Those who know how private equity works also know their deals can be complicated. Typically, they involve gathering loads of data and complex calculations to determine whether it’s a good deal. After all, investors need to analyze every aspect of a target company before investing in it. That’s when equity formulas come in handy.
Unfortunately, there isn’t a one-size-fits-all formula to analyze PE deals, and it’s also not a tune that business managers can play by ear. Typically, companies look for private equity advisory services from top-notch firms like Acquinox Advisors when the situation arises. Here’s why an equity formula can make or break an investment opportunity.
Learning the Variables
Equity formulas can have quite a few variables, but most of them end up subtracting liabilities from assets to arrive at the total equity value. Liabilities include mortgages, loans, and accounts payable, while the total assets are everything the company owns, from real estate to machinery, inventory, etc.
Such information is usually calculated by a private equity advisor. Investors must know how much they must invest in that company and the expected returns. That’s when numbers start dancing. The famous Total Equity = Total Assets – Total Liabilities formula isn’t enough to analyze every aspect of a PE deal, and more variables are necessary.
For instance, it’s necessary to determine the value and timing of cumulative distributions, which is the amount going back to limited partners. The equity value of limited partners is known as residual value or “non-exited investments.” Most PE funds report the amount of non-exited investments quarterly.
Here are some formulas typically used in such deals.
Realization Multiple
Also called DPI (Distribution to Pay-In), this multiple is the result of dividing the cumulative distribution amount by the paid-in capital (PIC). This formula helps investors determine their likely return on investment.
Investment Multiple
The TVPI (Total Value to Paid-In) or investment multiple shows investors a picture of costs and aggregated returns. However, the time variable isn’t part of this equation, so it doesn’t show when investors will get their share. The investment multiple is found by dividing cumulative distribution and residual value amounts by the paid-in capital. The realization and investment multiples are often used by private equity advisors to structure PE deals.
PIC Multiple
To determine the paid-in multiple, potential investors divide the PIC by the committed capital, which is the value investors have decided to put into the business. It’s one of the most important metrics since it can show whether an investment is worthwhile. For once, it shows much of the PIC will become committed capital.
RVPI Multiple
RVPI (Residual Value to Paid-In) indicates the amount of unrealized capital in the market against the total invested. Here, the residual value is divided by the paid-in capital to project upfront capital costs. This calculation involves paid cash flow, fees paid, net asset value, and anything that may impact limited partners’ funds to arrive at the RVPI multiple.
Why So Many Formulas?
Simply put, private equity is how companies are not publicly listed. This means that investors can find emerging companies unavailable in the stock market. Indeed, it’s a good solution for startups looking for business growth opportunities. Accredited and institutional investors are usually behind PE funds with large sums.
Emerging companies must prove their worth to have access to it. The process can be lengthy, and thorough due diligence is only one of many steps. It also involves creating an operating model, and the final proposal must go through a Financial Investment Committee for approval.
During the various stages of negotiation, companies must provide evidence that they have a solid plan for business growth and prove that they’re financially sustainable, competitive, and compliant with industry regulations. Equity formulas focus mostly on the financial side of the deal and are, indeed, its backbone.
Despite the plethora of documents these companies must provide, the share investors will pocket in the end is all that matters. Indeed, there are so many documents that non-disclosure agreements are usually among the first steps. However, this kind of investment takes time to bear fruit, and that’s why it’s so important for investors to project how a target company will perform in the next few years and how much they’re likely to gain from it.
Reading cash flow statements and balance sheets isn’t enough to peak into a company’s future or how the invested money will play out. So, these formulas help them determine potential risks or opportunities in their investments. Thanks to digital technologies, private equity specialists no longer need to run those numbers on ink and paper.
Most PE firms use powerful AI tools and advanced ML algorithms to make calculations and predictions. Nevertheless, crunching numbers remains crucial in private equity deals, and new methodologies keep emerging. The most competitive PE firms have also been investing heavily in cybersecurity, as data privacy and safety are cornerstones of this market.
FAQ
What are the formulas most commonly used in private equity deals?
The private equity advisory arsenal is vast, but the most used formulas include the following multiples: realization, investment, PIC, and RVPI. Each measures specific aspects of a target company, providing information that will be crucial to investors’ decision-making process.
Why is Acquinox Advisors the best option for private equity deals?
Acquinox Advisors provides many private equity advisory services for companies looking for investors, including due diligence, M&A, debt advisory, valuation, and financial modeling.
