Investment Banking · Topic lesson

LBO Basics

How a leveraged buyout is funded and how it makes money: sources and uses, what lenders allow, MOIC and IRR, the paper LBO and the debt schedule.

5 chapters About 58 minutes0 of 5 complete

Start chapter 1

In a leveraged buyout a private equity firm, the sponsor, buys a company using a large amount of borrowed money, repays that debt from the company's own cash flow over a few years, and then sells. Bankers finance these deals and advise on them, so LBO questions come up in almost every investment banking interview.

Funding. Lenders provide debt sized off EBITDA; the sponsor's equity fills the rest of the price and fees.
The hold. The company's free cash flow pays interest and repays debt, year after year.
The exit. The business is sold, the remaining debt is repaid, and the sponsor keeps the rest. MOIC and IRR measure how well that went.

The rule that solves every question

Debt is sized off cash flow, not price, so equity is the plug. Returns come from three places: EBITDA growth, the change in multiple, and debt paid down. Leverage magnifies them; it does not create them.

How a buyout works

From funding the deal to measuring the return. Each step points to the chapters that practice it.

1
Fund the deal
Uses = price + fees; debt in turns of EBITDA; equity is the plug.
Chapter 1
2
Check what lenders allow
Leverage, interest coverage and loan-to-value set the debt.
Chapter 2
3
Run the cash
Free cash flow pays interest and repays debt; the sweep decides how fast.
Chapter 4 Chapter 5
4
Sell and repay
Exit enterprise value less the debt left is the sponsor's equity.
Chapter 3 Chapter 4
5
Measure the return
MOIC, IRR, and how much came from growth, multiple and paydown.
Chapter 3

Chapters

Sources and uses

10 min

Every buyout starts with a table that must balance: what the money is for, and where it comes from.

Build total uses from the purchase price, debt refinanced and fees
Size the new debt and find the equity check as the plug
Work back from the equity check to the leverage
Explain why a higher price lands almost entirely on the sponsor

Credit statistics: what lenders will allow

11 min

Leverage, interest coverage and loan-to-value: the ratios that decide how much debt a buyout can carry.

Calculate senior and total leverage
Calculate interest coverage, before and after capex
Calculate loan-to-value and the equity cushion
Work out the most debt a coverage floor allows

LBO returns: MOIC, IRR and the three drivers

12 min

Where the sponsor's return comes from: EBITDA growth, the exit multiple and paying down debt.

Calculate entry equity, exit equity, MOIC and IRR
Split the equity gain into growth, multiple change and debt paydown
Work out the exit multiple needed for a target MOIC
Explain what leverage does, and does not do, to returns

The paper LBO

14 min

The whole buyout on a notepad: entry, five years of cash repaying debt, exit, MOIC and IRR.

Build a year of free cash flow: EBITDA less interest, tax and capex
Carry the debt paydown through five years
Calculate exit equity, MOIC and IRR, and check them with the rules of thumb
Work out the highest entry multiple that still meets a target return

The debt schedule and the cash sweep

11 min

Interest, scheduled repayments and the sweep: the order cash is used, and why paydown speeds up.

Calculate interest across a term loan and notes
Run the cash waterfall: interest, mandatory amortization, excess cash, sweep
Work back from the loan repaid to the cash the business generated
Explain why paydown accelerates, and why the notes are not swept