Many a time I’m requested to explain the relation between shareholder loan and the equity IRR. Should shareholder loan be part of equity IRR calculation? And if there are more than one equity investor, what should we do!
Shareholder loan is a debt-like form of financing provided by the shareholders. Usually, it is the most junior debt in the company's debt portfolio, and since this loan belongs to shareholders it should be treated as equity.
We have discussed the relation between project IRR and Equity IRR earlier. In this post we will be discussing only about the shareholder loan and the equity IRR.
Example 1: Consider a project with simple equity and debt funding, i.e. there is only one equity holder and one senior loan.
For this example, following assumptions are made:
Consider the project duration of 10 years, the exit value is assumed to be 1,650,000$.
The project cash flow will look like this:
Project IRR can be calculated by using Excel IRR formula. The IRR for this cash flow is 15.2%.
The financing cash flow for this project will be as follows:
The equity IRR will be 19.8%.
Example 2: Now, let’s take the above example and assume that the equity holder is participating 30% equity and 10% shareholder loan.
The assumptions can be summed up as follows:
Project cash flow and project IRR will remain unchanged.
Financing cash flow can be modelled as follows:
If you notice, the cash flow to equity holder and the equity IRR remain unchanged. However, it should be noted that shareholders loan is the most junior debt, and if there is any shortfall in the cash flow, shareholder loan will not be serviced. More specific model can be created depending on the shareholders loan terms.
Many equity investors may not like the idea of treating equity and shareholder loan as same. In such cases the equity investor can treat equity participation and shareholder loan separately (refer Example 2A in the attachment below).
The financing cash flow in such case would look like as follows:
Example 3: Now consider a more complex situation where two equity holders are involved but only one of them is providing shareholder loan.
Let’s assume the followings for this example:
For the sake of simplicity I have assumed that the cost of equity for both the equity holders are same.
Project cash flow and project IRR for this case will also remain unchanged and will be as follows:
Finance cash flow will be really interesting in this case:
You will notice that equity IRR for equity holder – 1 is lower than that of equity holder – 2. Equity holder - 1 has provided shareholder loan which is junior to the debt but have preference over the equity.
Hope you enjoyed this post on Shareholder Loan and Equity IRR. If you have any questions, let me know through the comment section below.
You can also download the Shareholder Loan and Equity IRR Excel workbook FREE!