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LBO Worked Example

STRATA DEBT STRUCTURING ASSOCIATION

About This Walkthrough

This guide walks through a complete LBO analysis using a realistic example. Follow each step to understand how the calculations connect, then apply the same logic to build your own models.

Our Target: Acme Manufacturing Co.

LTM Revenue $500M
LTM EBITDA $100M
EBITDA Margin 20%
Entry Multiple 10.0x
Total Leverage 5.0x ($500M)
Holding Period 5 Years

1 Entry Valuation

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First, we determine how much we're paying for the company. The purchase price is based on EBITDA multiplied by a negotiated multiple.

Enterprise Value Calculation

LTM EBITDA $100M
Entry Multiple × 10.0x
Enterprise Value (Purchase Price) $1,000M
What does 10.0x mean? We're paying $10 for every $1 of annual EBITDA. Entry multiples typically range from 8x-12x for quality companies. Lower is better for returns, but competition drives prices up.

2 Sources & Uses of Funds

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How do we fund a $1,000M acquisition? We use a mix of debt and equity. The "leverage" in LBO refers to the significant debt used.

Sources (Where the money comes from)
Term Loan A (1.5x EBITDA) $150M
Term Loan B (3.5x EBITDA) $350M
Total Debt (5.0x) $500M
Sponsor Equity (plug) $525M
Total Sources $1,025M
Uses (Where the money goes)
Purchase Enterprise Value $1,000M
Transaction & Financing Fees $25M
Total Uses $1,025M

Calculating Sponsor Equity (The "Plug")

Total Uses $1,025M
Less: Total Debt – $500M
Sponsor Equity Required $525M
Critical Rule: Sources must ALWAYS equal Uses. The sponsor equity is calculated last — it's whatever amount is needed to balance the equation after maximizing debt.

3 Operating Projections

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We project the company's financial performance over the 5-year holding period. These projections drive the entire model.

Key Assumptions

Revenue Growth 5% annually
EBITDA Margin 20%
CapEx 3% of revenue
D&A 4% of revenue
5-Year Operating Forecast ($M)
Metric Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Revenue 500 525 551 579 608 638
EBITDA 100 105 110 116 122 128
D&A 20 21 22 23 24 26
CapEx — 16 17 17 18 19
EBITDA Growth: From $100M to $128M over 5 years = 28% total growth. This is one of the three key return drivers in an LBO.

4 Cash Flow Waterfall

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The waterfall shows how EBITDA converts to cash available for debt repayment. This determines how quickly we can pay down debt.

Year 1 Cash Flow Waterfall

EBITDA $105M
Less: CapEx – $16M
Less: Increase in NWC – $3M
Less: Cash Interest – $42M
Less: Cash Taxes – $11M
Free Cash Flow Available $33M

Interest Expense Calculation (Year 1)

Term Loan A: $150M × 7.0% $11M
Term Loan B: $350M × 9.0% $32M
Total Interest Expense $42M
Tax Shield Benefit: Interest is tax-deductible. At a 25% tax rate, the $42M of interest saves $11M in taxes. Over 5 years, this "tax shield" creates ~$45M of value.

5 Debt Schedule & Paydown

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Free cash flow is used to pay down debt over time. We assume a 75% cash sweep (75% of FCF goes to debt paydown, 25% retained as cash buffer).

Debt Paydown Schedule ($M)
Year Beginning Debt Interest FCF Available Debt Paydown Ending Debt
1 500 42 33 25 475
2 475 40 37 28 447
3 447 38 42 32 416
4 416 35 47 35 381
5 381 32 52 39 342
Debt Paydown: From $500M to $342M = $158M paid down over 5 years. This is the second key return driver — every dollar of debt paid down increases equity value.

6 Exit Valuation & Returns

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At exit (Year 5), we sell the company and calculate returns to the sponsor. We assume exit at the same 10.0x multiple (conservative — no multiple expansion).

Exit Valuation

Exit Year EBITDA $128M
Exit Multiple × 10.0x
Exit Enterprise Value $1,276M

Exit Equity Value

Exit Enterprise Value $1,276M
Less: Remaining Debt – $342M
Exit Equity to Sponsor $934M
IRR
12.2%
MOIC
1.8x
Entry Equity
$525M
Exit Equity
$934M

MOIC Calculation

MOIC = Exit Equity ÷ Entry Equity
MOIC = $934M ÷ $525M = 1.8x

IRR Calculation

Year 0: –$525M (investment)
Years 1-4: $0 (no dividends)
Year 5: +$934M (exit proceeds)
=IRR({-525, 0, 0, 0, 0, 934}) 12.2%
Interpreting Results: A 1.8x MOIC means we nearly doubled the money. The 12.2% IRR is below typical PE targets of 20%+, which is why firms focus on operational improvement and multiple expansion.

7 Value Creation Attribution

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Where did the $409M of value creation come from? Breaking down the sources helps understand what drives LBO returns.

Value Bridge: Entry to Exit
Entry Equity Investment $525M
+ EBITDA Growth ($28M × 10.0x) $276M
+ Debt Paydown $158M
+ Multiple Expansion $0M
– Transaction Fees (at entry) –$25M
Exit Equity Value $934M

Attribution Summary

EBITDA Growth 68% of value creation
Debt Paydown 39% of value creation
Multiple Expansion 0%
Less: Fees –6%
The Three Levers: LBO returns come from (1) growing EBITDA, (2) paying down debt, and (3) exiting at a higher multiple. In this example, operational improvement drove most of the value since we assumed no multiple expansion.

8 Sensitivity Analysis

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Sensitivity tables show how changes in key assumptions affect returns. This helps identify which variables matter most and stress-test downside scenarios.

IRR Sensitivity: Exit Multiple vs. Revenue Growth
8.0x Exit 9.0x Exit 10.0x Exit 11.0x Exit 12.0x Exit
0% Growth 2.7% 6.5% 9.7% 12.6% 15.1%
3% Growth 5.0% 8.7% 11.8% 14.6% 17.1%
5% Growth 6.3% 9.9% 12.2% 15.7% 18.8%
7% Growth 7.6% 11.1% 14.2% 17.0% 20.5%
10% Growth 9.5% 13.0% 16.1% 18.9% 21.4%

Reading the Table

🟩 Green (20%+) Exceeds target
🟨 Yellow (10-20%) Acceptable
🟥 Red (<10%) Below threshold
📍 Highlighted Base case
Key Insight: Exit multiple has the largest impact on returns. A 1.0x change in exit multiple swings IRR by ~3%. To hit 20%+ IRR in this deal, you'd need either strong multiple expansion OR revenue growth above 7%.

Key Takeaways

Now that you've walked through a complete LBO, remember these core concepts: