How an LBO actually gets financed

The question behind the question

"Walk me through how an LBO gets financed" sounds like a request for the same LBO model everyone practices for private equity interviews. It is not quite that. A leveraged finance interviewer wants the financing side specifically: starting from a purchase price, how do you actually build a sources and uses table, decide how much debt the deal can support, split that debt into tranches, and arrive at a sponsor equity check that makes the whole thing add up. This is the walk that question is actually asking for, using clean, hypothetical numbers throughout.

Step one: establish the purchase price and total uses

Everything starts with what the buyer is paying. Assume a sponsor is acquiring a company with $200 million of EBITDA at a purchase multiple of 10.0 times, for a total enterprise value of $2,000 million. In a clean, cash-free debt-free transaction, the seller delivers the business with no cash and no debt, so the enterprise value is effectively what the buyer has to fund, before fees.

Layer on transaction costs, which are real and always appear in a proper sources and uses table: financing fees paid to the banks arranging the debt (call it $40 million, roughly 2 percent of the debt being raised, for illustration only) and advisory, legal, and other transaction expenses (call it $20 million). Total uses of funds come to $2,060 million. This is the number every source of financing has to add up to, exactly, by construction; a sources and uses table that does not balance is not a rounding issue, it is a sign something in the exercise was set up wrong.

Step two: decide how much total debt the business can support

Before tranching anything, the leveraged finance team has to answer the credit question first: how much total leverage can this business's cash flow support. That judgment comes from the credit analysis covered in full in credit analysis: how leveraged finance bankers read a borrower, weighing EBITDA stability, free cash flow conversion, and the covenant cushion the resulting structure would carry. For this illustration, assume the credit team concludes the business can support total debt of 7.0 times EBITDA, or $1,400 million, split as shown below, with the rest funded by sponsor equity.

The 7.0 times figure is not pulled from thin air in a real deal, and it should not be treated as a fixed rule in an interview either; it reflects a specific judgment about this specific business's cash flow, and a different borrower with more volatile earnings or heavier capex needs would support meaningfully less leverage at the same purchase multiple. What matters for the walk-through is showing you understand that this number is an output of credit analysis, not an input assumed at the start.

Step three: tranche the debt

With total debt sized at $1,400 million, the next job is splitting it across instruments, each priced and structured for a specific buyer. A representative structure:

Notice the revolver is sized into the structure but typically undrawn at closing; it exists as a liquidity backstop for working capital swings, not as a source of permanent acquisition financing, so it usually contributes $0 to the actual sources of funds even though it is part of the overall committed facility. The Term Loan B, sold primarily to CLOs and credit funds, anchors the structure as the largest single tranche, consistent with its role as the workhorse of sponsor-backed financings; the full comparison of loans against the high yield bonds rounding out this structure is in leveraged loans vs. high yield bonds, and the seniority ladder these tranches sit on is covered in the leveraged debt capital structure: seniority and security.

Step four: plug the sponsor's equity check

With total uses at $2,060 million and total debt at $1,400 million, the remainder has to come from sponsor equity: $660 million, or roughly 32 percent of the total capitalization. This is the plug, quite literally the final line that makes sources equal uses, and it is also the single number private equity interviewers care about most, because it defines the sponsor's cost basis and the leverage on which their returns will compound.

A useful sanity check: does the equity percentage look reasonable. An equity check in the roughly 30 to 50 percent range of total capitalization is a normal, if wide, band for a sponsor-backed buyout, and a candidate should be comfortable eyeballing whether a proposed structure falls inside or wildly outside that kind of range, rather than treating every plugged number as automatically correct. A structure that comes out with a 5 percent equity check should trigger a second look at the leverage assumption, not an automatic sign-off.

Where a bridge loan fits if syndication timing does not line up

The walk above assumes the debt is fully placed with permanent investors by the time the deal closes, but real transaction timelines rarely cooperate that neatly. A purchase agreement sets a closing date the deal has to meet, while a full syndication of a Term Loan B and a bond takes weeks of investor marketing to execute properly. When those two timelines conflict, the underwriting banks typically commit to a bridge facility, a short-term, more expensive loan that guarantees the financing will be there on closing day regardless of how the permanent syndication is going, with the explicit intention of replacing it with the permanent structure shown above shortly after close. The bridge is the mechanism that lets the sources and uses table above exist on paper on day one even when the actual institutional buyers have not finished being lined up yet, and it is also where a bank's own underwriting risk is most concentrated, covered in full in underwriting vs. best efforts in leveraged finance.

Where existing debt complicates the picture

The example above deliberately used a clean, cash-free debt-free assumption to keep the walk simple, but interviewers frequently add a wrinkle: what if the target already has debt outstanding. In that case, the uses side needs an additional line for repaying or refinancing that existing debt (unless the acquisition agreement specifically allows it to remain outstanding, which happens but is less common in a full change-of-control buyout), and the target's existing cash typically nets against that repayment. The mechanical adjustment is straightforward once you see it: existing net debt gets added to uses just like a fee line, funded by the same pool of new debt and equity sources, which means a target coming in with meaningful existing leverage effectively increases the total financing need for the same enterprise value, all else equal.

Why the sponsor wants leverage in the first place

It is worth being able to explain, briefly, why the sponsor is pushing for as much debt as the credit will support rather than simply funding more of the deal with equity, because interviewers sometimes ask this as a quick check on whether you understand the point of the exercise. Leverage magnifies equity returns when a deal goes well, because the sponsor is only putting in the equity portion of the purchase price, $660 million in the example above rather than the full $2,060 million, while still capturing the full upside on enterprise value growth and any debt paydown that happens along the way. Debt is also, all else equal, the cheapest form of capital in the structure, since lenders accept a lower return than equity investors in exchange for a senior claim and a fixed, contractual payment. That is exactly why the leveraged finance team's job of maximizing supportable leverage, without pushing the structure into a fragile, over-levered position, is not a side detail of the deal. It is a direct driver of the sponsor's return, which is also why the credit team's discipline in step two matters so much: a sponsor left to size its own leverage without a credit function pushing back would systematically want more debt than the business can safely carry.

Sensitizing the structure

A strong candidate does not stop at building one static sources and uses table; they can talk through how it would change if an assumption moved. If the purchase multiple rose to 11.0 times instead of 10.0 times, enterprise value and total uses rise proportionally, and if the credit team's leverage tolerance stays fixed at 7.0 times EBITDA, the entire incremental purchase price has to be absorbed by a larger sponsor equity check, not by more debt, because the business's cash flow capacity to service debt has not changed. If instead the credit team's own leverage tolerance moved, say down to 6.0 times because of a more cautious downside case, the debt tranches shrink and the equity check grows correspondingly at the same purchase price. Being able to trace an assumption change through to its effect on the equity check, rather than just reciting the base case table, is what separates a candidate who has internalized the mechanics from one who has memorized a single example.

Practice question

Walk me through how you'd finance a $2 billion leveraged buyout of a company with $200 million of EBITDA.

I'd start with total uses: the $2 billion purchase price, plus financing fees and advisory expenses, say another $60 million combined, for total uses of about $2.06 billion. Then I'd ask the credit question before tranching anything: how much total debt can this business's cash flow actually support, based on its leverage and coverage profile and how stable its EBITDA is. If the credit view supports, say, 7.0 times EBITDA, that's $1.4 billion of total debt. I'd split that across tranches based on who buys each piece: an undrawn revolver for liquidity, a Term Loan B as the largest tranche sold mainly to CLOs and credit funds, maybe some secured notes, and a piece of senior unsecured high yield debt rounding it out. Whatever's left after subtracting that $1.4 billion of debt from the $2.06 billion of total uses, roughly $660 million here, is the sponsor's equity check, which comes out to somewhere around 30 to 35 percent of the total capitalization, a reasonable range for a buyout like this. If actual deal timing didn't line up with a full syndication process, the underwriting banks would likely bridge the gap with a short-term facility at close and refinance it into that permanent structure shortly after.

What the interviewer is listening for: whether you sequence the walk correctly, purchase price and uses first, then a credit-driven leverage decision, then tranching, then equity as the plug, rather than jumping straight to a memorized debt-to-EBITDA number, and whether the sources and uses table actually balances.