LBO Model Guide: How to Build One From Scratch
10 min read
What an LBO Model Does
An LBO (Leveraged Buyout) model calculates the returns a PE firm can generate from acquiring a company using a combination of debt and equity. The model projects cash flows over a 3-7 year hold period, tracks debt paydown, and calculates sponsor returns (IRR and MOIC) at exit.
The Four Tabs
1. Sources and Uses (Transaction Summary)
Uses: What you are paying for — Enterprise Value (EBITDA × entry multiple) + transaction fees + debt financing fees.
Sources: Where the money comes from — senior debt (TLA, TLB), subordinated debt, mezzanine, and sponsor equity. Sources must equal uses.
2. Operating Model
Project the company's revenue, EBITDA, and free cash flow over the hold period. Key assumptions: revenue growth, margin expansion, capex, working capital changes. Keep it simple for interview models — 5-7 line items.
3. Debt Schedule
Track each debt tranche separately: opening balance, mandatory amortisation, optional prepayment (cash sweep), interest expense, closing balance. Calculate total interest expense and total debt outstanding each year.
Key concept: Free cash flow after debt service goes to pay down debt, which increases equity value at exit without the sponsor investing more money.
4. Returns Analysis
At exit: Exit EV = Exit EBITDA × Exit Multiple. Subtract remaining debt. The difference is exit equity.
MOIC = Exit Equity / Entry Equity
IRR ≈ MOIC^(1/years) - 1
The Three Return Drivers
PE returns come from three sources, and a good candidate can attribute returns across all three:
- EBITDA growth: Revenue growth or margin improvement increases exit EBITDA
- Multiple expansion: Exiting at a higher multiple than entry (not always assumed in base case)
- Debt paydown: Reducing net debt increases equity value without additional investment
Common Mistakes
Assuming multiple expansion in base case: Most PE firms model flat multiples (exit = entry). Expansion is upside, not base case.
Ignoring interest expense: High leverage means significant interest payments that reduce cash available for debt paydown.
Not stress-testing: What happens if EBITDA is flat? If the exit multiple compresses by 1x? If the hold period extends to 7 years?
Take Your Preparation Further
Download our LBO Model Template with a full debt schedule, returns analysis, and value creation bridge. For all four model templates (DCF, LBO, 3-statement, merger), get the Complete Modelling Toolkit.
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