Walk Me Through a Paper LBO
A paper LBO = compute a buyout's return by hand. Buy a company with mostly debt, grow EBITDA and pay down debt over ~5 years, sell at an exit multiple, then compare your exit equity to your entry equity. MOIC = exit equity / entry equity; back into IRR from that.
Definition
A paper LBO is a mental/pen-and-paper exercise where you calculate the returns (IRR and MOIC) of a leveraged buyout without a model, testing whether you understand LBO mechanics cold. The headline structure: (1) determine entry price and the debt/equity funding split, (2) project EBITDA growth and free cash flow used to pay down debt, (3) compute exit enterprise value using an exit multiple, (4) subtract remaining net debt to get exit equity, and (5) compare exit equity to entry equity to derive MOIC and IRR.
Formula
MOIC = Exit Equity Value ÷ Entry Equity Value IRR ≈ (MOIC)^(1/years) - 1 Exit Equity = (Exit EBITDA × Exit Multiple) - Remaining Net Debt
Entry Equity Value
Purchase enterprise value minus the debt used to fund the deal (the sponsor's check)
Exit EBITDA
Entry EBITDA grown over the hold period (revenue growth × margin, or assumed EBITDA CAGR)
Exit Multiple
EV/EBITDA at sale — usually assumed equal to or below the entry multiple to be conservative
Remaining Net Debt
Entry debt minus cumulative free cash flow used to pay it down over the hold
MOIC
Multiple of invested capital — exit equity divided by entry equity
Step 1 — Entry: Price and Funding
Start with entry EBITDA and the entry EV/EBITDA multiple to get the purchase enterprise value. Then split the funding: typically the deal is financed with ~50-60% debt and the rest equity. Entry equity (the sponsor's investment) = purchase EV - debt raised. Example: $100M EBITDA × 10x = $1,000M EV; fund with $600M debt and $400M equity. Keep the capital structure simple — interviewers usually give you a clean leverage ratio.
Step 2 — Project EBITDA and Free Cash Flow
Grow EBITDA over the hold (usually 5 years) using a given revenue growth rate and margin, or a stated EBITDA growth rate. Then estimate annual free cash flow available to pay down debt: EBITDA - interest - taxes - CapEx - change in working capital. In a paper LBO you simplify aggressively: often interviewers let you approximate cumulative FCF or even ignore working capital. The cumulative FCF over the hold is swept to pay down debt (a cash flow sweep), reducing net debt at exit.
Step 3 — Exit: Enterprise Value and Equity Value
Compute exit EBITDA (entry EBITDA grown over the hold) and multiply by the exit multiple to get exit enterprise value. Be conservative — assume the exit multiple equals the entry multiple unless told otherwise (multiple expansion is a return driver you should never assume for free). Then subtract remaining net debt (entry debt minus cumulative FCF paydown) to get exit equity value. Exit equity = (Exit EBITDA × Exit Multiple) - Remaining Net Debt.
Step 4 — Returns: MOIC and IRR
MOIC = exit equity ÷ entry equity. Then convert to IRR. Memorize the rule-of-thumb mappings for a 5-year hold: 2.0x MOIC ≈ 15% IRR; 2.5x ≈ 20%; 3.0x ≈ 25%; 4.0x ≈ 32%. For other horizons, IRR = MOIC^(1/years) - 1. PE interviewers want roughly 20%+ IRR / 2.5-3.0x MOIC over 5 years to call a deal attractive. Stating the rule-of-thumb conversions out loud signals you've done real LBO work. You can also flag the three return drivers: EBITDA growth, debt paydown, and multiple expansion.
Worked Example — With Real Numbers
Entry: $100M EBITDA, 10x multiple → $1,000M EV. Fund with $600M debt (60%) and $400M equity. Assume EBITDA grows 8%/year for 5 years → $100M × 1.08^5 ≈ $147M exit EBITDA. Assume cumulative free cash flow over 5 years pays down $250M of debt → remaining net debt = $600M - $250M = $350M. Exit at the same 10x → exit EV = $147M × 10 = $1,470M. Exit equity = $1,470M - $350M = $1,120M. MOIC = $1,120M ÷ $400M = 2.8x. Over 5 years, 2.8x ≈ a ~23% IRR (between the 2.5x→20% and 3.0x→25% benchmarks). Attractive deal, driven by EBITDA growth plus debt paydown with no assumed multiple expansion.
Key Takeaways
Five steps: entry price & funding → grow EBITDA & generate FCF → exit EV → subtract net debt → MOIC/IRR
Entry equity = purchase EV minus debt; exit equity = exit EV minus remaining net debt
MOIC = exit equity / entry equity; memorize 5-yr IRR rules (2x≈15%, 2.5x≈20%, 3x≈25%)
Assume the exit multiple equals the entry multiple unless told otherwise — never gift yourself expansion
The three return drivers are EBITDA growth, debt paydown, and multiple expansion — name them
Common Mistakes in Interviews
Forgetting to subtract remaining net debt at exit (returning EV, not equity, to the sponsor)
Assuming multiple expansion for free — always hold the exit multiple flat unless told otherwise
Not using free cash flow to pay down debt, which understates exit equity and returns
Mixing up MOIC and IRR or not knowing the rule-of-thumb IRR conversions for a 5-year hold
Over-complicating the cash flow build — paper LBOs reward fast, clean approximations
How Interviewers Test This
Talk while you compute — state each number out loud (EV, debt, equity, exit EBITDA, exit equity) so the interviewer follows your logic even if your arithmetic slips. Memorize the IRR-from-MOIC table cold for a 5-year hold; it lets you give the final answer instantly without a calculator. Round aggressively and keep moving — speed and structure matter more than the second decimal.
Related Concepts
Directly referenced in this topic
Leveraged Buyout (LBO)
A Leveraged Buyout (LBO) is the acquisition of a company using a significant amo...
Cash Flow Sweep
A cash flow sweep (or cash sweep) is a debt provision requiring a company to use...
EV/EBITDA Multiple
EV/EBITDA is a valuation multiple that compares a company's [enterprise value](h...
Capital Structure
Capital structure refers to the specific mix of debt and equity a company uses t...
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