Family Office Catches an Overstated IRR Before Committing Capital
Executive Summary
Illustrative Scenario
This case study is a composite, educational scenario built from patterns commonly observed in financial model audits. It does not describe a specific, identifiable client engagement, and any resemblance to a particular transaction is coincidental.
Background¶
A family office was evaluating a co-investment alongside a sponsor in a mid-market buyout, considering a minority equity commitment alongside the sponsor's own fund capital. The sponsor's financial model presented a base case and an upside scenario, each projecting an equity IRR over a five-year hold period, with the upside case built around a faster earnings growth trajectory and a modestly higher assumed exit multiple.
Before committing capital, the family office engaged an independent team to audit the sponsor's model structurally, separate from its own commercial assessment of the deal thesis.
The model used a single shared assumptions tab feeding both the base and upside scenarios through a scenario toggle, a common structure intended to keep both cases consistent with the same set of stated inputs, differing only where the scenario explicitly called for a different assumption.
The Problem¶
The upside scenario's headline equity IRR was significantly higher than the base case, which the family office's initial review attributed to the combination of faster earnings growth and the modestly higher exit multiple stated in the sponsor's assumptions summary.
Rather than accepting the assumptions summary and headline IRR figures as presented, the audit independently recalculated the terminal value and resulting equity IRR in both scenarios from the model's own formulas.
Findings¶
Tracing the terminal value formula in the upside scenario, the audit found that the exit multiple cell feeding that calculation did not reference the shared assumptions tab at all. It contained a hardcoded value, a finding of the type described in the Hardcoded Formulas technical guide, that was higher than the exit multiple stated in the assumptions summary the sponsor had presented to investors.
Recalculating terminal value using the exit multiple actually stated in the assumptions tab produced a lower terminal value, and consequently a lower projected equity IRR, than the figure shown in the upside scenario.
Root Cause¶
Reviewing the model's revision history, the exit multiple in the upside scenario had originally referenced the shared assumptions tab correctly. In an earlier draft, the sponsor's team had tested a higher exit multiple directly in the upside scenario cell to gauge its effect on headline returns, then updated the shared assumptions tab separately with a different, more conservative multiple intended to apply across both scenarios. The upside scenario's hardcoded test value was never reverted to reference the updated shared assumption.
This is a structural, mechanical root cause, a hardcoded value left in from an earlier iteration of the model, not a disagreement over what exit multiple was reasonable to assume.
Risk¶
Had the audit not caught the inconsistency, the family office would have continued evaluating the co-investment on the basis of a headline upside equity IRR that did not reflect the sponsor's own stated exit assumptions. Capital could then have been committed on the strength of a return case that the sponsor's own model, correctly applied, did not actually support.
Resolution¶
Presented alongside the recalculated upside-case IRR, the findings prompted the family office to raise the discrepancy directly with the sponsor, who corrected the formula to reference the shared assumptions tab consistently across both scenarios and reissued the model. The family office proceeded with its capital commitment using the corrected, consistent return figures as the basis for its decision.
Lessons Learned¶
- Terminal value and exit multiple assumptions warrant formula-level verification in every modelled scenario, not just the base case, since inconsistencies frequently appear in secondary scenarios.
- A hardcoded assumption cell in one scenario, left over from an earlier draft, can materially change a headline return figure without any error appearing in the shared assumptions tab investors are shown.
- Independent audit of a sponsor's model is a distinct exercise from an investor's own commercial assessment of the deal, addressed further in Audit vs Validation.
- Reconciling every scenario's key value-driver formulas against the shared assumptions tab is a practical, repeatable audit step for co-investment and minority-stake due diligence.
- Catching an inconsistency of this kind before capital is committed preserves the investor's ability to ask for correction or re-price its participation; after commitment, the same finding becomes far harder to act on.
Continue Reading¶
Related Pillars¶
Related Technical Guides¶
Related Glossary¶
Related Checklists¶
Related Products¶
Related Case Studies¶
How OXXON tests thisRun a free structural check with FMAE
Frequently Asked Questions
Is this a real client engagement?
No. This is an illustrative, composite scenario built from patterns commonly observed in financial model audits. It does not describe a specific, identifiable transaction.
What is a terminal value and why does it matter for equity IRR?
Terminal value is the estimated value of an investment at the end of the projection period, commonly calculated by applying an exit multiple to a terminal-year earnings figure. Because it is typically the largest single component of the projected exit proceeds, an error in how it is calculated has an outsized effect on the resulting projected equity IRR.
How is a hardcoded exit multiple different from disagreeing over what exit multiple is reasonable?
The exit multiple assumption itself, what value is reasonable to project, is a judgement question. Whether that assumption is applied consistently through the model's formulas, rather than replaced by a different, hardcoded value in one scenario, is a structural question. This case study addresses the latter.
How could this have been caught earlier?
Tracing the terminal value formula in every modelled scenario back to the shared assumptions tab, rather than reviewing only the base case, would have surfaced the inconsistency between scenarios directly.
What audit stage typically catches this kind of error?
Pre-commitment due diligence on a sponsor's model, before capital is called or a subscription agreement is signed, is the typical stage, since it is the last point before an investor's capital is at risk.
Does finding an inconsistent exit multiple mean the sponsor's overall return case was misleading?
Not necessarily. It identifies a structural inconsistency between the model's stated assumptions and what its formulas actually calculated in one scenario. The audit does not assess whether the underlying exit multiple assumption itself was reasonable, only whether it was applied consistently.
Related Articles
What Is a Financial Model Audit?
A financial model audit is an independent, structured examination of an Excel based financial model to confirm that its mechanics, logic, and outputs are reliable enough to support a decision. It is not a check of whether the assumptions are optimistic or conservative. It is a check of whether the model actually calculates what its author believes it calculates. Every year, lenders extend debt, investment committees approve capital, and boards sign off on transactions using numbers that came out of a spreadsheet nobody outside the immediate deal team has independently verified. A financial model audit exists to close that gap before it becomes expensive.
Audit vs Validation — What's the Difference?
Financial model audit and model validation are frequently used as interchangeable terms, and specifying the wrong one in a lender requirement or an internal policy leads to real confusion about what has actually been checked. They test different things. An audit tests whether a model's mechanics are correct. Validation tests whether the model's methodology and assumptions are appropriate for its intended purpose. Both are legitimate, useful exercises. They are not substitutes for each other.