Modeling Growth Equity Returns

When To Use

• Projecting gross and net returns for a minority or majority growth equity investment
• Analyzing how liquidation preference stacks, participation rights, and anti-dilution provisions affect investor economics across exit scenarios
• Comparing return profiles between participating preferred, non-participating preferred, and common equity structures
• Stress-testing entry valuation, hold period, and exit multiple assumptions for an expansion-stage deal
• Evaluating co-invest or follow-on allocation decisions within a growth equity portfolio

Inputs To Gather

• Deal terms: Investment amount, pre-money valuation, ownership percentage, share class, liquidation preference multiple (1x, 1.5x, etc.), participation cap (if any), anti-dilution mechanism (broad-based weighted average vs. full ratchet)
• Capital structure: Existing cap table with all prior preferred rounds, option pool size, outstanding convertible instruments (SAFEs, notes), any pay-to-play provisions
• Operating forecasts: Revenue, EBITDA/EBIT, or net income projections for each year of hold period; gross margin trajectory; expected cash burn or free cash flow profile
• Exit assumptions: Target hold period (typically 3–7 years), exit revenue/EBITDA multiples, probability-weighted exit scenarios (IPO, strategic sale, secondary, recap)
• Follow-on / dilution: Expected future funding rounds, anticipated dilution per round, pro-rata rights and whether the fund intends to exercise them
• Fee and carry structure (for fund-level returns): Management fee rate, carry percentage, preferred return/hurdle rate, GP catch-up, fund-level recycling assumptions

Workflow

1. Map the cap table — Build the current ownership waterfall including all preferred layers, common, and option pool. Confirm conversion ratios and any ratchet triggers. [VERIFY] anti-dilution provision language from the term sheet or charter.

2. Construct the preference stack — Order liquidation preferences by seniority (pari passu vs. stacked). Model each layer's claim: preference amount, accrued dividends (if cumulative), and participation rights. Calculate the "as-converted" breakpoint where preferred holders would elect to convert to common.

3. Build exit waterfall scenarios — For each exit value (e.g., 0.5×–5× of post-money):

   • Pay senior preferences first, then junior preferences
   • Distribute remaining proceeds per participation rights (uncapped, capped, or non-participating)
   • Compare participating vs. as-converted payout at each exit value to determine optimal election
   • Output investor cash-on-cash and IRR at each scenario point

4. Model the operating case — Project revenue and margin over the hold period using management forecasts and comparable company benchmarks. Apply a base, upside, and downside case. Tie exit enterprise value to exit-year revenue or EBITDA × selected multiple.

5. Layer in dilution and follow-on — Simulate future rounds with estimated pre-money valuations. Reduce ownership proportionally unless pro-rata is exercised. Recalculate waterfall economics post-dilution.

6. Calculate return metrics — For each scenario compute:

   • Gross MOIC (multiple on invested capital)
   • Gross IRR
   • Net MOIC and net IRR (after management fees and carried interest)
   • DPI (distributions to paid-in) if modeling interim liquidity events

7. Run sensitivity analysis — Build two-way data tables varying entry multiple vs. exit multiple, and hold period vs. revenue growth rate. Highlight breakeven and target-return thresholds (e.g., 3× MOIC, 25% IRR).

Output

• Waterfall summary table: For each exit scenario, show total proceeds, preference payouts by layer, common distribution, and investor share
• Return matrix: Gross and net MOIC/IRR across base, upside, and downside cases
• Sensitivity tables: Two-way tables on key variable pairs (entry valuation vs. exit multiple; growth rate vs. hold period)
• Breakeven analysis: Minimum exit value required to achieve 1× return, target MOIC, and target IRR
• Key assumptions register: Itemized list of every assumption with source or [VERIFY] flag

Quality Checks

• Waterfall total distributions equal total exit proceeds in every scenario (zero residual)
• As-converted breakpoint is correctly identified — preferred holders convert only when common payout exceeds preference + participation
• IRR and MOIC are internally consistent (IRR derived from actual cash flow timing, not approximated)
• Dilution math is additive across rounds — total ownership percentages sum to 100% after each modeled round
• Participation cap, if present, is correctly applied so that capped holders stop receiving pro-rata above the cap threshold
• Sensitivity ranges bracket realistic outcomes — entry and exit multiples aligned to comparable transaction data [VERIFY]
• Net return calculations correctly sequence management fees (on committed vs. invested capital) and carry (American vs. European waterfall) per fund terms [VERIFY]