How do you run a paper LBO?

Buy a company with 100 of EBITDA at a 10x multiple for a 1,000 price, funded with 600 debt and 400 equity. Grow EBITDA to 150 over five years, sweep debt from 600 to 300, then exit at 10x for 1,500 enterprise value. Subtract 300 debt for 1,200 equity, a 3.0x MOIC.

LBO

The LBO and the paper LBO

By Michael Song · Wharton MBA · ex-Greenhill · investment banking interview coach

4 min read · updated June 29, 2026

A leveraged buyout is exactly what it sounds like: a private equity firm buys a company using mostly borrowed money, then uses the company's own cash flow to pay that debt down. The sponsor puts in a thin slice of equity, the company carries the rest as debt, and over a five-year hold the debt shrinks while (hopefully) the business grows. Sell at the end, and the equity that's left is the prize.

Reason from the sponsor's seat. They don't care about EPS or accounting niceties. They care about one thing: how much cash do I get back versus how much I put in, and how fast? Everything in an LBO serves that return.

Sources and uses

Every LBO starts here. Uses is what you have to pay for (the purchase price plus fees). Sources is where the money comes from (debt plus the sponsor's equity). They must equal, and the equity check is just the plug.

$\text{Equity} = \text{Purchase Price} + \text{Fees} - \text{Debt Raised}$

Buy a company for $1,000, fund $600 with debt, and the sponsor writes a $400 equity check. That's the entire setup: more debt means a smaller check today, and a bigger return multiple if it works.

Why leverage juices returns

Debt is cheaper than equity, and here's the key: the lenders don't share in the upside. They get their fixed interest and principal back, and everything above that flows to the equity. So the more of the purchase funded with debt, the more concentrated the gains on the sponsor's small slice.

Key insight

Leverage is an amplifier, not magic. The same business bought with more debt produces a higher equity return because the gains land on a smaller equity base. But the downside is amplified the same way. That two-edged nature is exactly why PE firms obsess over cash flow stability: predictable cash is what services the debt. A volatile business can't carry much leverage.

The two return metrics

MOIC (multiple on invested capital) is exit equity divided by initial equity. Put in $400, get back $1,000, that's a 2.5x MOIC. Simple, ignores time.
IRR (internal rate of return) is the annualized return, which does account for the holding period. Sponsors typically target an IRR in the ~15% to 25% range, with 20% the classic benchmark.

A handy mental bridge: over a 5-year hold, a 2.0x MOIC is roughly a 15% IRR, and a 2.5x is roughly 20%. Knowing those landmarks lets you sanity-check a deal without a calculator.

The paper LBO

The "paper LBO" is the interview's favorite LBO test: build the whole thing on a sheet of paper (or out loud) with round numbers. Here's the canonical run:

Entry. Buy a company with $100 of EBITDA at a 10x multiple → $1,000 purchase price. Fund $600 with debt, $400 equity.
Grow. Hold 5 years; grow EBITDA from $100 to $150 (say, 8% to 10% a year, kept clean).
Pay down debt. Free cash flow over the hold sweeps the debt from $600 down to $300.
Exit. Sell at the same 10x multiple → $150 × 10 = $1,500 enterprise value. Subtract the remaining $300 of debt → $1,200 of exit equity.
Returns. $1,200 /$ 400 = 3.0x MOIC over 5 years, well north of a 20% IRR.

Notice the three levers that created value: EBITDA growth, debt paydown, and (here, neutral) multiple expansion. Those are the only three ways an LBO makes money.

Interview tip

Drill the paper LBO until it's a reflex with the same skeleton every time: entry (price, debt, equity) → grow EBITDA → pay down debt → exit at a multiple → compute MOIC and IRR. Use round numbers (10x in, 10x out, clean EBITDA) so the arithmetic never traps you, and narrate the three return drivers as you go. That structured walk, done in two minutes without a calculator, is precisely what the test is checking.

Glossary

New to the lingo? Every term used above, in plain English.

LBO (Leveraged Buyout): Buying a company using mostly borrowed money, then using the company’s own cash flow to pay that debt down over time. The classic private equity playbook.
Private equity (PE): Firms that raise money to buy whole companies, improve them over several years, and sell them for a profit. They often use large amounts of borrowed money to do it.
Sponsor: A private equity firm. In an LBO the sponsor is the buyer that puts up the equity and controls the company.
EPS (Earnings Per Share): A company’s profit divided by its number of shares. It is the per-share slice of earnings that each shareholder owns.
MOIC (Multiple on Invested Capital): How many times an investor got their money back, calculated as cash returned divided by cash invested. A 2.5x MOIC means getting back 2.5 dollars for every dollar put in. It ignores time.
IRR (Internal Rate of Return): The annualized percentage return on an investment, which accounts for how long the money was tied up. Private equity firms often target an IRR of around 20%.
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. A rough proxy for a company’s operating cash profit, before financing and accounting choices.
Multiple: Valuation shorthand like EV/EBITDA or P/E. It shows how many times a metric the market is paying for a company, which lets you compare businesses of different sizes.
FCF (Free Cash Flow): The cash a company has left after paying for its operations and its investments. It is the cash actually available to investors.
EV (Enterprise Value): The value of a company’s whole operations, to every investor including lenders and shareholders. It does not depend on how the company is financed.
Multiple expansion: Selling a company at a higher valuation multiple than you paid for it. It is one of the ways a buyout can create value, alongside growing profits and paying down debt.

Frequently asked

What is a leveraged buyout?: A leveraged buyout is when a private equity firm buys a company using mostly borrowed money, then uses the company's own cash flow to pay that debt down. The sponsor puts in a thin slice of equity, the company carries the rest as debt, and over a five-year hold the debt shrinks while the business hopefully grows.
Why does leverage juice returns in an LBO?: Debt is cheaper than equity and the lenders do not share in the upside. They take fixed interest and their principal back, and everything above that flows to the equity. So the more of the purchase funded with debt, the more concentrated the gains on the sponsor's small slice. The downside is amplified the same way.
How do you run a paper LBO?: Buy a company with 100 of EBITDA at a 10x multiple for a 1,000 price, funded with 600 debt and 400 equity. Grow EBITDA to 150 over five years, sweep debt from 600 to 300, then exit at 10x for 1,500 enterprise value. Subtract 300 debt for 1,200 equity, a 3.0x MOIC.

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