Class 02: Investment Returns and Leverage

A profitable business may still be difficult to sell

I described a medical-equipment business whose owners tried several times to sell. It earned cash, but they struggled to find a buyer at terms they could accept.

Ask who might buy the business and why they would want it. Even if it performs well, we still need a buyer willing and able to pay when we want to sell.

The business can also pay cash to its owners without being sold. How much can it pay while keeping enough to run and grow?

Harbor Maintenance: connect the asking price to the cash you receive

Harbor Maintenance is a fictional heating, ventilation, and air conditioning (HVAC) business. We used it in Class 2’s opening quiz on Class 1.

The asking price is $4 million, and it has no debt. It earns $600,000 of annual cash after running costs, taxes, and routine equipment spending.

One customer brings in half its revenue, and that contract expires in six months.

The case gives us $600,000 of cash. It does not give earnings before interest, taxes, depreciation, and amortization (EBITDA), a different measure of earnings.

Before buying, check the cash figure against the accounts. Does it cover the spending needed to keep the business running?

With no debt, divide $600,000 by the $4 million purchase price to get a 15% annual cash yield. This cash yield shows the yearly cash as a share of the price.

Divide the price by annual cash to get a 6.67× price-to-cash multiple. It would take about 6.67 years to earn back the price if cash stayed the same and reached the buyer.

Harbor cash yield at three purchase prices

Purchase price	Annual cash assumed	Annual cash yield	Price ÷ annual cash
$2.4 million	$600,000	25%	4.00×
$3.0 million	$600,000	20%	5.00×
$4.0 million	$600,000	15%	6.67×

Paying less gives us a higher yield on the same cash. The investment still depends on whether the business can keep producing that cash.

We used a 25% cash yield to test the price. At $600,000 a year, that gives a maximum price of $2.4 million.

We would still need to allow for changes in cash and any extra money the business needs.

Losing half the revenue could remove much more than half the profit

The large customer is the first risk to investigate. How much profit does its work earn, and which costs could stop if it left?

Note: rent and managers’ pay may not fall when sales do. Work out which costs would go down.

Example: suppose a business has $2.4 million in yearly sales. Variable costs, which rise and fall with sales, take 60% of revenue.

Fixed costs stay at $360,000. These made-up figures give $600,000 of operating profit before interest and tax.

We chose them to match Harbor’s starting cash amount. The two measures still mean different things.

The $2.4 million here is annual revenue, not the screening purchase price calculated earlier.

If half the revenue disappears, variable costs also halve, while fixed costs stay at $360,000. Operating profit falls from $600,000 to $120,000, an 80% decline.

That customer brought in $480,000 after costs that rose and fell with its work. Losing the customer cuts profit by $480,000 because the fixed costs stay.

Seven questions that describe an investment

We asked seven questions about each investment. Buyers can want different things: one seeks control, one buys a smaller stake to fund growth, and one plans to own forever.

Seven dimensions for describing an investment

Dimension	Question to ask
Public or private	Are the shares traded on a public market, and would the deal change that?
Financial or strategic purpose	Does the buyer want a financial return, a benefit for another business it owns, or both?
Holding period	Is there a planned sale date, or can the owner hold with no end date?
Investment vehicle	Does the money come through a pooled fund or a direct investment?
Control	How much does the buyer own, and what control or governance rights come with that stake?
Business maturity	Is the company early-stage, growing, or established?
Financing	How much of the purchase uses equity, and how much uses debt?

We focused on owning private businesses. Buying control with a loan is one common approach. The other questions help explain each buyer’s plan.

Buffett and Munger: business quality, price, and the ownership horizon

We came back to Warren Buffett to build on Class 1. Benjamin Graham taught him to buy cheaply. Charlie Munger pushed him to care about the quality of the business he bought.

See’s Candies shows this change in thinking. Berkshire’s 2007 letter says it bought See’s in 1972 for $25 million.

The letter explains how the business earned cash while needing little extra money.

A wonderful business still needs a sensible purchase price. The questions worth asking are:

• What keeps customers coming back?

• How much more money does the business need to grow?

• At this price, what has to go right for the buyer to earn an attractive return?

Berkshire can keep a business without a set end date. A typical private equity (PE) fund has a limited life and must return money to investors.

The fund’s end date affects the choice to sell now or put more money into the business.

I encouraged students to read Berkshire Hathaway’s shareholder letters and to find people who sharpen their thinking. Buffett and Munger show how a thoughtful partner can change an investor’s judgment over time.

Deal articles: identify the business, the buyer, and the reason to invest

We started with HYROX. Then each group took one of five articles: the four in the table below, plus Marshall Aerospace. Each group explained its story to classmates. The goal was to look past the headline and ask what the buyer might see in the business.

HYROX: growth, durability, and the seller’s timing

HYROX runs races that combine running with workout stations. We discussed the reported L Catterton deal.

Could the sport keep growing, and who else might join? Why would an owner sell now?

The reading was Dong Cao’s September 7 Bloomberg report, L Catterton Is Said to Near Acquisition of Fitness Brand Hyrox. That report described talks, before the public announcement.

On September 8, the founders’ adviser confirmed their partnership with an L Catterton-led consortium to acquire Infront’s majority stake.

Students suggested reasons an owner might sell then. Those were ideas to check; we did not know the seller’s private reasons.

AXIS-Y, A1, Spire, and McGill: compare the investment questions

We discussed these four stories in class. The links go to the news report or announcement. The last column shows the question we asked.

Assigned deal readings and investment questions

Business	Original reading or source	Question from the discussion
AXIS-Y: Korean skincare brand	The GeneOnline reading gives the value in Korean won (KRW): “MBK Partners Values Skincare Brand AXIS-Y at KRW 430 Billion.” The AXIS-Y announcement is the original source.	What does overseas demand tell us, and what would support further growth?
A1 Garage Door Service: residential repair and replacement	Reuters: KKR to acquire A1 Garage Door Service for around $2 billion, sources say	How durable is demand, and how does the company win customers?
Spire Healthcare: private hospitals	The Guardian: Spire agrees takeover by Toscafund	How do demand, what patients can pay, and government policy affect the investment?
McGill and Partners: specialty insurance and reinsurance broker	The Cap Table: EQT buys control of McGill, drawing on City AM’s original reporting	What changes when the financial owner changes, and who still owns a stake?

A1: turn customer demand into profitable jobs.

A1 repairs garage doors, a service people keep needing. Demand alone does not tell us what the business is worth. We still have to look at competition, labor, pricing, and the cost of winning a customer.

Reuters reported an agreement based on its sources. KKR and the seller, Cortec, declined to comment.

An agreement still needs to close. Check which stage a deal headline describes.

Note: a name starting with “A” does not put a business first in Google results. Google says local ranking depends mainly on relevance, distance, and prominence.

Search engine optimization (SEO) helps people find a business online. Sterling Sky’s case study of A1 Garage Door Service describes its work with A1’s teams on Google Business Profiles and local web pages. It shows how a service business tries to turn searches into customer calls.

A search inquiry becomes valuable when it turns into a profitable job. Follow the customer from search to booking, then compare what it cost to win the job with the profit from doing it.

McGill: a payout, retained ownership, and fund deployment mean different things

The McGill story raised a question about what employees gain from a sale. They can receive some cash and still own part of the business.

McGill employee economics and EQT fund deployment

Point to distinguish	What the sources establish
Employee payout	The assigned article reports a payout through the employee ownership arrangement. A payout alone does not show that every employee sold their whole stake.
Continuing participation	EQT says founding management and colleagues will reinvest and keep a meaningful stake. There will also be a new employee equity participation plan.
The 85–90% figure	This is how much of the EQT X fund is expected to be invested after the deal. It is not the share of McGill that EQT bought.

The table’s details come from EQT’s announcement.

What does the person hold: shares, voting rights, or a promised bonus? Read the terms to see what they can gain or lose, and what happens if they leave.

Further reading: Marshall Aerospace and Los Tacos No. 1

These readings are for further study. Marshall was among the five assigned articles, and Los Tacos was shared for practice.

We did not finish discussing them in class.

Additional deal readings for follow-up

Reading	Business and transaction	Question to consider when reading
Aviation Week: Marshall Aerospace nears sale to a private equity firm	Aircraft maintenance business; sale agreement with Aurelius.	What would the new owner need to spend on relocation and improvement, beyond the purchase price?
Nation’s Restaurant News: Los Tacos No. 1 receives private-equity investment	Taco restaurant brand; investment from TSG Consumer. The article does not give the financial terms.	How can a successful restaurant grow and keep its food and service just as good?

Investment returns and leverage: how much cash comes back, and when?

Cash yield compares yearly cash with the price paid; MOIC compares total value returned with money invested. IRR also accounts for when the money goes in and comes back.

Sunrise Bunsik, our fictional teaching case, brought us back to the buyer’s return. We used $5.6 million invested, a five-year holding period, and a 25% annualized return target. How much money would the owner need to get back?

Start with all the money invested on day 1 and no debt. The owner gets no payouts, or distributions, until the sale at the end of year 5.

At a 25% annualized target, multiply the required value by 1.25 for each of the five years.

Required year-five proceeds = $5.6 million × 1.25⁵ = $17.09 million.

Five-year proceeds required for a 25% annual return

Measure	Result under those assumptions
Initial equity investment	$5.60 million
Annual return target	25%
Holding period	5 years
Required proceeds at the end of year five	$17.09 million
Total proceeds ÷ initial investment	3.05×

To earn 25% a year for five years, you need a little more than three times your starting money. A 25% gain over the whole period would return only $7 million.

With the same payment dates, that is about 4.56% a year.

Cash yield, money multiple, and annual return answer different questions

The table compares cash yield, multiple on invested capital (MOIC), and internal rate of return (IRR).

Cash yield, MOIC, and IRR definitions

Measure	What it tells us	What else we need to know
Cash yield	Annual cash divided by the price paid.	Whether the cash will continue, can be distributed, and what happens at sale.
MOIC: multiple on invested capital	Total cash investors get back, divided by the equity they put in.	How long the money was invested and when receipts arrived.
IRR: internal rate of return	The annualized return implied by how much money went in and came back, and when.	The actual cash-flow schedule and the assumptions behind it.

Definition: before everything is sold, MOIC can count cash received plus the estimated value still owned. In these examples, MOIC uses cash received because everything has been sold.

These are the owners’ returns from the deal before fund fees and carried interest. Carried interest is the fund manager’s agreed share of the profit.

Harbor’s 25% cash-yield test compares one year’s cash with the purchase price. Sunrise’s 25% deal IRR target counts every equity payment and its timing.

A preferred return, or carry hurdle, is a separate fund rule that affects when carry is paid. Neither 25% target here is that hurdle.

With money paid once at the start and returned once five years later, IRR is the yearly rate used above.

Tripling money over five years earns about 24.57% annually. So “roughly 3 times” gets us close to our 25% target, but falls a little short.

Cash counts for investors only when they receive it

Once all the new shops are fully running, the case forecasts $700,000 + 5 × $80,000 − $210,000 = $890,000 of annual business cash.

The shops must earn what we expect, and the central team must stay within its budget.

How much of that cash can the owners take out, and when? The business may first need money for new shops, day-to-day operations, or debt payments.

Students asked: what if the buyer puts money in over time, or takes cash out before selling? Then we would list the amount and date of every payment in and out, and calculate the return from that list.

Note: the $17.09 million target assumes you get no cash until the sale. If you get cash earlier, you may need less at sale to earn the same yearly return.

If the business keeps cash, count that cash only once when you work out what owners receive at sale.

Note: profit and EBITDA are not the same as cash that lenders or owners can take. Inventory, unpaid customer bills, equipment spending, and taxes can use up cash.

Sunrise’s cash figure already takes out some of these items. Do not subtract them twice, and do not call it EBITDA. Check cash while the new shops start up, and again when they are fully running.

How borrowing changes the equity required

Borrowing reduces the cash owners must put into the purchase. This use of leverage can increase their percentage gain or loss.

For practice, we assume a $1.4 million loan toward the $5.6 million investment. This equals twice the existing business’s $700,000 annual cash figure; it is a teaching assumption.

The $700,000 is last year’s cash from the 10 existing shops. The $890,000 forecast adds five new shops once they are running, minus the central team’s cost. The worked example, “The same business with and without debt,” assumes the full $890,000 arrives from year 1 and keeps the loan at $1.4 million.

Sunrise funding with and without borrowing

Funding source	All-equity example	Example with $1.4 million of debt
Buyer equity	$5.6 million	$4.2 million
Acquisition debt	$0	$1.4 million
Total funding	$5.6 million	$5.6 million

Uses tell us where the money goes: $4.2 million to the seller and $1.4 million into the business. Sources tell us where it comes from: the buyer’s money, called equity, and the loan.

The amounts happen to match, but the loan is not earmarked for the new shops. Equity and debt together fund the full purchase and expansion budget.

A loan lets the buyer put in less money. The business must then pay interest.

At sale, the lender gets back the unpaid loan amount, called principal. The equity owner receives what is left.

Note: real deals commonly quote debt as a multiple of agreed earnings, such as EBITDA. The buyer and lender must agree on that measure and the loan terms.

A loan might require some principal to be repaid each year. That leaves less cash for owners now and less debt to repay at sale.

The slides add a 10% yearly interest rate, which means $140,000 of interest a year on $1.4 million of debt. The rate and the loan are for practice; no lender offered either.

At the end of class, we talked about lender relationships and whether a business this size could borrow.

How much the business could borrow depends on its cash, the lender’s terms, and what could go wrong. A lender might require cash to stay in the business or limit payments to owners; we have not set those rules here.

Debt can raise the owner’s return when things go well and deepen a loss when they go poorly. Track interest, loan payments, cash paid to owners, and debt still owed at sale.

Post-class worked example: the same business with and without debt

Note: follow the money from purchase to sale. We chose the sale price and payment dates below for teaching; we did not work them out in class.

Keep the business identical in both cases and change only how we finance it:

• Invest $5.6 million at the start and sell the operations for $8.4 million at the end of year five, before settling any debt.

• Assume $890,000 of cash is available each year before financing costs, starting in year one. Running costs, taxes, and needed spending on the business are already paid.

  We skip the time new shops take to reach full earnings. We also assume they need no extra funding.

• In the debt case, borrow $1.4 million at 10% interest. Pay interest each year and pay back the loan at sale.

  Pay all the cash left each year to equity owners. Leave out loan fees, tax savings from interest, fund fees, and carried interest.

Annual interest is $1.4 million × 10% = $140,000. That leaves $890,000 − $140,000 = $750,000 for equity owners each year in the debt case.

The assumed sale price is 50% above the starting investment. What supports it?

Favorable scenario: equity cash flows by year

Cash received or paid by equity owners	All equity	With $1.4 million of debt
Start: equity invested	−$5,600,000	−$4,200,000
End of year 1: distribution	$890,000	$750,000
End of year 2: distribution	$890,000	$750,000
End of year 3: distribution	$890,000	$750,000
End of year 4: distribution	$890,000	$750,000
End of year 5: distribution plus sale proceeds after debt repayment	$9,290,000	$7,750,000

Enterprise value and equity proceeds: the year-five buyer pays $8.4 million for the operations, the assumed enterprise value at sale. Subtract the loan still due to find the owners’ sale proceeds in this example.

First, pay back the $1.4 million loan. That leaves $7 million for the owners, plus their final yearly cash payment.

We assume no extra cash sits in the business and no other price changes apply at sale. If the business kept cash, add it where it belongs in the sale calculation, counting it once.

The final all-equity receipt is $890,000 + $8,400,000 = $9,290,000. With debt, it is $750,000 + $8,400,000 − $1,400,000 = $7,750,000.

Favorable scenario: total receipts, MOIC and IRR

Five-year result for equity owners	All equity	With debt
Total cash received, including sale	$12,850,000	$10,750,000
Total cash received ÷ equity invested (MOIC)	2.29×	2.56×
Annualized return using the dated cash flows (IRR)	22.31%	25.85%

Both cases produce the same business cash and sell at the same price. Debt leaves owners with fewer dollars, but they invested less, raising IRR from 22.31% to 25.85%.

Calculate the debt case’s IRR

Enter these six cash flows in cells A1:A6, with no heading in those cells. Amounts are in $ millions, from the initial investment through the end of year 5.

Spreadsheet inputs: one payment each year

Cell	Time	Cash flow ($m)
A1	Start	-4.20
A2	End of year 1	0.75
A3	End of year 2	0.75
A4	End of year 3	0.75
A5	End of year 4	0.75
A6	End of year 5	7.75

In another cell, enter =IRR(A1:A6) and format the result as a percentage. The annual IRR is about 25.85%.

The final $7.75 million includes $0.75 million of annual cash plus $7 million from the sale after debt repayment. Count that sale payment once.

For irregular payment dates, put the dates in B1:B6 and use =XIRR(A1:A6,B1:B6). Microsoft explains when to use IRR and XIRR.

The owners’ share can gain value if the business earns more, a buyer pays more for each dollar of earnings, or debt minus cash falls. Ask which change your plan depends on.

Which changes can the owner bring about?

The $140,000 interest bill remains due if cash falls. Now test a weaker outcome.

These returns leave out fund fees and carried interest. Owners also get cash each year.

The earlier $17.09 million target assumed they got nothing until sale. With yearly cash payments and less equity invested at the start, the debt case clears the 25% target at an $8.4 million sale price. The all-equity case earns 22.31%.

Post-class downside: less cash and a lower sale price

Now assume annual cash before financing costs falls to $400,000 and the year-five sale value falls to $4.2 million. Keep the same starting investment, five-year period, yearly payouts, and loan terms.

The loan still requires $140,000 of interest each year, leaving $260,000 for equity owners in the debt case. At sale, the remaining $1.4 million principal must also be repaid.

Downside scenario: equity cash flows and returns

Downside cash flows and results	All equity	With debt
Initial equity invested	$5,600,000	$4,200,000
Distribution at each year-end, years 1–4	$400,000	$260,000
Year 5: distribution plus sale proceeds after debt repayment	$4,600,000	$3,060,000
Total cash received over five years	$6,200,000	$4,100,000
Annualized equity return (IRR)	2.37%	−0.55%

The final debt-case receipt is $260,000 + $4,200,000 − $1,400,000 = $3,060,000. Across all five years, those owners receive $4.1 million against their initial $4.2 million investment.

Here, the all-equity owner earns a small positive return, while the owner using debt loses money. The loan helped owners meet their target in the strong case. It hurts them in this weaker case.

A poor return is different from a payment shortfall

Example: in the weak case above, the business still pays its $140,000 yearly interest and pays back the loan at sale. Owners lose money even though lenders get paid.

Now suppose only $100,000 is available before financing costs in one year, while interest remains $140,000. With no spare cash or new funding, the business is $40,000 short. That is before it pays back any loan principal or pays owners.

Now try a separate sale example: only $1 million is available against the $1.4 million loan. Assume there is no other money to recover and no other claim on it.

The lender receives $1 million. Equity owners get nothing at sale.

The lender is still $400,000 short. Being paid first does not mean being paid in full.

This tells us what owners receive at sale. To find their full return, count any earlier payments too.

Questions to carry into the next class

We finished the first loan calculation in class. The full return needs more work. Use these questions for review and discussion.

1. At what price would you investigate Harbor further, and what would you need to learn about its largest customer?

2. Why can a profitable business still be difficult to sell?

3. How does a planned sale date change an owner’s decisions, compared with owning with no end date?

4. Why does a 25% annual return over five years require more than a 25% total gain?

5. First, show where the $5.6 million comes from and where it goes in each financing case. Without copying the table, show when owners pay or receive cash in each version of the strong case.

   Calculate total receipts and MOIC, then calculate IRR from that timeline. Explain why the debt case returns fewer dollars but produces a higher percentage return.

6. Explain how owners can lose money even when the loan gets paid. Then find the gap when only $100,000 is available to pay $140,000 of interest.

   Separately, show who gets $1 million at sale when the loan is $1.4 million. Assume there is no other money to recover and no other claim on it.

7. In a deal announcement, is a percentage about ownership, how much of a fund is invested, or something else?

8. Choose all equity, $1.4 million of debt, less borrowing, or PASS on the stated terms. Support your choice with the return calculation, one risk that matters, and a condition that would change your decision.

   For any proposed borrowing, identify one lender protection.

Answer checks

1. If yearly cash stays at $600,000, a 25% cash yield gives a price of $2.4 million. Treat that as a starting point to test.

   Will the customer renew, how much profit does it bring, and which costs would go away if it left?

2. A business can earn cash and still lack a buyer at the price and time you want. Ask whether it could pay cash to owners while they wait to sell.

3. A fund with an end date faces pressure to sell and return money. An owner who can hold longer still needs to pay a sensible price and use cash well.

4. With no earlier payouts, 25% a year requires $17.09 million after 5 years, or 3.05×. A 25% total gain is only about 4.56% a year because it does not repeat and compound each year.
5. All equity: $12.85 million received, 2.29× MOIC and 22.31% IRR. With debt: $10.75 million received, 2.56× MOIC and 25.85% IRR. Check your timeline against the cash-flow table. Debt reduces both the cash owners receive and their starting investment; here, the smaller starting investment raises the percentage return.
6. The weak case pays lenders in full while equity earns −0.55%. The separate interest test has a $40,000 shortfall. At the stressed sale, the lender receives $1 million and is $400,000 short; equity receives zero. Payment priority cannot make up missing cash.

7. Ask “a percentage of what?” and read the source. The McGill 85–90% figure tells us how much of EQT X’s fund would be invested after the deal.

   It does not tell us how much of McGill it bought.

8. You can make a sound case for all equity, either loan choice, or PASS. Use the numbers, name a risk that matters, and say what would change your mind.

   If you propose a loan, name one lender protection and explain how the business can pay interest and repay the loan. If you choose all equity or PASS, you do not need to propose loan terms.

   You need more than a return above 25% on paper.

Class details

Class 2 course details

Course and lesson	Details
Course	Introduction to Private Equity, second offering · Fall 2026
Instructor	Shayne Fitz-Coy
Institution and classroom	Seoul National University, Building 58, Room 331
Course number	M1338.005800 (001)
Class date and scheduled time	September 8, 2026 · Tuesday, 10:00–12:50
Main work	Harbor Maintenance, ownership structures, PE deals in the news, and Sunrise Bunsik returns

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