The Complete LBO Model Guide

An LBO (Leveraged Buyout) is the acquisition of a company using significant debt financing. The PE firm typically contributes 30-40% equity, with the remainder funded through senior and subordinated debt tranches. Returns are generated through three levers: debt paydown, EBITDA growth, and multiple expansion.

The Mental Math: Rule of 72

Before you touch a spreadsheet, learn to estimate returns in your head. The Rule of 72 tells you how many years it takes to double your money: divide 72 by the annual return. A 20% IRR doubles equity in ~3.6 years. A 2.5x MOIC over 5 years implies roughly 20% IRR. This mental shortcut separates analysts who "get it" from those who need a model for everything.

Sources & Uses

The Sources & Uses table is the foundation of every LBO model. Sources include equity from the PE sponsor, senior secured debt (typically 3-5x EBITDA), mezzanine financing, and any rollover equity from management. Uses include the enterprise value, transaction advisory fees (1-2% of EV), and debt financing fees (2-3% of committed debt).

The key constraint: total sources must equal total uses. The equity check — whatever Sources minus Debt equals — determines your initial investment and therefore your return denominator.

Building the Operating Model

• Project the target company's financials over a 5-7 year hold period. Key assumptions include:
• Revenue growth: organic top-line expansion, pricing power, new market entry
• EBITDA margin: operating leverage, cost optimization, synergies from add-ons
• Working capital: days sales outstanding, inventory turns, payable stretching
• CapEx: maintenance vs. growth capital expenditure split

Free Cash Flow (FCF) is what matters for debt paydown: EBITDA minus cash taxes, minus changes in net working capital, minus CapEx. Every dollar of FCF that goes to debt paydown is a dollar that accrues to equity value at exit.

Debt Schedule Mechanics

• Model each tranche separately. A typical mid-market LBO capital structure might include:
• Term Loan A: SOFR + 250-350bps, 5-7 year maturity, 5-10% annual amortization
• Term Loan B: SOFR + 350-500bps, 7 year maturity, 1% annual amortization
• Subordinated Notes: 8-12% fixed, PIK toggle option, bullet maturity

Track mandatory amortization, optional prepayments (cash sweep), interest expense per tranche, and covenant compliance. The leverage ratio (Debt / EBITDA) and interest coverage ratio (EBITDA / Interest) are your covenant guardrails.

Cash Flow Sweeps

A cash flow sweep is the mechanism that directs excess FCF toward mandatory debt repayment. In a 100% sweep, all levered free cash flow after mandatory amortization goes to prepaying the senior term loan. Some structures step down: 75% sweep if leverage is below 4.0x, 50% below 3.0x, and 0% below 2.0x.

Returns Analysis

• Calculate sponsor returns at exit:
• IRR (Internal Rate of Return): The discount rate that makes NPV of all cash flows zero. Typical PE targets: 20-25% gross, 15-18% net
• MOIC (Multiple on Invested Capital): Exit equity value / initial equity check. Target: 2.0-3.0x over 4-6 years
• Cash-on-Cash: Annual distributions / equity invested. Relevant for dividend recaps

The Three Return Levers

Decompose your returns to understand where value comes from: 1. Deleveraging: Debt paydown using FCF. The "free lunch" of LBO returns — you're using the company's cash flow to reduce debt, which accrues entirely to equity 2. EBITDA Growth: Revenue growth and margin expansion. This is operational alpha 3. Multiple Expansion: Exiting at a higher EV/EBITDA multiple than entry. Increasingly unreliable in the current rate environment

Interview Angle

In a PE Superday, you'll be asked to walk through a paper LBO. Structure your answer: "Given a $500M acquisition at 8x EBITDA, with 50% leverage and 5% revenue growth, I'd expect roughly a 2.5x MOIC over 5 years, implying a ~20% IRR. The key drivers would be 1.5 turns of deleveraging and organic EBITDA growth from 62.5M to approximately 80M at exit."

Practice This Concept

Try the Project Skyfall challenge to build an LBO model for a SaaS acquisition with real operational complexity and mistake cascades.