LBO Model Interview Questions: What to Expect (18:48)

In this tutorial, you’ll learn about the most common LBO modeling-related questions and some tricks and rules of thumb you can use to approximate the IRR and solve for assumptions like the purchase price and EBITDA growth in leveraged buyouts.

Will you get LBO-related questions in interviews?

Yes, possibly, but full case studies are unlikely unless you’re interviewing for PE roles or more advanced IB roles.

Interviewers now ask trickier questions about the fundamentals, they ask progressions of questions on the same topic or scenario, and they’re more likely to give you *simple* cases and numerical tests rather than complex ones.

A typical progression for LBO models might be as follows:

Question #1: LBO Model Walkthrough

“In a leveraged buyout, a PE firm acquires a company using a combination of Debt and Equity, operates it for several years, and then sells it; the math works because leverage amplifies returns; the PE firm earns a higher return if the deal does well because it uses less of its own money upfront.”

In Step 1, you make assumptions for the Purchase Price, Debt and Equity, Interest Rate on Debt, and Revenue Growth and Margins.

In Step 2, you create a Sources & Uses schedule to calculate the Investor Equity paid by the PE firm.

In Step 3, you adjust the Balance Sheet for the effects of the deal, such as the new Debt, Equity, and Goodwill.

In Step 4, you project the company’s statements, or at least its cash flow, and determine how much Debt it repays each year.

Finally, in Step 5, you make assumptions about the exit, usually using an EBITDA multiple, and calculate the MoM multiple and IRR.

Question #2: Ideal LBO Candidates

Price is the most important factor because almost any deal can work at the right price – but if the price is too high, the chances of failure increase substantially.

Beyond that, stable and predictable cash flows are important, there shouldn’t be a huge need for ongoing CapEx or other big investments, and there should be a realistic path to exit, with returns driven by EBITDA growth and Debt paydown instead of multiple expansion.

Question #3: Approximating IRR

“A PE firm acquires a $100 million EBITDA company for a 10x multiple using 60% Debt.

The company’s EBITDA grows to $150 million by Year 5, but the exit multiple drops to 9x. The company repays $250 million of Debt and generates no extra Cash. What’s the IRR?”

Initial Investor Equity = $100 million * 10 * 40% = $400 million

Exit Enterprise Value = $150 million * 9 = $1,350 million

Debt Remaining Upon Exit = $600 million – $250 million = $350 million

Exit Equity Proceeds = $1,350 million – $350 million = $1 billion

IRR: 2.5x multiple over 5 years; 2x = 15% and 3x = 25%, so it’s ~20%.

Question #4: Back-Solving for Assumptions

“You buy a $100 EBITDA business for a 10x multiple, and you believe that you can sell it again in 5 years for 10x EBITDA.

You use 5x Debt / EBITDA to fund the deal, and the company repays 50% of that Debt over 5 years, generating no extra Cash. How much EBITDA growth do you need to realize a 20% IRR?”

Initial Investor Equity = $100 * 10 * 50% = $500

20% IRR Over 5 Years = ~2.5x multiple (2x = ~15% and 3x = ~25%)

Exit Equity Proceeds = $500 * 2.5 = $1,250

Remaining Debt = $250, so Exit Enterprise Value = $1,500

Required EBITDA = $150, since $1,500 / 10 = $150

Question #5: Approximating IRR in an IPO Exit

“A PE firm acquires a $200 EBITDA company for an 8x multiple using 50% Debt.

The company’s EBITDA increases to $240 in 3 years, and it repays ALL the Debt. The PE firm takes it public and sells off its stake evenly over 3 years at a 10x multiple. What’s the IRR?”

Initial Investor Equity = $200 * 8 * 50% = $800

Exit Enterprise Value = Exit Equity Proceeds = $240 * 10 = $2,400

“Average Year” to Exit = 1/3 * 3 + 1/3 * 4 + 1/3 * 5 = 4 years

IRR: 3x over 3 years = ~45%, and 3x over 5 years = ~25%

Approximate IRR: ~35% (This one’s a bit off – see Excel.)

About Brian DeChesare

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.