Module IV· Returns DisaggregationAdvanced
Question
How do you model the cash-flow impact of an equity cure on returns?
Answer
What
An equity cure is additional sponsor equity injected to cure a covenant breach. It reduces the equity IRR, because more capital is needed for the same exit return.
Example
initial investment Year 0 of $150m sponsor equity. Year 3 covenant breach, equity cure $20m. Year 5 exit $400m.
| Variant | MOIC | IRR |
|---|---|---|
| Without cure (theoretical) | 400/150 = 2.67x | 21.7% |
| With $20m cure | 400/170 = 2.35x | 18.4% |
| IRR drop from the cure | – | −3.3 percentage points |
Deep diveShow more details
Example bridge with an equity cure
| Driver | Effect |
|---|---|
| Entry equity | −$150m |
| EBITDA growth | +$80m |
| EBITDA decline in Year 3 (drove the cure) | −$30m (theoretical) |
| Equity cure | −$20m additional in Year 3 |
| De-leveraging | +$120m |
| Multiple expansion | +$50m |
| Operational recovery Year 4–5 | +$50m |
| Exit equity | +$250m (vs $400m with no cure) |
Consequence
- In multi-cure scenarios (2 cures instead of 1), the IRR drop can reach 5–7 percentage points.
- The cure limit in the credit agreement is typically 2 cures in total: in structural distress that is often not enough.
- An equity cure is defense, not value creation: the sponsor loses IRR and only buys time.
Common pitfalls
the sponsor pitch ignores cure risk. The IC asks for a stress test. Modeling best practice is a cure sensitivity at a −15% and −25% EBITDA drop.
Pitch tip
Question: "At what EBITDA decline would an equity cure be needed?"
Answer: "Sensitivity test in the memo. At −15% EBITDA a cure is likely needed — senior leverage rises from 4.5x to 5.3x against a 5.0x cap. Cure cost ~$10m, IRR impact −1.5 percentage points. At −25% EBITDA it's two cures, IRR falls from 22% to 14% — critical"