The three return levers are not created equal. Debt paydown is the most mechanical: as long as the company generates free cash flow above interest expense, equity value grows automatically. EBITDA growth requires genuine operational improvement — pricing power, cost reduction, revenue expansion. Multiple expansion is the most speculative: it depends on market conditions at exit that the sponsor cannot control. A disciplined LBO analysis stress-tests the deal with zero multiple expansion.
Equity Proceeds = Exit EV − Remaining Debt = (Exit EBITDA × Exit Multiple) − Remaining Debt
| Return Driver | Worked Example ($0.5B equity in) | Approximate IRR Contribution |
|---|---|---|
| Leverage + debt paydown | $400M debt repaid; equity value grows mechanically even with flat EBITDA | ~14 percentage points |
| EBITDA growth | EBITDA grows from $150M to $195M (+30%) over 5 years | ~7 percentage points |
| Multiple expansion | Exit at 11x vs. entry at 10x — one-turn improvement | ~4 percentage points |
| Total | Equity: $0.5B → $1.545B | MOIC: 3.1x | ~25% IRR |
Stress test: what happens if the exit multiple compresses from 11x back to 10x (no multiple expansion)? Equity proceeds drop to $1.35B (EV of $1.95B minus $0.6B debt), IRR falls to ~22%. The deal still works, because leverage and EBITDA growth carry the load. Now stress zero EBITDA growth AND exit at 10x: equity proceeds = $1.5B − $0.6B = $0.9B, IRR ≈ 12.5%. Still positive, but well below the 20%+ sponsor target. This is why debt paydown alone is insufficient — sponsors need at least one of growth or multiple expansion to hit institutional return thresholds.
Sit with the ideas.
A PE sponsor pays 10x EBITDA on $150M EBITDA (EV = $1.5B), funded with $1.0B debt and $0.5B equity. Five years later EBITDA is $195M (+30%) and the sponsor exits at 11x (EV = $2.145B). Through the hold, $400M of debt is repaid, leaving $600M. What is the approximate equity IRR, and what drove it?