LBO basics
How leverage manufactures a return.
- Sponsor equity is the residual after debt capacity is used.
- Returns come from debt paydown, EBITDA growth and multiple change.
- MOIC of 2.0x over five years is roughly a 15% IRR.
Sources and uses
Uses: purchase equity, refinance existing debt, pay fees. Sources: new debt, sponsor equity, rolled management equity.
The sponsor equity check is the plug — whatever debt will not cover.
The three return drivers
Debt paydown: cash flow retires debt, so equity grows even at a flat enterprise value.
EBITDA growth: revenue growth and margin expansion.
Multiple expansion: exiting at a higher multiple than entry. The least reliable, and never the base case.
Paper LBO arithmetic
Entry EV = entry EBITDA × entry multiple. Equity = EV − debt. Project EBITDA and debt paydown to the exit year.
Exit equity = exit EBITDA × exit multiple − remaining debt. MOIC = exit equity ÷ entry equity, and IRR follows from MOIC and the holding period.
Apply the lesson to explain how leverage manufactures a return. Start with the answer, show the bridge, and sanity-check the direction before stopping.
- 1Lead with the definition or conclusion for lbo basics.
- 2Show the mechanics in a fixed sequence and state every assumption.
- 3Finish with the practical implication, risk, or reason the result matters.
Entry EBITDA $100M at 8.0x with 5.0x of debt. What is sponsor equity?
Which return driver is considered the lowest quality to underwrite?
- Sponsor equity is the residual after debt capacity is used.
- Returns come from debt paydown, EBITDA growth and multiple change.
- MOIC of 2.0x over five years is roughly a 15% IRR.