Technical / Deal Mechanics
Walk Me Through an LBO: The Paper LBO Guide
How to answer "Walk me through an LBO" and solve a Paper LBO in an interview. The 3-step framework for calculating IRR in your head.
"The secret to making money in a leveraged buyout is the same as making money in real estate: other people's money." — Carl Icahn
Core Mechanics
An LBO mirrors buying rental property with a massive mortgage. Minimal equity down, tenant rent services the debt, sell the asset for profit.
- Buy: Acquire a company with minimal Equity and maximum Debt.
- Operate: Use cash flow to pay down debt over 3-5 years.
- Sell: Exit the investment. Lower debt balance means higher Equity value.
Value Creation Levers
Every LBO return derives from three sources:
Paper LBO Framework
Step 1: Entry Equity
Step 2: Exit Equity
IRR Lookup Table
Memorize this.
Worked Example
Prompt: Buy a company for $100M at 5x EBITDA. 60% Debt, 40% Equity. 10% interest rate. EBITDA flat at $20M with 100% FCF conversion. Exit after 5 years at same multiple. Calculate IRR.
Step 1: Entry Equity
- Purchase Price: $100M
- Debt: $60M (60%)
- Entry Equity: $40M
Step 2: Exit Equity
- Annual FCF: $20M EBITDA − $6M Interest = $14M
- Total Cash Generated: $14M × 5 = $70M
- Debt Repaid: $60M (fully paid off)
- Excess Cash: $70M − $60M = $10M
- Exit EV: $100M (5x × $20M EBITDA)
- Exit Equity: $100M + $10M = $110M
Step 3: Returns
Standard Interview Response
"Walk me through an LBO."
"An LBO is an acquisition funded primarily with debt, where the target's cash flows service that debt over a 3-5 year holding period.
Step 1: Make assumptions—Purchase Price, Debt/Equity split, Interest Rate.
Step 2: Build Sources & Uses. Sources: Debt + Equity. Uses: Purchase Price + Fees.
Step 3: Adjust the Balance Sheet for the new capital structure. Add Goodwill if purchase price exceeds book value.
Project financials to calculate Free Cash Flow available for debt repayment.