SRI

Here’s the formula for calculating an equity multiple:

Equity Multiple = Total Distributions / Total Equity Invested (principle)

Example 1:

An investor invested $1,000,000 in a deal.  The sponsor has distributed annual returns of $200,000 to the investor over a 5 year period.

$200,000 x 5 years + $1 million investment / $1 million total equity invested = 2.0x

In this example, an investor receives an equity multiple of 2.0.  In other words, for every $1 invested in the property the investor gets back $2. (An equity multiple greater than 1.0 means you receive more cash back than invested, while an equity multiple below 1.0 means less money is returned than what was originally invested.)

Example 2:

An investor invested $1,000,000 in a deal.  The sponsor has distributed annual returns of $100,000 to the investor over a 10 year period.

$100,000 x 10 years + $1 million investment / $1 million total equity invested = 2.0x

The equity multiple for both of the above examples is 2x, however as you can clearly see the hold period for example 2 is twice that of example one.   So an investor should not compare two different deals just based on equity multiples as two deals with the same equity multiple can have very different hold periods.  This is where the use of IRR becomes important.

Internal Rate of Return

The IRR calculation considers the time value of money (TVM) while the equity multiple calculation doesn’t. However, equity multiple reports the total cash return of an investment while the internal rate of return measures average cash return over a hold period, taking into consideration that the value of money depreciates over time.

A property with a high IRR may return more money to investors faster, but not necessarily more money overall. Here is an example:

In the above example the initial investment by the investor was $200,000. The total returns are $300,000 (including the initial investment of $200,000). The IRR for this deal is 18% and the equity multiple is 1.5x

Notice that the sponsor returned $100,000 back as distributions in year one which makes the IRR inflated.

In this second example we use the same initial investment of $200,000. However the distribution improves over time.  Notice that because in the IRR calculations the money earned today is weighted more than money earned tomorrow or the day after tomorrow the IRR for this particular deal is 11%.  However, the equity multiple for this deal still remains at 1.5x because the total returns haven’t changed between the two deals. So, IRR can be manipulated by timing the cash flows 

Based on the examples given, investment decisions should be based not only on one metric but all.

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