LBO Case Building Blocks For Interviews
This conversation was generated using Cook'd AI's career assistant and reviewed by Fallon Han from our editorial team for accuracy.
I am trying to learn how an LBO case is built step by step. Can we walk through it layer by layer instead of jumping straight to the answer? I am a postgraduate student in Australia moving from engineering into leveraged finance at a mid-sized advisory boutique, so I want to understand the logic, not just memorize a formula.
Absolutely. The clean way to think about an LBO is to build it in three layers: purchase price and financing, operating performance and debt paydown, then exit and returns. Since you want the logic, we will start with the entry. In a basic LBO, a sponsor buys a company using a mix of equity and debt. The key first question is: how much debt can the business support without breaking the downside case? That depends on stable cash flow, leverage multiples, and what lenders think is safe in the industry.
So if I am asked how much debt the business can take, what do I actually look at first? Is it EBITDA, free cash flow, or something else?
Start with EBITDA, but do not stop there. EBITDA is the common shorthand for debt capacity because it is easy to compare across deals. Then adjust for capex, working capital needs, and cash taxes to see how much real cash is available for debt service. A useful interview answer is: first estimate leverage as a multiple of EBITDA, then check interest coverage and free cash flow to make sure the company can actually repay principal. In advisory boutiques, that second layer matters because buyers care about both valuation and financing feasibility.
Okay, suppose the company can support, say, 5.0x net debt at entry. How does that connect to returns? I know leverage boosts equity IRR, but I want to see the mechanism, not just the slogan.
The mechanism is simple: the sponsor puts in less equity upfront, so any increase in enterprise value accrues to a smaller equity base. But the real driver is debt amortization. If EBITDA grows and cash flow is used to pay down debt, equity value rises faster than the business value alone. So equity return comes from three sources: EBITDA growth, multiple change at exit, and debt paydown. Leverage amplifies all three, which is why the capital structure is so important. In a mini case, I would say: returns improve when entry debt is high enough to reduce equity check size, but not so high that the company cannot service interest and principal.
How do I think about the exit assumptions in the case? If I assume the same entry and exit multiple, is that too simplistic for an interview?
Using the same multiple is a good base case, not a full answer. It keeps the model clean and lets you isolate operational value creation. Then you can layer in a sensitivity for multiple expansion or contraction. In a real case, the exit multiple should be tied to the quality of earnings, growth, and cyclicality. For a mid-sized advisory boutique interview, a strong answer is: begin with a market-comparable exit multiple near the entry multiple, then test a range to see how dependent returns are on valuation assumptions.
If I were to summarize the full logic of the case in one pass, how would you connect debt capacity, returns, and exit assumptions together?
You can frame it like this: first, determine how much debt the target can support based on EBITDA, cash generation, and lender comfort. Second, use that debt to size the equity cheque and estimate how leverage affects returns. Third, forecast EBITDA growth and debt paydown over the holding period, then apply an exit multiple to calculate terminal equity value. Finally, compare exit equity to entry equity to get IRR and money multiple. The key connection is that entry leverage, operating performance, and exit valuation are not separate topics. They are the three moving parts of the same story.