth vs. leverage
   • Downside, base, and upside scenarios with clearly labeled assumption sets
   • Breakeven analysis: minimum exit multiple or EBITDA level needed to return 1.0x MOIC

Output

• Sources & uses table with clearly labeled debt and equity components
• Annual operating projections with revenue, EBITDA, FCF, and debt balances
• Return summary table: MOIC, gross IRR, net IRR for each exit year (Year 3 through Year 7)
• Value creation bridge: quantified attribution across growth, margin, multiple, and leverage drivers
• Sensitivity tables: at minimum, entry/exit multiple grid and EBITDA growth/exit multiple grid
• Key assumptions register: every material assumption listed with source or [VERIFY] tag

Quality Checks

• Sources & uses must balance to the penny — flag any rounding discrepancy
• IRR calculation must use actual cash flow dates (or mid-year convention if specified); confirm no circular references in debt sweep calculations
• Exit equity value must reconcile: exit EV minus net debt minus fees equals equity to sponsors
• Value creation bridge components must sum to total equity gain within ±0.1x MOIC rounding tolerance
• Confirm leverage ratios (Debt/EBITDA) stay within covenant levels at each projection year [VERIFY specific covenant thresholds from credit agreement]
• Cross-check modeled returns against sector benchmarks — flag if gross IRR exceeds 40% or falls below 10% as warranting additional assumption review
• Verify tax treatment of carried interest and management fee offsets align with fund LPA terms [VERIFY jurisdiction-specific tax rates and fund terms]