In conducting a 2011-2013 survey of buyout professionals, two professors and a graduate student asked for the percentage of deals for which they used different metrics to determine value, such as gross IRR, multiple of invested capital, adjusted-present-value discounted cash flow, and weighted-average-cost-of-capital-based discounted cash flow. Multiple of invested capital and gross IRR were by far the most popular responses.
Respondents said they used multiple of invested capital 95 percent of the time on average in evaluating investments, followed by gross IRR 93 percent of the time, according to a draft paper describing the survey results. After that came comparable company EBITDA multiples (72 percent), free cash flow return to equity (44 percent), other (14 percent), weighted-average-cost-of-capital-based discounted cash flow (11 percent) and adjusted-present-value discounted cash flow (9 percent).
Similarly, buyout pros have little taste for discounted cash flow methods when it comes to determining exit value for a given pro forma model. Buyout professionals said they used comparable companies to calculate projected exit values 81 percent of the time on average, and comparable transactions 71 percent of the time. By contrast, they said they used a discounted-cash-flow-based “growing perpetuity” calculation just 27 percent of the time.
The authors found the results “contrary to what one might expect” given “the focus on net present value in most business school finance courses.” They added: “It may indicate that IRR and (multiple of invested capital) techniques are sufficiently robust or effective that (discounted cash flow) techniques are not necessary. Alternatively, it may indicate some practical deficiency with (discounted cash flow) techniques.”
The draft paper, What Do Private Equity Firms (Say They) Do?, is co-authored by Paul Gompers, professor at Harvard Business School, Steven N. Kaplan, professor at the University of Chicago Booth School of Business, and Vladimir Mukharlyamov, a graduate student at Harvard University. It is based on a survey of 79 buyout firms that as of year-end 2012 held more than $750 billion in private equity assets under management.