LBO – Returns Attribution Analysis (18:42)

In this tutorial, you’ll learn about what drives the IRR or money-on-money multiple in a leveraged buyout.

You’ll also see how EBITDA growth, multiple expansion, and debt pay-down and cash generation all play a role – and what drivers make a deal look favorable or less favorable.

How Do PE Firms Make Money?

To make money in a leveraged buyout, one or more of the following must happen:

  1. The company’s EBITDA must grow.
  2. There must be multiple expansion (exit EBITDA multiple is higher than the purchase EBITDA multiple).
  3. A significant amount of debt must be used and repaid and/or a significant amount of cash must be generated in the same period.

So yes, you CAN buy a company at one multiple and sell it at the same multiple and still earn a 20% IRR… if you have enough of the two other factors.

Returns Attribution Analysis Formulas

EBITDA Growth:

(Final Year EBITDA – Initial EBITDA) * EBITDA Purchase Multiple

Intuition: How much more do you get for your money?

Multiple Expansion:

(Exit Multiple – Purchase Multiple) * Final Year EBITDA

Intuition: How much more value does the final EBITDA contribute?

Debt Paydown and Cash Generation:

Back into this by subtracting the other two above from the total returns to equity investors in the LBO.

Intuition: “Everything else!”

Setting Up a Simple LBO Model

To test this yourself, look at the template above and fill out the assumptions for revenue, EBITDA, Pre-Tax Income, and Net Income, and then the Cash Flow Statement line items.

Debt repaid each year is equal to MIN(Free Cash Flow, Previous Year’s Ending Balance).

Then, debt decreases by the amount that’s repaid; cash increases by any FCF that’s left over and was NOT used for debt repayment.

IRR and MoM Multiples

Calculate the Exit Enterprise Value with Final Year EBITDA * Assumed EBITDA Exit Multiple, and subtract debt and add cash to get the Proceeds to Equity Investors.

IRR = (Exit Proceeds to Equity Investors / Initial Equity Contribution) ^ (1 / # Years in Model) – 1

MoM Multiple = (Exit Proceeds to Equity Investors / Initial Equity Contribution)

Returns Attribution

Calculate this using the formulas above.


Ideally, we would prefer nothing from multiple expansion as it’s unreliable and hard to predict or take advantage of.

We would also like to see more from debt paydown, because the company could afford to take on more debt in the model.

If the company’s growth rate were slower or its margins were lower, we might *have* to use additional debt to make the model work.

So back to that question in the beginning: yes, a dividend recap is one way to make a deal work if there’s no multiple expansion… but it’s not the only way.

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.