Case 068LBOCore

A sponsor buys Anvara Education at 10x EBITDA with 50% debt. Build a 3 x 3 IRR grid for exits in years 3, 5 and 7 at 8x, 10x and 12x, and say which cell the sponsor should underwrite to.

The situation

A sponsor buys Anvara Education, a chain of test-preparation centres, at 10.0x EBITDA of Rs 80 crore, Rs 800 crore. Half is funded with debt, Rs 400 crore, and half with equity, Rs 400 crore.

EBITDA grows 8% a year. Free cash flow repays Rs 40 crore of debt every year. Ignore fees and assume the sponsor receives nothing until exit.

Your task

Build the IRR grid for exits in years 3, 5 and 7 at 8x, 10x and 12x EBITDA, and say which cell the investment committee should underwrite to.

Quick check

If the exit multiple falls to 8x, does holding longer help or hurt the IRR?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Underwrite the flat-multiple cell: exit at 10x in year 5, an IRR of about 19.5% and 2.44x the money. EBITDA reaches Rs 117.5 crore and debt falls to Rs 200 crore, so equity is worth Rs 975 crore against Rs 400 crore in. The 12x column is multiple expansion, which is hope; the 8x column, 13.1% in year 5, is the downside the committee must be able to live with.

Step 1How do you fill each cell of the grid?

Each cell asks one question: if the sponsor sells in year t at multiple m, what is the equity worth? Exit equity is m times EBITDA in year t, less the debt still outstanding; IRR is that over Rs 400 crore, annualised over t years. EBITDA in year t is Rs 80 crore grown at 8%: Rs 100.8 crore in year 3, Rs 117.5 crore in year 5, Rs 137.1 crore in year 7. Debt is Rs 400 crore less Rs 40 crore a year: Rs 280, 200 and 120 crore.

Take the base cell. At 10x, year-5 EBITDA of Rs 117.5 crore is worth Rs 1175.5 crore; less Rs 200 crore of debt, equity is Rs 975.5 crore, 2.44x the Rs 400 crore put in. 2.44 to the power of one fifth, less one, is 19.5%. The gain splits into Rs 375 crore from EBITDA growth at a constant multiple and Rs 200 crore from debt repaid. Neither needs the market to be kinder at exit than at entry.

Anvara IRR by exit year and exit multiple: underwrite the flat multipleExit at 8xExit at 10xExit at 12x(entry was 10.0x)Exit in year 3debt left 2809.6%1.32x the money22.1%1.82x the money32.4%2.32x the moneyExit in year 5debt left 20013.1%1.85x the money19.5%2.44x the money24.8%3.03x the moneyExit in year 7debt left 12013.6%2.44x the money17.7%3.13x the money21.1%3.81x the moneyRed under 15% Paper 15 to 20% Green 20 to 25% Lime over 25%Pine outline: the cell to underwrite, a flat exit multiple in year 5
Anvara's IRR runs from 9.6% for an exit at 8x in year 3 to 32.4% at 12x in year 3; the base case, a flat 10x in year 5, gives 19.5% and 2.44x the money.
Exit yearEBITDADebt leftIRR at 8xIRR at 10xIRR at 12x
3100.82809.6%22.1%32.4%
5117.520013.1%19.5%24.8%
7137.112013.6%17.7%21.1%
Rs crore. Equity in is Rs 400 crore in every cell; only the exit year and the multiple change. The 10x column assumes the market pays at exit what the sponsor paid at entry.
Step 2Which cell should the sponsor underwrite to, and why?

Think of buying a flat to renovate. You budget on selling it at today's price per square foot; if prices rise, that is a bonus, not the plan. A sponsor underwrites to a flat or lower exit multiple, because multiple expansion depends on markets the sponsor does not control. Here that is 10x in year 5, 19.5%. If the fund's target is about 20%, the deal roughly clears on its own engines: paying about Rs 792 crore instead of Rs 800 crore would land exactly on 20%.

Then read the downside column. At 8x in year 5 the IRR is 13.1% and the sponsor still makes 1.85x its money, because growth and paydown cushion the fall. A deal that only works in the 12x column is a deal to walk away from; one whose 8x column still returns capital comfortably, as this one does, is one an investment committee can approve.

Time dilutes the multiple: a quick win at 12x, a slow repair at 8x10%15%20%25%30%Year 3Year 5Year 7exit at 12xexit at 10xexit at 8xYear of exit
At a 12x exit Anvara's IRR falls with time, from 32.4% in year 3 to 21.1% in year 7, while at 8x it rises from 9.6% to 13.6%, because a change in multiple is a one-off gain or loss that time spreads out.

That shape answers a follow-up interviewers like: why sponsors sell quickly when multiples are high and hold when they are low. A multiple gain is banked once, so selling early maximises its effect on IRR; a multiple loss is repaired by more years of growth and paydown. The limit of the grid is that it treats growth and paydown as certain; a full model would add an EBITDA growth axis, which for an education business depends on enrolments and fee increases.

Where candidates lose it

The usual miss is presenting the 12x year-3 cell, 32.4%, as the headline. It depends entirely on the market paying more at exit than at entry, which the sponsor cannot plan for.

The second is forgetting to reduce the debt for each exit year. Using Rs 400 crore in every cell understates equity by Rs 120 to 280 crore and makes the later years look much worse than they are.

What the interviewer asks next

  • EBITDA grows 4% instead of 8%. What is the base-case IRR?
  • How would a dividend recap in year 3 change the year-5 cells?
  • What entry multiple gives a 20% IRR at an 8x exit in year 5?

Company names and figures are illustrative.