The Critical Path of a Timed LBO, Explained

The question

Walk me through the critical path of a timed LBO build: the order in which you'd construct the model to guarantee you reach a returns number before time runs out.

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The answer

I start with Sources and Uses because sponsor equity is the plug and drives every downstream return. I calculate entry enterprise value as entry EBITDA times entry multiple, size debt off the leverage multiple, and let equity be the residual that balances sources equal to uses.
Next I project EBITDA to exit. I grow revenue, apply a margin, then bridge to free cash flow by subtracting cash interest, cash taxes, capex, and any increase in working capital.
Then I build the debt schedule with a cash sweep, senior tranche first. To break the circularity quickly, I compute interest on the beginning-of-period balance or enable iterative calculation, and free cash flow sweeps the remaining debt each year.
I calculate returns last. Exit enterprise value is exit multiple times final-year EBITDA; I subtract remaining net debt to get exit equity. MOIC equals exit equity divided by sponsor equity, and IRR is roughly MOIC to the one-over-hold-period power minus one. I sanity-check the result against the three levers: deleveraging, EBITDA growth, and multiple expansion.

Sources & uses

Sources
Term Loan B	400
Senior notes	250
Sponsor equity	370
Total sources	1,020

Uses
Purchase of equity	900
Refinance existing debt	100
Financing & advisory fees	20
Total uses	1,020

Illustrative figures

Also asked as

Given entry EBITDA of $80M, a 9x entry multiple, and 5.0x leverage, compute the entry enterprise value, total debt, and sponsor equity check. State which of these is the plug and why.
Bridge EBITDA to the free cash flow that pays down debt. List every line item you subtract and explain in one sentence why each is a genuine cash outflow that EBITDA ignores.
A company is bought at 10x $100M EBITDA with 6x leverage. Over five years EBITDA is flat, the multiple is flat, and $200M of debt is repaid. Compute MOIC and approximate the IRR, then state in one sentence what the entire return is attributable to.
Explain the circular reference in an LBO debt schedule precisely (which line depends on which) and give the two acceptable ways to resolve it in a timed Excel test, noting the trade-off of each.
In a sources & uses, management rolls $40M of equity and there is a 10% management option pool that vests only at exit. Explain how each of these affects the sponsor's equity check at entry and the sponsor's proceeds at exit.
Entry: $120M EBITDA, 8x multiple, 5.5x leverage on a term loan at 9% cash interest (interest on beginning balance), 25% cash tax rate, D&A $25M, capex $30M/yr, NWC increase $8M/yr, EBITDA grows 6%/yr, 4-year hold, exit at 8x. Build the Year-1 free cash flow, estimate ending debt after four years assuming paydown accelerates, and produce MOIC and IRR. Show your arithmetic.
Decompose a deal's value creation into deleveraging, EBITDA growth, and multiple expansion via an attribution bridge, using entry EBITDA $100M, entry 9x, 6x leverage, exit EBITDA $130M, exit 9x, and $250M of ending debt. Show that the three buckets sum to total equity value creation, compute total MOIC, and identify the least reliable slice.
The credit market tightens and the maximum leverage on your deal drops from 6.0x to 4.0x, purchase price unchanged. Walk through the effect on the sponsor equity check, MOIC, and IRR, and then argue both sides of whether the deal has become better or worse for the fund.
In Year 3 of a 5-year hold, the sponsor executes a $150M dividend recapitalization. Explain quantitatively why this raises IRR far more than it raises MOIC, what it does to the risk profile of the deal, and how a lender would react to the request.

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The rest of this topic

Building an LBO, start to finish

Why must total sources equal total uses in an LBO, and is this an accounting identity or a real economic constraint? Explain the difference.Describe the mechanical flow of an LBO operating model from revenue down to levered free cash flow, naming each line item in order.Walk me through a debt schedule from free cash flow to ending debt balances. Name each step in order.The Revolver as an LBO Cash Plug, Explained Management Rollover as a Funding Source, Explained Management Equity Rollover, Explained

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