hard · Private Equity value-creation
Two sponsors model the same target with identical entry/exit multiples, leverage, and Year-5 EBITDA. Sponsor A assumes a 3.0% perpetual revenue CAGR with margins held flat; Sponsor B assumes 1.0% revenue CAGR but 250 bps of margin expansion, arriving at the SAME Year-5 EBITDA dollar figure. Both also assume working capital is a constant percentage of revenue.
Holding everything else equal, why might Sponsor B's plan produce a HIGHER equity IRR despite identical exit EBITDA and exit equity value?
- Because lower revenue growth means smaller incremental net working capital investment each year, freeing more cash for debt paydown and reducing exit net debt
- Because margin-expansion income is taxed at a lower effective rate than revenue-growth income, lowering the sponsor's cash tax bill over the hold
- Because higher margins mechanically command a materially higher exit EBITDA multiple than lower-margin peers, lifting Sponsor B's exit equity value above Sponsor A's
- Because the lower revenue growth path reduces annual maintenance capex and depreciation, increasing reported net income and dividend capacity over the hold
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