LBO Returns
How a sponsor measures, explains and improves a buyout return: IRR and MOIC, the value bridge, the entry price, bolt-ons, dividend recaps and management's share.
A private equity fund lives or dies by its returns, and a private equity interview tests whether you can do more than calculate one. You need to say where a return came from, what would change it, and who shares in it. This lesson assumes the buyout mechanics from Investment Banking · LBO Basics: entry and exit equity, MOIC, IRR and the paper LBO.
- Measure it. MOIC counts the dollars; IRR is how fast they came. The hold period links the two.
- Explain it. Every equity gain splits into EBITDA growth, multiple change and debt paydown.
- Improve it. Pay less, buy smaller companies cheaply and re-rate them, or get money back sooner.
- Share it. Management rolls equity and earns an incentive pool, at a cost to the sponsor.
Debt is sized off EBITDA, so price lands on the equity. Exit equity = exit EBITDA × exit multiple − debt left. MOIC = exit equity ÷ equity in, and IRR = MOIC^(1/n) − 1 when there is one check each way.
How a sponsor thinks about a return
From the headline numbers to who takes home what. Each step points to the chapters that practice it.
Chapters
IRR versus MOIC
10 minHow many times the money, and how fast. The hold period ties the two together.
- Turn a multiple of money into an IRR over any hold
- Work out the multiple a hurdle rate needs
- Find the longest hold that still clears a hurdle
- Explain why a fund cares about both numbers
The value creation bridge
12 minSplit the equity gain into EBITDA growth, multiple change and debt paydown, to the dollar.
- Calculate the three pieces of the equity gain
- Check that they add up to exit equity minus entry equity
- Work back from a multiple of money to the exit multiple achieved
- Explain why committees care where the return came from
The entry price
11 minWhy one turn of purchase price moves returns more than almost anything else, and the most you can pay.
- Calculate MOIC and IRR at a given price
- Show what one turn cheaper does to the IRR
- Work out the highest entry multiple for a target IRR
- Back out the price paid from a reported multiple of money
Bolt-ons and multiple arbitrage
12 minBuy smaller companies cheaply, sell them inside a bigger one at the platform's multiple.
- Calculate the value created by re-rating a bolt-on's EBITDA
- Calculate a blended entry multiple
- Calculate the combined MOIC of platform plus bolt-on
- Work out the most you can pay for a bolt-on without lowering the MOIC
The dividend recap
12 minBorrow against a business that has paid down debt, and send the cash to the sponsor early.
- Size a dividend from a recap to a new leverage multiple
- Show why MOIC is unchanged while IRR rises
- Work out the recap leverage that returns the whole equity check
- Explain what a recap costs and who might object
Management rollover and the incentive pool
12 minManagers reinvest part of their proceeds and get a slice of the upside. Who ends up with what.
- Calculate management's proceeds, rollover and ownership of the new equity
- Split exit equity between the incentive pool, the sponsor and management
- Work out the rollover needed for a target stake
- Explain what the incentive pool costs the sponsor