How does leverage affect IRR — and why is that dangerous?
Leverage is the most important IRR lever — and at the same time the biggest danger.
With fixed EBITDA growth and a stable multiple, every additional turn of leverage raises the equity IRR substantially. Example: same EBITDA growth 50 → 60, multiple stable at 8x. At 0x leverage, IRR 3.7%. At 5x leverage, IRR 14.9%. At 7x leverage, IRR 32.0%.
If EBITDA declines to 35 instead of $60m, the effect reverses. At 5x leverage, IRR −27.5%. At 7x leverage, the equity is completely wiped out — total loss.
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Initial: EBITDA $50m, multiple 8x → EV $400m. Exit Year 5: EBITDA $60m, multiple 8x → EV $480m.
| Leverage | Equity closing | Equity exit | MOIC | IRR |
|---|---|---|---|---|
| 0x | $400 | $480 | 1.2x | 3.7% |
| 3x | $250 | $380 | 1.52x | 8.7% |
| 5x | $150 | $300 | 2.0x | 14.9% |
| 7x | $50 | $200 | 4.0x | 32.0% |
| Leverage | Equity exit | MOIC | IRR |
|---|---|---|---|
| 0x | $280 | 0.7x | −7% |
| 3x | $130 | 0.52x | −12% |
| 5x | $30 | 0.2x | −27.5% |
| 7x | −$70 (equity wiped) | 0x | −100% |
Leverage cuts both ways — positive skew in the up case, negative skew in the down case. With too much leverage, a total loss is possible on a moderate EBITDA decline.
Question: "What would the equity-loss risk be in your pitch?"
Answer: "At 5.5x leverage and a 30% EBITDA decline, the equity at risk would be ~80%. The modeling shows a stress test in the IC memo. I can use an equity cure, but with a structural problem that only protects you short-term"