What is the multiple on invested capital (MOIC)?
MOIC stands for "Multiple on Invested Capital" and is a widely accepted measure of investment performance in the private equity industry.
It is calculated by dividing the exit value purchase price of an investment by the purchase price of the initial investment.
The multiple on invested capital helps investors assess the performance of the investment relative to the initial capital deployed. A higher MOIC is a sign of a more successful investment.
MOIC is interchangeable with several other terms, such as the "multiple on money (MoM)" and the "cash-on-cash return".
How to calculate MOIC for private equity?
The MOIC formula in private equity is very straightforward:
Divide the exit value purchase price of the investment with the purchase price of the initial investment. Remember that we are comparing entry equity value to exit equity value, not enterprise value. It's about the initial cash outlay vs. the cash received at the time of sale.
That's it. That's how you get the multiple on invested capital.
What is an example of MOIC in private equity?
Here's an example of how to calculate MOIC:
A private equity firm funds the purchase of an LBO target with $30 million. So, at the end of the holding period, the private equity firm sells the company and receives $90 million in equity value.
The MOIC is $90 million / $30 million = 3.0x
You take $90 million (exit value purchase price) and divide it by $30 million (initial investment).
What is a good MOIC in private equity?
Higher is generally better: Generally, a higher MOIC is better as it implies substantial returns. A lower MOIC is worse because the investment is not performing well.
A private equity company raises funds from its limited partners and various investors to invest in promising businesses with high growth potential and stable cash flows. All investors of the private equity fund want to make a profitable investment and not just recoup their initial capital invested.
A MOIC below 1 indicates that the investment fails to recover its initial capital.
A MOIC greater than 1 signifies positive returns on investment.
A low MOIC is usually less than 2x. This is a suboptimal investment for a private equity fund.
A MOIC of 2.0x or higher is generally a good benchmark for investment performance in private equity. It means you have doubled your initial investment.
A high MOIC is anything larger than 3.0x or higher. Meaning this opportunity tripled the initial investment.
What is a good MOIC in venture capital?
Venture capital firms have a different investment strategy compared to private equity funds. They target much higher MOIC values, like 10x or even more.
Early-stage, high-growth potential startups have a higher risk profile and don't have stable cash flows compared to more mature companies. Private equity investments are larger, more leveraged and more stable.
A substantial part of VC investments will likely fail. However, the ones that succeed deliver exceptionally high returns to compensate for the losses on capital invested.
Limits of the MOIC calculation
The multiple on invested capital is one of the most common performance metrics for private equity. However, the MOIC calculation alone cannot assess investment performance on the invested capital.
MOIC focuses only on the nominal return on the initial investment. It does consider time value. A multiple on invested capital does not account for the duration over which the returns on the initial investment are generated.
The investment duration has a significant impact on whether a high MOIC is good or not.
For example, a 2x MOIC is generally an acceptable benchmark. However, if the investment takes a holding period of 10 years to double its invested capital, that's not good enough.
On the other hand, if an investment manages to double its invested capital within a holding period of 2-3 years, that's a great investment opportunity.
2x MOIC in 2-3 years is a more profitable investment compared to a 2x multiple on invested capital in years in 10 years.
MOIC vs IRR: the time value of money
What is The internal rate of return (IRR)?
MOIC tells you how the nominal value of an investment grew regardless of the investment duration.
The internal rate of return (IRR) tells you how much return that investment generated annually over the holding period. In other words, the IRR puts a high MOIC into perspective.
An IRR is the single annualized rate of return that equates to the net present value of all the negative and positive cash flows.
That means it finds the average rate of return if the total investment was made all at once, compounded over the investment period and liquidated at the end.
Holding period matters: same MOIC, different IRR
To put this into perspective, let's stick with the example from above
2.0x MOIC in 2-3 years equals an IRR of 26-41%
2.0x MOIC in 10 years equals an IRR of 7%
It's the same MOIC but with significantly different IRRs. Doubling your money in 2-3 years results in an IRR of 26-41%, which is excellent. However, if you take 10 years to double your money, your IRR is only 7%. This is how time value works. The quicker your investment returns materialize, the more profitable the investment.
This is way below the hurdle rate of roughly 20% that a private equity firm is looking for in promising investment opportunities.
So, private equity firms look at both and carefully calculate MOIC as well as IRR to evaluate the performance of their investments.
MOIC to IRR approximations
If you're gearing up for private equity interviews, it's highly advised to commit to memory the most prevalent MOIC to IRR approximations:
2.0x MOIC to IRR approximations
2.0x MOIC in 2 years → ~41% IRR
2.0x MOIC in 3 years → ~26% IRR
2.0x MOIC in 4 years → ~19% IRR
2.0x MOIC in 5 years → ~15% IRR
3.0x MOIC to IRR approximations
3.0x MOIC in 2 years → ~73% IRR
3.0x MOIC in 3 years → ~44% IRR
3.0x MOIC in 4 years → ~32% IRR
3.0x MOIC in 5 years → ~25% IRR
MOIC's role in private equity
MOIC measures the returns generated from an investment relative to the capital initially invested. MOIC is usually synonymous with the terms "cash-on-cash" and "multiple-on-money (MoM)".
As investments progress over the holding period, the goal is to realize returns that surpass the initial capital invested. A MOIC greater than 1 signifies positive returns on investment. A MOIC below 1 indicates that the investment fails to recover its initial money.
A MOIC of 2.0x or higher is generally considered a good benchmark for private equity investments. Anything below 2.0x is a low MOIC. A MOIC of 3.0x or higher is excellent.
However, the multiple on invested capital is just one metric used to evaluate potential investments. MOIC tells you how the nominal value of an investment grew regardless of the investment duration. The internal rate of return (IRR) tells you how much return that investment generated annually over the holding period. The IRR puts a high MOIC into perspective.
