Complete Guide
LBO Modeling
Master leveraged buyout modeling from the ground up. Learn the mechanics, build models from scratch, and nail the paper LBO in PE interviews.
What Is a Leveraged Buyout?
A leveraged buyout (LBO) is when a private equity firm acquires a company using a significant amount of borrowed money (debt) to fund the purchase. The target company's assets and cash flows are used as collateral and to repay the debt.
The "leverage" amplifies returns: if the company performs well, equity investors earn outsized returns because they only put up a fraction of the purchase price. But leverage also amplifies risk, if things go wrong, equity can be wiped out.
Typical Structure
60-70% debt, 30-40% equity contribution from the PE fund
Target Returns
20%+ IRR and 2-3x+ MOIC over 5-7 year hold period
Exit Strategy
Sale to strategic buyer, another PE firm, or IPO
Value Creation
EBITDA growth, multiple expansion, debt paydown
Building an LBO Model: 4 Key Steps
Transaction Assumptions
Entry multiple, purchase price, debt/equity split, financing fees
- Entry EV/EBITDA multiple
- Sources and uses of funds
- Debt structure (senior, sub, mezz)
- Transaction and financing fees
Operating Model
Project revenue, EBITDA, and cash flows over the hold period
- Revenue growth assumptions
- Margin expansion/contraction
- Working capital changes
- Capital expenditures
Debt Schedule
Model interest expense and debt paydown over time
- Mandatory amortization
- Cash flow sweeps
- Interest rate assumptions
- Debt paydown waterfall
Returns Analysis
Calculate exit value, equity proceeds, IRR, and MOIC
- Exit multiple assumption
- Exit enterprise value
- Equity value at exit
- IRR and MOIC calculation
The Paper LBO Framework
In PE interviews, you'll need to solve an LBO in 10-15 minutes with just pen and paper. These rules let you calculate IRR without Excel.
Rule of 72
If equity doubles, IRR ≈ 72 ÷ years
Rule of 114
If equity triples, IRR ≈ 114 ÷ years
Rule of 144
If equity quadruples, IRR ≈ 144 ÷ years
Paper LBO Example
Given: Buy company at 8x EBITDA, $100M EBITDA
Structure: 60% debt ($480M), 40% equity ($320M)
Assumptions: EBITDA grows to $130M, exit at 8x, pay down $150M debt
Exit EV: $130M × 8 = $1,040M
Remaining Debt: $480M - $150M = $330M
Exit Equity: $1,040M - $330M = $710M
MOIC: $710M ÷ $320M = 2.2x
IRR: ~17% (using Rule of 72: 2.2x in 5 years)
LBO Value Creation Levers
Understanding how PE firms create value is essential for interviews.
| Lever | Description | Impact |
|---|---|---|
| EBITDA Growth | Grow earnings through revenue or margin improvement | High |
| Multiple Expansion | Exit at a higher multiple than entry | Medium |
| Debt Paydown | Use cash flow to reduce debt, increasing equity value | High |
| Dividends/Recaps | Extract value during the hold period | Medium |
Common LBO Interview Questions
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