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LBO

What drives LBO returns

By SuperdayReps · Wharton MBA · ex-Greenhill · investment banking interview coaching

6 min read · updated July 2, 2026

There are exactly three ways an LBO makes money. Debt paydown. EBITDA growth. Multiple expansion. That's it. Every return a sponsor earns traces back to one of those three levers, and a strong interview answer names all three and ranks them by how much you actually control.

Most candidates lean on the wrong one. They assume you buy at 10x and sell at 12x and call it a day. But multiple expansion is the lever you control least. The two you actually earn are deleveraging and growth. Get that ordering right and you already sound like someone who has sat in the seat.

Entry equity is a thin slice. Grow EBITDA, sweep the debt down, and the equity that's left at exit is the whole game.

Lever 1: debt paydown (deleveraging)

This is the quiet workhorse. You buy the company with a lot of debt, then the business's own free cash flow pays that debt down year after year. Enterprise value can sit completely flat and your equity still grows, because equity is what's left after debt.

Remember the bridge: Equity=EV−Net Debt\text{Equity} = \text{EV} - \text{Net Debt}. If enterprise value holds steady but net debt drops, equity value climbs by exactly the amount of debt you retired. You're converting the lender's claim into your own.

That paydown comes from the cash sweep: after the company pays interest, taxes, and capital expenditures, leftover cash goes to knocking down principal. A stable, low-capex business throws off a lot of that cash, which is precisely why sponsors hunt for boring, predictable companies.

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Frequently asked

What drives returns in an LBO?
There are exactly three levers: debt paydown, EBITDA growth, and multiple expansion. Ranked by control, EBITDA growth and debt paydown are earned through operating the business and generating cash, while multiple expansion is mostly hoped for. A strong answer names all three, then leans on the two you actually control.
How does debt paydown create equity value?
Equity equals enterprise value minus net debt, so if enterprise value holds steady but net debt drops, equity climbs by exactly the amount of debt you retired. Free cash flow left after interest, taxes, and capex sweeps down principal year after year. You are converting the lender's claim into your own without the business getting more valuable.
Why do sponsors assume a flat exit multiple?
Multiple expansion is the lever you control least. Exit multiples depend on where the market is in five years, who the buyers are, and how the sector trades. You cannot underwrite a deal assuming the multiple goes your way, so serious sponsors model buying at 10x and selling at 10x, treating any expansion as upside.
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