Comprehensive use of multiple evaluation indicators of fund returns to avoid falling into the “DPI theory” from the “IRR” theory / s / J10u_wRXz4IqtzlWOAHbAg “>” FOFweekly “(ID: FOF_weekly) , author: Xinxin Zhang.
In actual private equity investment activities, LP sometimes finds that the actual cash return it receives from the fund does not match the fund ’s IRR (internal rate of return) displayed to it by GP, so a direct response to A performance measure of “gold and silver” returns. Therefore, DPI (return on invested capital) has become the focus of LP.
But the author believes that different income indicators only measure fund returns from different angles. There is no distinction between the advantages and disadvantages of each indicator. The key is to choose the appropriate fund according to the specific circumstances of the fund and the purpose of the LP. Evaluation indicators look at the level of return of specific funds.
Common fund performance indicators
In the private equity fund industry, MOC (Multiple of Capital Contributed, MOC), IRR (Internal Rate Of Return, IRR), and DPI (Distribution over Paid- In, the return on invested capital (DPI) refers to these three indicators to evaluate the income of a fund product.
Among them, MOC is the investment return multiple of the fund, and the calculation formula is relatively simple, that is, the current asset value of the fund divided by the size of the fund, such as a fund product with a fund size of 100 million, if its current asset value is 5 100 million, then the MOC of this fund product is 5. The advantage of the MOC indicator is that it can be seen at a glance how many times the investment cost has doubled. The disadvantage is that it does not consider the cost of time.
IRR is an income indicator that takes into account the cost of time, and this indicator fully considers the effect of time on the fund’s income level. However, because the indicator of IRR is very sensitive to the parameter of time, if it is a fund product that has just been established, even if only individual projects receive new financing value-added, but because the fund runs short, it will cause a very high IRR If the LP does not understand this premise, it is easy to be misled by the excessive fund IRR level provided by the fund GP.
Because MOC and IRR do not take into account the actual withdrawal of the funds allocated to the fund LP when measuring the level of the fund, the two indicators describe the wealth on paper and are not actually realized, so a special measurement was introduced for this purpose The fund hasThe indicator DPI for distribution of income.
DPI refers to the proportion of the fund ’s allocated income to LP to the fund ’s size. The income allocated to LP generally includes two parts, one is the dividend of the project, and the other is the withdrawal of the transfer of project equity. The calculation formula is: DPI = exit income / invested capital
For example, the exit income is 500 million, the original shareholder invested 100 million, DPI = 5/1 = 5. DPI embodies the actual income of the fund LP that has really been settled, but this indicator also has certain limitations. If LP does not consider the duration of the fund, investment stage, investment strategy, investment track and other factors, and simply use the fund’s DPI at a certain point in time to evaluate the fund’s return level, it may cause misunderstanding of the true return of the fund and fail to objectively The overall return of the fund. In addition, a single DPI indicator can not reflect the valuation of the rest. For some long-period angel investments, perhaps in four to five years, the DPI is still relatively low. This data is biased.
Here we will specifically introduce how to use DPI as an indicator to evaluate fund returns in practice.
Basic concepts of DPI
As mentioned above, DPI as an indicator to measure the fund ’s income refers to the ratio of the fund ’s allocated income to the LP ’s overall size of the fund. DPI equals 1 is the profit and loss balance point, which represents the cost has been recovered; It means that LP has obtained excessive benefits; when it is less than 1, it means that LP has not recovered all costs; if it is equal to 0, there is no benefit.
On the one hand, as an indicator to measure the fund’s income, the advantages of DPI are very obvious. It truly reflects the cash return that the fund brings to LP, not just the wealth on paper. On the other hand, while DPI measures the cash return that the fund brings to the fund LP, it also ignores the impact of time cost and investment stage of specific fund products and investment strategies on the fund’s return.
At present, some investment institutions on the market have further subdivided DPI and classified DPI into narrow DPI and broad DPI. The narrow sense DPI refers to the cash allocated to the fund LP, and the broad term DPI refers to the stocks of companies listed in the fund’s investment portfolio that have passed the lock-up period in addition to the cash allocated to the fund LP. This division of generalized DPI is mainly based on the fact that the shares of listed companies that have passed the lock-up period can be sold in the secondary market at any time to distribute the fund LP, and its liquidity can be comparable to cash, so it is also regarded as a “cash income “.
However, the author believes that even if the listed company ’s stock passes the lock-up period, the company ’s stock price will fluctuate and fluctuate with changes in the market, and the amount of its earnings is not fixed. In addition to the fluctuations in stock prices, there are many factors that affect the timing of the fund GP ’s choice of liquidity, and there are many considerations for the fund GP. Therefore, the stocks of listed companies that have passed the lock-up period cannot be determined at a certain time.Based on these two points, the author believes that stocks that have passed the lock-up period cannot be equal to the value of cash included in the DPI.
Especially in the market, there is a situation where the valuation of the company is reversed after listing. In this situation, even if the company ’s stock lock-up period has passed, it can be freely traded, and the fund GP can retreat or not. Too. Especially for funds that entered later in the company ’s development, not only will the time cost of the investment be lost if it is withdrawn, it may even be difficult to recover the principal.
Factors to consider when using DPI
In reality, to use DPI to measure the income level of a specific fund, it is necessary to comprehensively consider the duration of the fund, investment stage, investment strategy and investment track.
(1) The impact of duration on DPI
The duration of private equity funds is generally 7 years to 10 years. The entire duration of the fund is generally divided into an investment period, a withdrawal management period and an extension period. The investment activities of the fund are mainly completed in the investment period of about 3 years. During the investment period, the main job of the fund is to find suitable projects for investment. Very few projects exit during the investment period, so the DPI of the fund during the investment period is generally equal to 0. . Of course, it cannot be ruled out that the fund will have projects withdraw from allocation to LP during the investment period. If this happens, the value of DPI will be greater than zero.
After the investment period ends, the fund enters the exit management period. During this period, the projects in the fund’s investment portfolio will be withdrawn one after another, and the fund GP will distribute the withdrawal funds to the fund LP one after another. In other words, during this period the fund’s DPI entered a growth period.
If the fund does not complete the withdrawal of all projects in the fund’s portfolio during the withdrawal management period, the fund GP will generally extend the fund on the basis of obtaining the consent of all partners. The extension period of the fund is generally two years.
The author believes that if the fund LP wants to use the DPI indicator to measure the fund’s income level, then the fund is preferably a fund that is in the exit management period or the extension period.
(2) Impact of investment stage on DPI
According to the different stages of fund investment projects, private equity funds are generally divided into PE funds, VC funds and angel investment funds. The general investment stage of PE funds is relatively late and has entered the growth stage. Angel investment funds generally invest in projects in the initial stage, and the VC fund invests in projects between the initial stage and the growth stage.
Because different types of funds invest in projects at different stages, the exit time of the projects is different, which in turn affects the overall exit progress of the fund.
Generally speaking, the exit time of the projects in the growth period is faster than that of the angels. After all, the projects that have been integrated into the C round or more rounds are only one step away from the IPO.The project can successfully complete the IPO, and the fund GP can choose a suitable time to exit after the lock-up period has passed. The angel project usually takes a long time to develop and grow. Of course, the funds that hold these angel projects will also exit through equity transfer before the project is listed. This depends on how the GP’s exit strategy is arranged.
(3) The impact of investment strategy and investment track on DPI
As mentioned above, the investment strategy of the fund GP will affect the exit arrangement of the projects in the fund’s portfolio. In practice, when the fund GP introduces the proposed fund product to the potential fund LP during the fundraising stage, it will introduce the potential fund LP in detail to the potential fund LP a series of important information related to the proposed fund product such as the investment strategy and investment track of the proposed fund.
Some mature fund GPs will bring their own future withdrawal scripts from the beginning of the fund’s establishment. With regard to the reserve projects to be invested by the fund and the exit path of each reserve project, the fund GP will have a rough exit plan in mind. In response to the fund set up by the fund GP that has already exited the script in the chest, the fund LP can monitor the arrival of the fund’s large-scale exit point according to the key point and trigger point of the fund plan’s exit. The author believes that DPI is used at this point It is more appropriate to measure the return level of the fund.
In addition to the fund’s investment strategy that will affect the fund’s DPI, the difference in the fund’s investment track will also affect the DPI. Because the growth cycle of projects on different tracks is different, for example, pharmaceutical R & D projects generally require longer growth time than game projects, which will inevitably affect the time for the fund to withdraw from the project.
So when considering the use of DPI as an indicator to measure the fund ’s income level, the fund LP should comprehensively consider the fund ’s duration, investment stage, investment strategy and investment track to consider whether the DPI at a certain point is objective The reaction reflects the overall return level of the fund.
Special matters affecting DPI in practice
Although the formula for calculating DPI is very simple, that is, the ratio of the fund ’s allocated income to LP to the overall size of the fund, there are some special circumstances in practice that will affect the value range of DPI.
Cyclic investment is one of the special circumstances that will affect the fund ’s DPI level. Assuming that the fund GP does not allocate funds to the fund LP after receiving the withdrawal money of a certain project, but instead invests in other projects, then the withdrawal money does not return to the LP, then this withdrawal is not related to the fund DPI. Any relationship.
In addition to the revolving investment, there is also a situation where the fund GP invests part of the management fee that should be paid to the fund management company as an investment fund on the project, then the problem will arise if There are project withdrawals or dividends, then these withdrawal dividends should be directly allocated toAs for LP, it is first to make up for the fund’s management fee. There is no doubt that if the withdrawal dividends are used first to make up for the fund’s management fees, then the fund LP will not receive the withdrawal in full, which will affect the fund’s DPI.
The organizational form chosen when setting up the fund will also affect the fund ’s exit amount and exit efficiency, which in turn will affect the fund ’s DPI level. At present, the domestic fund organization forms are company type, partnership type and contract type. The specific selection of different organizational forms, there will be different treatment methods in industrial and commercial registration, laws and regulations and tax policies, which will affect the process of the fund allocation to LP. Generally speaking, partnership funds and contract funds are more flexible and convenient when allocating to LP, and the tax burden is lighter, while the distribution procedures of company funds are relatively complicated and the tax burden is heavier.
Non-cash distribution will also affect the fund ’s DPI. Non-cash distribution generally occurs before the end of the fund’s duration. It is worth noting that at the time of signing the fund partnership agreement, there are references to non-cash distribution in the terms of fund distribution. That is to say, if the fund cannot realize the full withdrawal of the project before the end of the fund’s duration, it can negotiate with LP for non-cash distribution, so that LP does not get the cash but the equity of the project. Then this part of the equity need not be included in the income of DPI. If it is to be included, how to price it is a problem. Different treatments will definitely lead to different DPI levels.
DPI and IRR discrimination
I believe everyone has heard more or less that when the fund GP introduces the fund exit arrangement, the reason why a project has not yet exited is not because the project does not have a smooth exit channel, but the future of this project There is still room for development and growth. If you wait for a while, it may usher in the outbreak of the project. If you exit at that time, it may bring a considerable return.
This illustrates a problem. Sometimes the DPI of the fund may be small, but the IRR is high, and there will be inconsistencies between the two.
The reason why this happens is that although IRR and DPI are both indicators of measuring the level of fund returns, both of them examine the return of funds to investors, but the two methods of calculating fund returns are different. of.
In terms of the value of income, in the IRR calculation model, the fund’s income includes not only the cash that has actually been allocated to the fund’s LP, but also the asset value that has not been realized on the fund’s book. The DPI income refers only to the cash that has actually been allocated to the LP pocket of the fund, and does not consider the book assets of the fund that have not been allocated.
In terms of time cost, IRR takes into account the value of time when calculating the fund ’s return level, but DPI does not incorporate the time factor into the calculation formula, so naturally it does not consider the impact of time on the fund ’s return level.
Because IRR and DPI have different methods of calculating the fund’s return level, sometimes the same fund may have a high IRR and a low DPI, or in turn, a high DPI and a low IRR.
Sometimes if the fund pursues DPI, it may exit the project prematurely and miss the best time to exit, so that even if a good DPI level is obtained in the short term, it will reduce the IRR level of the fund. IDG sold its share of Tencent shares is a typical example.
This is why the fund GP likes to find professional investment institutions or professional personal LPs when raising funds. In addition to the strong investment ability of these professional investment institutions or professional personal LPs, another important reason is these Professional investment institutions and professional personal LPs are more patient. They understand the impact of the market environment on fund exit arrangements and are likely to wait patiently with the fund GP for the best time to exit.
Of course, the existence of the fund has a time limit. Regardless of the reason, the fund GP should try its best to withdraw from the fund’s investment portfolio at the end of the fund’s duration and allocate cash to the LP. The fund LP should also comprehensively use the DPI and IRR indicators to objectively understand the overall fund return level.
Thinking about DPI
Through the previous introduction, we have roughly learned how the DPI indicator measures the level of fund returns, and what special circumstances will be affected by the use of this indicator.
Finally, it falls into the essence of the indicator DPI, that is, DPI is only used as a tool indicator to measure the return level of the fund. The most important thing is to let the LP understand the true return of the fund through the indicator DPI.
So how should LP make good use of the DPI indicator in practice, the author gives my own views here:
First, just like the mature fund GP, when raising funds, it will bring its own fund reserve project’s future exit script, professional LPs should also invest from a fund’s duration and investment stage when investing in a fund. , Investment strategy, investment track and other aspects to comprehensively consider whether the future exit plan of the proposed investment fund meets the income expectations in your mind, try to plan your exit script for this investment in advance, and be aware of it.
Second, a thorough pre-investment due diligence must be conducted on the fund GP. Although the GP ’s past historical performance cannot represent the future investment performance of its current fund, from the historical performance of the GP ’s liquidated funds or the funds that are withdrawing from the fund, we can find clues about the fund ’s GP ’s exit arrangements, and verify that the fund GP is raising How likely is the withdrawal arrangement announced by the fund. One of the specific operations can be to make an annual distribution of the withdrawal amount of the fund GP that has completed liquidation in the withdrawal management period and extension periodAccording to statistics, it is mainly observed in the period of existence of the fund’s large-scale exit, find out an exit rule of the fund’s GP history management fund, and then use this rule to predict the future exit plan of its new fund.
Third, compared with the fund GP, the fund LP is not so closely connected with the project company after all, so the choice of when the project exits is mainly dominated by the fund GP. However, the fund LP can strengthen communication with the fund GP, through the fund GP to understand the development of key project companies in the fund portfolio, and then understand the project’s exit time. At the same time, it also prevents the fund GP from failing to allocate the fund LP withdrawing funds to the fund account in time to avoid extending the time that the fund LP funds are unnecessarily occupied by the fund GP.
All in all, the reason why DPI is important is that “paper wealth” actually contains a very large risk: the fall of many star projects, and the funds behind it have also experienced from exciting book valuation to write- With the disappearance of off, among the institutional investors in the United States, DPI can be regarded as one of the most watched indicators.
The DPI of the RMB fund market in the past was not ideal. On the one hand, due to the immature stage of GP development, on the one hand, it was also constrained by the exit environment. However, due to the complexity of private equity investment practice, LP should not only rely on a single indicator to evaluate the fund’s income level, but still need to comprehensively use multiple evaluation indicators of fund income such as IRR, MOC and DPI to comprehensively and objectively understand the fund’s income Level, to avoid falling into the “DPI-only theory” from the “IRR” theory.
* This article only represents the author’s point of view
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