Walk me through an LBO in under a minute: what happens, why leverage amplifies returns, and the three drivers of the sponsor's return.

1. A sponsor buys a company using mostly debt, then uses the company's own cash flows to pay down that debt over roughly five years before selling. Returns come from EBITDA growth, debt paydown, and multiple expansion.
2. Leverage amplifies returns because the sponsor only puts up a fraction of the purchase price as equity. As free cash flow repays debt, value shifts from the debt column to the equity column, so even modest enterprise value growth or debt reduction produces a much larger percentage gain on the equity check.
3. The three drivers: EBITDA growth raises exit EBITDA and exit enterprise value directly. Debt paydown (deleveraging) uses post-interest, post-tax free cash flow to reduce net debt, and every dollar retired adds a dollar of equity value. Multiple expansion means selling at a higher EBITDA multiple than you paid, and that premium flows entirely to equity. Combined, these produce an exit equity value; MoIC is exit equity over entry equity, and annualizing it gives IRR. For a quick sanity check: 2x over five years is around a 15% IRR, 2.5x about 20%, and 3x about 25%.

What the interviewer is actually testing

1. Comfort with mental arithmetic under a frame you must hold in your head. The paper LBO is a working-memory test disguised as finance: you must retain entry equity, track debt paydown, and compute exit equity without notes (or with one sheet). Interviewers watch how you compute: candidates who structure first ("entry equity is EV minus debt, so 60; now the debt at exit...") almost always finish; candidates who dive into multiplication drown. Signal mastery by narrating the scaffold before the arithmetic.

2. Whether you know what each model is for. The killer questions are purpose questions: "Your deal is 8% accretive. Good deal?" (Not necessarily: accretion says nothing about price paid vs intrinsic value; you can accretively overpay for a low-P/E declining business.) "Why do sponsors care about IRR and MoIC?" (IRR is gameable with timing: dividend recaps and quick flips inflate it; MoIC measures money actually made. LPs look at both.) A strong candidate attaches the purpose caveat unprompted in one sentence.

3. Directional agility. After the build, they'll flip one lever: "Same deal, but rates are 200bps higher." "Entry and exit multiples both fall by 1x." "Stock instead of cash." You should answer directionally in seconds, with the mechanism: higher rates → more interest expense → slower paydown and lower affordable leverage at entry → lower returns and lower max price. This is where prepared candidates separate from scripted ones, because flips can't all be memorized.

4. Purchase accounting precision. Goodwill, write-ups, DTLs, and amortization are where mixed rounds get quietly technical. Interviewers use them to check whether your merger model is a real model or a story. Know the DTL-increases-goodwill loop cold: it's the most common 'gotcha' at the EB level.

The composure rule from Mock 1 still applies, with an LBO-specific addendum: if you lose the thread mid-paper-LBO, don't restart silently. Say "let me re-anchor: entry equity was 60, debt started at 140." Recovering out loud demonstrates exactly the trait a modeling seat requires.

The traps that kill LBO/M&A rounds

Trap 1: Computing entry equity off the wrong base. Candidates take "5.0x leverage on $100M EBITDA at 10x" and say equity is $500M... then forget fees, or subtract leverage from the equity purchase price instead of EV. Structure first, always.

Say it out loud: "Enterprise value is 10x × 100 = $1,000M. Debt is 5x × 100 = $500M. Ignoring fees, sponsor equity is the difference: $500M. With, say, $30M of transaction and financing fees, the check grows to $530M."

Trap 2: Forgetting that FCF pays down debt only after interest and taxes. In paper LBOs, candidates apply EBITDA straight to debt paydown. EBITDA is not cash: subtract interest, taxes, CapEx, and working capital before anything sweeps.

Say it out loud: "Free cash flow for the sweep is EBITDA minus interest, minus cash taxes, minus CapEx, minus working capital investment; in a quick paper LBO I'll approximate it, but I won't skip interest, because leverage exists precisely to consume that cash flow early on."

Trap 3: Saying stock deals are dilutive 'because you issue shares.' Issuing shares is only half the fraction: you also add the target's net income. The comparison is earnings yields, not share count.

Say it out loud: "A 100% stock deal is accretive when the acquirer's P/E is higher than the price paid over the target's earnings: you're issuing expensive currency to buy cheaper earnings. Share issuance alone doesn't determine the direction."

Trap 4: Treating EPS accretion as value creation. The most common conceptual fail at the EB level. Accretion is an arithmetic property of relative earnings yields and financing cost; value creation is about price versus intrinsic value plus synergies.

Say it out loud: "Accretion and value creation are different questions. Buying a melting-ice-cube business at a low P/E with cheap debt is mechanically accretive and can still destroy value. I'd judge the deal on price versus standalone DCF value plus credible synergies, net of integration costs."

Trap 5: Getting the DTL sign wrong on write-ups. Candidates subtract the DTL from goodwill or forget it entirely. In a stock deal, the write-up creates future book depreciation that will never be tax-deductible, so a liability is booked, and because liabilities assumed increase the gap between price and net assets, goodwill goes up.

Say it out loud: "The write-up reduces goodwill, but in a stock deal it also creates a deferred tax liability equal to the write-up times the tax rate, and that DTL increases goodwill. Net, goodwill falls by the write-up times one minus the tax rate."

Trap 6: Quoting IRR without sanity-checking against MoIC and hold period. Under pressure, candidates announce "about 35% IRR" for a 2.0x over five years. Interviewers catch it instantly.

Say it out loud: "2.0x over five years is about 15% IRR: the doubling-in-five anchor. I keep the pairs 2x/15%, 2.5x/20%, 3x/25% in my head and interpolate from there."