The LBO model, in 5 minutes

If you can explain the LBO model in 5 minutes, you can probably get through most of an interview. Most candidates can't, not because it's hard, but because nobody tells them which parts are the actual mechanics and which parts are decoration.

An LBO is one company buying another using a small amount of equity and a lot of borrowed money. The borrowed money sits on the target's balance sheet after the deal. You hold the company, use its cash to pay down debt, then sell it. The math is built from four pieces.

1. Entry: what you're paying

Start with the entry enterprise value: EBITDA × entry multiple. Subtract net debt and you get the equity check. That equity check splits into sponsor equity (the PE firm's money) and new debt (what the lenders put in).

2. The debt schedule

This is the heart of the model. Each year:

• Company generates EBITDA.
• Subtract interest, taxes, capex, working capital. Whatever's left is free cash flow.
• That FCF gets swept against the debt — paying it down.
• Next year's interest is lower because the debt balance is lower.

This is the part interviewers love. They want to see you carry numbers down a column without losing track of what's beginning balance vs ending balance.

3. The exit

Five years later, you sell. Exit EV = exit EBITDA × exit multiple. Subtract remaining debt to get exit equity. That equity belongs to the sponsor.

4. Returns

3.0× MOIC over 5 years is about a 25% IRR. 2.5× over 5 is about 20%. Memorize a few of these and you can sanity-check your model in your head.

Where the value comes from

People love to draw the value creation bridge. There are three sources:

1. EBITDA growth — the company is bigger when you sell.
2. Multiple expansion — the market values the company higher (sometimes). Don't underwrite to this. Interviewers will roll their eyes.
3. Debt paydown — the company has less debt at exit, so more of the EV becomes equity.

Try it

FundSim's LBO tab gives you all of this on one screen. You set EBITDA, entry multiple, debt %, growth rate, exit multiple, and hold period. The model builds the debt schedule, computes exit equity, and shows the value creation bridge. There's also a sensitivity grid showing IRR across entry multiple × exit multiple — the chart every MD asks you to walk through.

Open the LBO simulator ›

Common interview gotchas

• "Walk me through a paper LBO." Start at entry equity. Compound EBITDA. Apply exit multiple. Add back debt paydown. State the IRR. Don't draw a schedule unless they hand you paper.
• "What's a good leverage ratio?" Historically 5–7× EBITDA for sponsor deals. 6× is the safe verbal answer.
• "What's a cash sweep?" Mandatory prepayment of debt from excess cash. Speeds up the IRR.
• "Why is debt paydown an IRR driver?" Because every dollar of debt repaid becomes a dollar of sponsor equity at exit.

Related

PE waterfall explained · J-curve · Cap table dilution