Understanding MOIC: The Key Metric behind Investment Returns

You can assess ROI in PE and VC by reviewing a company's MOIC. Unlike IRR, which is based on time value, MOIC finance considers the profit compared to the capital spent, irrespective of the period. Taxes play a simple and understandable role in helping investors and managing funds consider investments ' financial success.
In the fast-moving world, clear and simple ideas usually triumph. MOIC is used because it demonstrates an investment's outcome by calculating return times. If an investor pays $1 million and receives $3 million, the MOIC is 3.0 xs.
What is MOIC?
MOIC divides the profits by the amount invested by the company. The amount of money invested or given to the fund is divided to determine MOIC. Private fund managers of venture capital, private equity, and hedge funds often decide to share their investment results through MOIC.
The MOIC lets investors compare each investment's performance and a fund's complete holdings.
What Impacts MOIC?
Let's evaluate certain factors that impact MOIC:
- Investment Performance
A company with fast growth, generous profits, and quick returns on investment has a higher MOIC.
- Time Horizon
Security held for a longer time tends to produce higher MOIC due to the longer period for increased value.
- Fees and the Costs
The realization of the portfolio's total value may decrease due to fee and expense deductions.
- Exit Strategy
Management of your exit can greatly affect your MOIC.
Methods for Calculating MOIC
It is easy to understand how MOIC is calculated.
MOIC = Total Value of Investment / Invested Capital
The term "Total Value of Investment" generally indicates either the actual cash received from selling or the expected reasonable selling price if the investment has not been sold. Invested Capital means the invested amount in the asset in the beginning. It also requires investors to invest equity and reinvest if the company performs well. MOIC ignores the time value of money, unlike IRR, which considers the span of the investment.
Multiple on invested capital (MOIC) is a ratio that helps decide on the gross return when combined with other factors.
- Cash Inflows ➝ Invest Cash at the Beginning
- Exit Value of the Risky Asset ➝ Cash Outflow (i.e., Sale Value of Company Invested in the LBO)
What is the Difference between MOIC and IRR?
MOIC shows the return earned on every dollar invested and is not affected by how quickly those results appear. IRR delivers the yearly return percentage instead of the overall rate of return. It is better to see a 2.0x MOIC for two years than for ten years. IRR addresses the difference by increasing the first scenario's return rate.
Still, IRR may not accurately reflect the investment profitability if some assets are withdrawn early. MOIC is free from any dependence on time and remains pure. For this reason, many investors choose to observe both kinds of returns. MOIC measures the total value produced, and IRR reflects how efficiently and quickly it is completed. The IRR vs. MOIC enables stakeholders to see how efficiently and quickly value has been created, aside from the total amount.
Limitations of MOIC
Despite being quite simple and clear, MOIC still has some limitations. Its most striking feature is it doesn't care about time. Short-term or long-term holding of similar MOIC investments can lead to greatly varying levels of financial benefit. If the profits from a long-term investment develop slowly, a high MOIC is not appealing to investors.
MOIC doesn't contain details about when funds might be released. Though the timing of cash returns may differ in various investments, the MOIC considers them equal if the amounts are similar. Valuing unrealized investments is only as precise as the methods used for valuation, and these can be subjective.
Difference between MOIC and TVPI
Both TVPI and MOIC show how much gross value (including unrealized and realized parts) is in a private equity investment. It's the denominator that separates the two. MOIC means dividing the total value of the investment by the initial investment, while TVPI uses the paid-in amount instead. Once the fund reaches its total amount and all required capital is supplied, TVPI is similar to MOIC. When investors do not receive their investments, TVPI is bigger than MOIC since TVPI tracks only the paid.
Conclusion
Investors rely on MOIC as an important tool, especially when focusing on private equity. It allows one to evaluate how much an investment has earned compared to the amount invested. Its simplicity allows it to stand out as a practical choice for fund managers and investors, even though the time value of money is not considered. While determining investment performance, monitoring the MOIC and other crucial metrics is important. If managed well, it clearly shows whether an investment is successful and how capital is being used effectively.
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