Paper LBO Case Study

What a Paper LBO Tests in an Interview

A paper LBO is a leveraged buyout worked out by hand, with no spreadsheet, usually with round numbers so the math stays manageable. Interviewers use it to see whether you understand how a financial sponsor makes money, and whether you can carry a multi-step calculation through cleanly while explaining each step out loud.

The Framework Behind Every Paper LBO

Every paper LBO follows the same five steps. Start at entry by multiplying EBITDA by the purchase multiple to get the purchase enterprise value. Build sources and uses, where uses are the purchase price plus fees, and the sponsor's equity is whatever the debt does not cover. Project the cash flow available to repay debt over the hold period. At exit, multiply exit EBITDA by the exit multiple and subtract the remaining debt to get the sponsor's equity proceeds. Finally, compare those proceeds with the original investment.

MOIC = Sponsor Exit Equity Proceeds ÷ Sponsor Initial Equity

Interviewers often follow up with the IRR. Over a five-year hold, a 2.0x MOIC is roughly a 15% IRR, 2.5x is roughly 20%, and 3.0x is roughly 25%.

Where the Returns Come From

A sponsor earns its return from three sources: EBITDA growth, paying down debt, and the change in valuation multiple between entry and exit. A strong answer names all three and sizes each one. Growth and deleveraging build value over the hold. A lower exit multiple than entry multiple takes some of it back.

Common Mistakes

• Leaving transaction fees out of uses, which understates the equity check.
• Treating all EBITDA as cash available to repay debt. Cash interest, taxes, capex, and working capital investment come out first.
• Subtracting the original debt at exit instead of the balance remaining after paydown.
• Calculating MOIC from exit enterprise value instead of exit equity value.
• Skipping the downside. Expect a follow-up asking what happens at a lower exit multiple, so know how to rerun the exit step quickly.

Interview Tips

Describe the structure before you calculate: entry, financing, cash flow, exit, and returns. Keep a small table for the debt schedule so you can show each year's paydown. This Medium case follows Summit Widget Company, acquired at 10.0x EBITDA with $100M of debt and a five-year hold. It adds transaction fees, annual cash flow for debt paydown, and an exit multiple below the entry multiple, so the deal has to grow and delever to clear its return hurdle.

The medium paper LBO builds on the basic framework by introducing a more realistic sources and uses calculation, transaction fees, annual cash flow available for debt paydown, and an exit multiple below the entry multiple.

That makes the return profile more informative because the sponsor needs the business to grow and delever in order to clear its return hurdle.

In this case, Summit Widget Company generates $20.0 million of entry EBITDA and is acquired at 10.0x EBITDA, implying a $200.0 million purchase enterprise value. The sponsor finances the transaction with $100.0 million of debt, pays $5.0 million of transaction fees, and holds the business for five years.

By Year 5, Summit's EBITDA is expected to grow to $33.0 million, and the sponsor assumes a 9.0x exit multiple. The stated return hurdle is at least 2.0x MOIC.

1. Calculate the Purchase Enterprise Value

Start with Summit's entry EBITDA of $20.0 million and the 10.0x entry purchase multiple.

Purchase enterprise value is calculated as $20.0 million × 10.0x = $200.0 million.

Summit's purchase enterprise value is therefore $200.0 million.

This is the value being paid for the operating business before transaction fees and financing are considered.

2. Calculate the Sponsor's Initial Equity Contribution

The sponsor needs to fund both the $200.0 million purchase enterprise value and $5.0 million of transaction fees.

Total uses are therefore $200.0 million + $5.0 million = $205.0 million.

The transaction is financed with $100.0 million of initial debt, so the sponsor must contribute the remainder as equity.

Sponsor equity contribution is therefore $205.0 million - $100.0 million = $105.0 million.

The sponsor invests $105.0 million of equity at close.

This is an important difference from the Easy case. Transaction fees increase the amount of equity the sponsor must contribute without increasing the value of the operating business.

That additional equity investment reduces returns, all else being equal.