LBO Returns: Organic Growth vs Arbitrage, Explained
The question
Explain the difference between organic EBITDA growth, acquired EBITDA at cost, and multiple arbitrage, and why an LP would want a platform's return decomposed across all three.
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
The answer
Organic EBITDA growth is the expansion of the platform’s existing earnings through price, volume, or margin improvement, completely independent of any deal. Acquired EBITDA at cost is new earnings purchased via an add-on, valued exactly at the multiple you paid for it, which reflects your sourcing and execution skill.
Multiple arbitrage is the instant re-rating gain when that acquired EBITDA is folded into a platform that commands a higher valuation multiple simply because it’s larger and more institutional. An LP wants returns decomposed this way because it separates repeatable operational skill from market structure gains. If most of the return came from organic growth and margin expansion, that signals a sustainably better business.
If it came from buying small competitors at six times and selling the combined entity at ten times, that’s real cash value but depends heavily on the size-multiple gap holding through exit and on clean integration.
LPs know that multiple arbitrage can compress or reverse if a buyer sees the platform as a messy rollup, so they treat it as less certain than organic improvement and underwrite it differently when assessing a sponsor’s track record.
Sources & uses
| Term Loan B | 400 |
| Senior notes | 250 |
| Sponsor equity | 370 |
| Total sources | 1,020 |
| Purchase of equity | 900 |
| Refinance existing debt | 100 |
| Financing & advisory fees | 20 |
| Total uses | 1,020 |
Also asked as
- Define multiple arbitrage in a buy-and-build strategy and explain, conceptually, why smaller businesses trade at lower multiples than the platforms that acquire them.
- A platform is valued at 8.0x EBITDA. It buys an add-on with $5M of EBITDA for $30M. Compute the add-on's purchase multiple and the multiple arbitrage captured.
- A platform funds an add-on entirely through an accordion facility with no new sponsor equity. Explain why this makes the add-on's marginal IRR contribution disproportionately large, and what risk this financing choice adds to the deal.
- Platform EBITDA is $45M at 5.0x leverage ($225M debt); the credit agreement caps pro forma leverage at 6.0x. The sponsor wants to buy a $9M-EBITDA add-on at 6.5x. Compute available accordion capacity and determine how much (if any) new sponsor equity is required.
- Why can quality-of-earnings adjustments matter disproportionately for add-on acquisitions compared to platform-level deals, and how does an unadjusted headline EBITDA number distort the calculated multiple arbitrage?
- Describe two structural reasons a buy-and-build strategy's addressable pipeline of add-ons is finite, and how a sponsor should account for this when underwriting fund-level returns.
- A platform enters at $35M EBITDA and 9.0x. Over the hold it completes three add-ons: $6M EBITDA at 5.5x, $9M EBITDA at 6.0x, and $11M EBITDA at 7.0x, while organic EBITDA grows to $50M. Exit multiple is flat at 9.0x. Compute total exit EBITDA, exit EV, and decompose the EV growth into organic growth and multiple arbitrage for each add-on.
- Using the same deal as above, suppose diligence later reveals the $11M-EBITDA add-on's true run-rate EBITDA was only $8.5M (the rest was a one-time contract). Recompute that add-on's effective purchase multiple, its true multiple arbitrage, and restate total exit EBITDA and exit EV accordingly.
- A sponsor invests $150M of equity in a platform at $40M EBITDA and 9.5x. Over 5 years it completes four debt-funded add-ons adding $30M of EBITDA at an average 6.0x, while organic EBITDA grows from $40M to $55M. At exit, the buyer, citing integration risk across the four add-ons, pays only 8.0x instead of the underwritten 9.5x. Compute exit EV and equity value under both multiples (assume exit net debt of $200M in both cases), and quantify how much of the MoIC difference is attributable to multiple compression versus the underlying EBITDA growth being unaffected.
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The rest of this topic
LBO returns: IRR, MoIC and the value bridge