15 LBO interview questions, with exact answers

Question 1

Walk me through an LBO.

A private equity firm acquires a company using a small equity check and a large amount of debt, which sits on the target's balance sheet post-close. Over the hold period — typically 4–7 years — the company's free cash flow pays down that debt. At exit, the sponsor sells the company; because debt is lower, more of the enterprise value flows to equity. Returns are measured as IRR and MOIC on the equity check.

Question 2

What drives returns in an LBO?

Three things: EBITDA growth (the company is worth more at exit), multiple expansion (the market re-rates the business higher, though sponsors shouldn't underwrite to this), and debt paydown (lower debt at exit means more equity value). Of the three, EBITDA growth and leverage are the most reliable — multiple expansion is a bonus, not a plan.

Question 3

What happens to IRR if you pay down debt faster?

IRR increases. Faster debt paydown means more of the enterprise value at exit is equity rather than debt repayment — the equity proceeds are larger relative to the original equity check. It also reduces interest expense, which increases free cash flow and creates a compounding effect through the hold period.

Question 4

Why does leverage increase returns?

Leverage amplifies equity returns because you're buying a fixed-value asset with a smaller equity base. If the company's value grows from $500M to $700M and you put in $150M of equity, your gain on equity is proportionally larger than if you'd funded the whole $500M in equity. The same percentage gain in enterprise value translates into a much larger percentage gain in equity — as long as the company can service the debt.

Question 5

How does EBITDA growth affect the exit?

Exit EV = exit EBITDA × exit multiple. So EBITDA growth directly increases exit EV. If EBITDA grows from $50M to $70M and the exit multiple is 10x, that's $200M more enterprise value at exit, all else equal. After paying off remaining debt, that uplift flows directly to equity — which is why operational improvement is the most durable LBO return driver.

Question 6

What is a debt sweep?

A cash sweep — or mandatory prepayment — is a provision requiring the borrower to apply a portion of excess free cash flow to paying down debt principal ahead of schedule. Most LBO credit agreements include a cash sweep, often 50–75% of excess cash flow above a minimum threshold. It speeds up deleveraging, reduces interest expense over time, and improves the equity return.

Question 7

What's the difference between entry and exit multiple?

Entry multiple is the EV/EBITDA multiple paid at acquisition. Exit multiple is the EV/EBITDA multiple at which the sponsor sells. If the exit multiple is higher than entry, the sponsor captures multiple expansion on top of EBITDA growth and debt paydown. If exit is lower — multiple compression — the sponsor needs stronger EBITDA growth and deleveraging to hit return targets. Most conservative models assume entry multiple equals exit multiple.

Question 8

Why would a sponsor underwrite to a lower exit multiple than entry?

To be conservative. Multiples compress during market downturns, sector re-ratings, or when a company's growth slows. A sponsor who underwrites exit at entry multiple is betting on market stability. One who underwrites to a lower multiple is stress-testing whether the deal still works if sentiment turns. For most credit committee presentations, the base case assumes some multiple compression, with upside if multiples hold.

Question 9

What is PIK interest and why do lenders accept it?

PIK stands for Payment-in-Kind. Instead of paying cash interest, the borrower adds the interest to the principal balance — the debt grows rather than being serviced. Lenders accept PIK in situations where the borrower's cash flow is tight and a cash interest burden would be unsustainable, or when the deal economics require maximizing equity upside. The lender is compensated through a higher interest rate and the expectation of a larger principal repayment at exit.

Question 10

How does a revolver work in an LBO?

A revolver is a revolving credit facility — essentially a line of credit the company can draw on and repay repeatedly. In an LBO capital structure, the revolver sits at the top of the debt stack and is drawn for working capital needs (e.g., seasonal inventory builds) and repaid when cash comes in. It's typically undrawn at close and doesn't show up in base-case return calculations, but it provides liquidity cushion. Lenders price revolvers with a commitment fee on the undrawn portion.

Question 11

What is the difference between IRR and cash-on-cash?

Cash-on-cash (same as MOIC) is the total multiple of money returned — exit equity divided by entry equity, with no adjustment for time. IRR is the annualized return, which accounts for how long the money was invested. A 3x MOIC over 3 years is a ~44% IRR; the same 3x over 7 years is a ~17% IRR. MOIC is simpler to communicate; IRR is more useful for comparing deals with different hold periods or interim cash flows.

Question 12

Why does a longer hold period compress IRR (even if MOIC is higher)?

Because IRR is annualized. The same dollar of gain spread over more years produces a lower annual rate. A 4x MOIC over 10 years is ~15% IRR; a 3x over 4 years is ~32% IRR. Beyond a certain hold period, the compounding math works against you — you need exponentially larger MOIC to maintain the same IRR. This is why PE funds have finite fund lives and pressure to exit within 5–7 years.

Question 13

What is a covenant and what happens when one breaks?

A covenant is a contractual restriction or requirement in a debt agreement — either a maintenance covenant (the company must maintain a minimum EBITDA/interest coverage ratio each quarter) or an incurrence covenant (triggered only when the company takes a specific action, like issuing more debt). When a maintenance covenant is breached, it's an event of default: lenders can accelerate repayment, block distributions, or force a restructuring. Lenders often grant waivers in exchange for fees or tighter terms rather than immediately accelerating.

Question 14

How do management rollovers work?

In a management rollover, the target company's executives reinvest a portion of their existing equity into the new deal structure alongside the sponsor. Instead of cashing out fully at close, they exchange their old shares for equity in the new leveraged entity. This aligns management incentives — they're sharing the risk and upside — and signals to the sponsor that management believes in the business. Rollovers are typically 3–10% of equity and are structured to incentivize performance through vesting and ratchets.

Question 15

What is a secondary buyout?

A secondary buyout (SBO) is when a PE firm sells a portfolio company to another PE firm, rather than through an IPO or strategic sale. The selling sponsor has typically held the company for 4–7 years and is exiting to return capital to its LPs. The buying sponsor believes there's more value to unlock — additional operational improvement, add-on acquisitions, or multiple expansion — in the next holding period. SBOs are common when a company is too large or complex for a strategic acquirer but not ready for the public markets.