Debt as a Liquidity Provider and IRR Booster

Introduction

It allows the economic value embedded in assets—particularly appreciated or cash-flowing assets—to be converted into usable capital without triggering immediate ownership transfer, tax realization, or strategic disruption. When deployed deliberately, debt enables liquidity without liquidation, reshapes equity returns through leverage, and allows investors to acquire cash-generating assets whose own cash flows service the borrowing.

1. Liquidity without liquidation: borrowing against appreciated assets

For high-net-worth individuals and controlling shareholders, the dominant source of wealth is often unrealized appreciation rather than cash income. Equity stakes in operating companies, founder shares in public firms, real estate holdings, and private investments may represent substantial economic value, but monetizing that value through sale often entails immediate capital gains taxation, loss of control, signaling effects, or portfolio disruption.

Borrowing against these assets alters the timing and structure of liquidity. Loan proceeds are not treated as income; they are an obligation offset by collateral. When the collateral consists of appreciated assets, borrowing replicates the economic effect of a partial sale—cash today—while deferring the realization of gains. The investor preserves ownership, voting rights, and future upside, while converting balance-sheet value into spendable liquidity.

This mechanism underlies what is commonly described as “buy-borrow-die”: assets are acquired or held, appreciation is allowed to compound, borrowing finances consumption or reinvestment, and realization is postponed. From a balance-sheet perspective, this is equivalent to advancing future wealth into the present. From a tax perspective, it exploits the asymmetry between realization-based taxation and the non-taxable nature of loan proceeds.

Importantly, this is not a costless strategy. Collateral values fluctuate, loan-to-value limits can tighten, interest rates can rise, and lenders can require additional margin. The liquidity benefit exists precisely because lenders demand protection. Debt functions as a liquidity provider only when the borrower can manage volatility, maintain excess collateral, and withstand adverse scenarios.

2. Debt as an amplifier of equity returns

Beyond providing liquidity, debt reshapes the distribution of returns between capital providers. When an asset generates returns in excess of its cost of debt, introducing leverage increases the return on equity by reducing the initial equity capital required and accelerating the timing of equity cash flows.

The decomposition of equity returns makes clear that operational improvements—organic growth, margin expansion, efficiency gains, and strategic repositioning—create value at the enterprise level. However, the translation of that enterprise value into equity returns is strongly influenced by capital structure. By funding part of the asset with debt, the same absolute value creation is allocated over a smaller equity base, resulting in a materially higher internal rate of return to equity holders.

This amplification does not require superior operating performance. Even moderate, stable value creation can produce high equity IRRs when leverage is present, provided debt costs remain below asset returns and financial distress is avoided. This explains why leverage is often described as “financial engineering”: it changes outcomes without changing the underlying business.

3. Sensitivity of equity IRR to leverage levels

Equity returns respond non-linearly to increases in leverage. As debt levels rise, equity becomes more sensitive to changes in enterprise value and cash flow performance. Initial increases in leverage tend to raise equity IRR, but the relationship is convex: the marginal benefit of additional leverage declines as financial risk increases.

This dynamic highlights the dual role of debt as both enhancer and risk concentrator. At moderate levels, leverage magnifies equity performance by reducing capital invested and accelerating distributions. Beyond a certain point, however, debt service requirements, refinancing risk, and covenant constraints can dominate, making equity outcomes fragile. The existence of this trade-off is why professional investors treat leverage as a calibrated input rather than a maximization problem.

4. Debt as a “cash-flow buyer” in acquisition structures

The liquidity role of debt is most transparent in acquisition contexts. In a leveraged buyout or similar transaction, borrowed capital is used to purchase a cash-flowing asset, and the asset’s own free cash flows are then used to reduce the outstanding debt balance over time. This transforms future operating cash flows into an immediate purchasing capability.

Equity value creation in these structures arises from three sources: improvements in operating earnings, changes in valuation multiples, and debt paydown. The last of these is often underestimated. As net debt declines, equity value increases mechanically, even if enterprise value remains unchanged. Debt therefore functions as a bridge between future cash generation and present ownership.

This is the defining distinction between productive debt and consumer debt. The former is supported by identifiable, recurring cash flows and is integral to the investment thesis. The latter relies on external income sources and does not generate the means of its own repayment. In acquisition finance, lenders underwrite not the borrower’s personal balance sheet but the durability of the asset’s cash flows.

5. Portfolio-level evidence: leverage as a dominant return amplifier

When returns are examined across a diversified investment set, the effect of leverage on equity outcomes becomes quantifiable rather than conceptual. Across average, geometric mean, and median measures, equity returns consistently increase when leverage is introduced, with the magnitude of uplift varying by statistic but remaining economically meaningful in all cases.

On an arithmetic average basis, unlevered equity returns of 15.1% increase to 23.0% once leverage is applied. This represents a 1.52× multiple on returns, or an incremental 7.9 percentage points attributable to capital structure rather than changes in operating performance. In absolute terms, this uplift alone exceeds the total return of many unlevered investments, highlighting how leverage can dominate outcome dispersion.

Using the geometric mean—which better reflects the compounded experience of long-term investors—the effect persists, though at a moderated level. Unlevered returns of 11.8% rise to 13.9% with leverage, corresponding to a 1.17× return multiple. The smaller relative uplift reflects volatility drag and the asymmetric downside risk introduced by leverage, but still demonstrates that leverage improves long-run compounding when financial distress is avoided.

Median outcomes show a similarly strong pattern. The median unlevered IRR of 9.0% increases to 13.0% under leverage, a 1.44× multiple. This indicates that leverage does not merely benefit a small number of outsized successes; rather, it shifts the entire return distribution upward. Even the “typical” deal experiences a material improvement in equity performance due to leverage.

Taken together, these figures demonstrate three important points. First, leverage meaningfully increases equity returns across all standard summary statistics, not just in best-case outcomes. Second, the uplift ranges from approximately 17% to over 50%, depending on how returns are measured, confirming that capital structure decisions are first-order drivers of realized performance. Third, the declining uplift from average to geometric mean reflects the real costs of leverage—volatility, risk concentration, and downside asymmetry—rather than invalidating its effectiveness as a return-enhancing tool.

6. Interpreting leverage-driven return dispersion

The numerical spread between unlevered and levered outcomes reinforces the idea that equity returns are often shaped more by how an asset is financed than by marginal differences in operating performance. A shift from 15% to over 23% in average returns, or from 9% to 13% at the median, does not require exceptional growth or multiple expansion. It requires stable cash flows, access to reasonably priced debt, and disciplined capital structure management.

This is why leverage is central to private equity, real asset investing, and founder liquidity strategies. Debt converts future cash flows and unrealized value into immediate capital, while simultaneously magnifying the sensitivity of equity to enterprise value changes. When asset returns exceed borrowing costs, the equity holder captures that spread repeatedly—through lower initial equity investment, faster cash recovery, and debt amortization.

At the same time, the divergence between arithmetic and geometric outcomes serves as a constraint. Leverage raises expected returns but also increases outcome dispersion. Poorly timed leverage, cyclical cash flows, or refinancing shocks can reverse the return advantage. As a result, leverage functions as a conditional liquidity and return mechanism—powerful when cash flows are durable, dangerous when they are not.

7. Synthesis: debt as liquidity, not merely leverage

Across individual balance sheets, acquisition structures, and portfolio outcomes, the data converge on a single conclusion: debt acts as a liquidity provider that reshapes equity outcomes. It allows asset holders to access value without liquidation, enables investors to purchase cash-flowing assets with limited upfront equity, and materially increases equity IRRs across average, median, and compounded measures.

The empirical evidence shows that leverage-driven uplift of 4 to 8 percentage points in equity IRR is not exceptional—it is systematic. This explains why sophisticated investors treat debt not as a residual financing choice, but as a strategic instrument for timing, taxation, and return optimization.

Sources & References

DC Fiscal Policy institute. (2024). How Wealthy Households Use a “Buy, Borrow, Die” Strategy to Avoid Taxes on Their Growing Fortunes. https://www.dcfpi.org/all/how-wealthy-households-use-a-buy-borrow-die-strategy-to-avoid-taxes-on-their-growing-fortunes/ 

FMH. (2022). How has leverage changed IRR? https://www.financialmodellinghandbook.org/how-has-leverage-changed-irr/ 

McKinsey. (2015). A better way to understand internal rate of return. https://www.mckinsey.com/~/media/McKinsey/Business%20Functions/Strategy%20and%20Corporate%20Finance/Our%20Insights/A%20better%20way%20to%20understand%20internal%20rate%20of%20return/A%20better%20way%20to%20understand%20internal%20rate%20of%20return.pdf 

Yale Budget Lab. (2025). “Buy-Borrow-Die": Options for Reforming the Tax Treatment of Borrowing Against Appreciated Assets. https://budgetlab.yale.edu/research/buy-borrow-die-options-reforming-tax-treatment-borrowing-against-appreciated-assets 

Yale School of Management. (2022). On the Nature of Modeling and Valuation in a Search Fund Acquisition. https://som.yale.edu/sites/default/files/2025-04/On%20the%20Nature%20of%20Modeling%20and%20Valuation%20in%20a%20Search%20Fund%20Acquisition%20%28Jan%2025%202023%29.pdf