The 3 most common ways to increase IRR are: growing EBITDA, paying off debt, and increasing the exit multiple.
Growing EBITDA is the most common way to increase IRR. Most PE firms plan to grow EBITDA either by increasing revenues, cutting costs, or some combination of the two. Even if they sell the company at an exit multiple that is equal to the entry multiple, the multiple will be applied to a higher EBITDA, so the investment will have grown in value.
Paying off debt is the second most common way to increase IRR. PE firms usually take a significant amount of leverage, anywhere between 4-6x Debt / LTM EBITDA. However, PE firms will usually pay off some of this debt with the company’s cash flows. By paying off debt, they are increasing their equity ownership of the company, similar to how paying off a mortgage will result in greater equity ownership of a house. Even if the company does not grow in value, the PE firm’s equity ownership will, and so paying off debt increases IRR.
Increasing the exit multiple is the third most common way to increase IRR. A PE firm can improve the attractiveness of a business by fixing some of its internal issues, such as augmenting the management team, changing a bloated cost structure, improving high employee turnover, enhancing brand / reputation, or even resolving union / labour conflicts. A PE firm can also improve the attractiveness of a business by improving its future outlook by entering attractive markets, exiting unattractive markets, cross-selling existing products, creating a larger platform through add-on acquisitions, etc. These factors will cause outside buyers to value the company more and pay a higher multiple for the company than the original PE firm paid.