LBO (Leveraged Buyout)
The acquisition of a company financed with a significant proportion of borrowed money (debt), with the target’s own cash flows used to service and repay that debt. The core private equity buyout structure.
Why LBO (Leveraged Buyout) matters in interviews
The LBO is the core mechanic of private equity, and every buyside interview will test whether you understand why leverage creates returns rather than merely that it does. The question behind the question is always: where does the money actually come from?
How it works in practice
A sponsor acquires a company using a mix of equity and a large amount of debt secured against the target's own assets and cash flows. The target then services that debt from its operating cash flow over a three-to-five-year hold, and the sponsor exits by sale or IPO.
Returns come from three sources: EBITDA growth (operational improvement or acquisitions), debt paydown (every pound of debt repaid converts directly into equity value), and multiple expansion (selling at a higher multiple than you paid — the least controllable, and the one interviewers are most sceptical of).
A simple case: buy a business at 10.0x $100m EBITDA for $1.0bn, funded with $400m equity and $600m debt. Over five years EBITDA grows to $140m and $250m of debt is repaid. Exit at the same 10.0x gives enterprise value of $1.4bn, less $350m remaining debt, leaving $1.05bn of equity. That is 2.6x MoIC on $400m, roughly a 21% IRR.
What candidates get wrong
- Saying leverage "creates" value on its own. Leverage amplifies returns on the equity slice in both directions; the value has to come from cash flow.
- Ignoring what makes a good LBO candidate: stable and predictable cash flows, low capital intensity, a defensible market position, and assets that can be pledged as security.
- Assuming multiple expansion in a case study. Interviewers expect you to hold the exit multiple flat, or haircut it, and make the returns work on operations and deleveraging.
LBO (Leveraged Buyout): frequently asked questions
What makes a good LBO candidate?
Predictable, recurring cash flows to service debt; low ongoing capital expenditure requirements; a defensible market position with limited disruption risk; hard assets or contracted revenue that lenders can secure against; and a clear path to exit. Cyclical, capital-hungry or technologically fragile businesses are poor candidates regardless of how cheap they look.
Why does leverage increase returns in an LBO?
Because the sponsor puts in less equity for the same asset, so any increase in enterprise value accrues to a smaller equity base. Debt paydown reinforces this: cash flow used to repay debt transfers value from lenders to equity holders pound for pound. The same mechanism amplifies losses if the business underperforms.
What leverage multiple is typical in an LBO?
It varies with credit conditions and sector, but total debt in the range of 4.0x to 6.0x EBITDA has been a common band for mid-market and large-cap deals, with more available for highly stable businesses and less for cyclical ones. Lenders size it against the target's ability to service interest, not against a fixed rule.
Go deeper
This term comes up constantly in private equity interviews and on the desk.
Private Equity interview prepRelated Private Equity terms
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