A leveraged buyout (LBO) is a transaction where a company is acquired using a significant amount of debt. Private equity firms use LBOs to maximize returns by financing a large portion of the purchase price with borrowed money, then repaying the debt over time using the company’s cash flows.
LBO models are built to answer a few core questions: How much can the buyer afford to pay? How much debt can the company support? What returns will the equity investors achieve? This article walks through how to build an LBO model from the ground up — using structure, discipline, and professional standards.
Core Structure of an LBO Model
A basic LBO model includes the following components:
- Assumptions sheet — purchase price, leverage, interest rates, exit year
- Sources & Uses — how the deal is funded and where the funds go
- Debt schedule — principal, interest, repayments
- Financial projections — income statement and cash flow logic
- Exit analysis — proceeds from sale, debt payoff, and equity returns
- IRR and multiple calculations — to measure performance
The model is built around cash flow — not just earnings — since debt must be repaid from actual cash available.
Purchase Price and Transaction Assumptions
Start by estimating the purchase price, typically as a multiple of EBITDA. For example, if EBITDA is $50 million and the acquisition multiple is 10x, the purchase price is $500 million.
Then define the leverage ratio — e.g., 60% debt, 40% equity. This determines the size of the loan and the amount of equity required.
Key assumptions to set:
- Entry multiple
- Debt types (senior, mezzanine, PIK)
- Interest rates
- Amortization terms
- Hold period (e.g., 5 years)
- Exit multiple (assumed)
These drive the entire structure of the model.
Sources and Uses Table
This is the deal funding map. It shows:
Sources of Funds:
- Debt tranches (senior, subordinated, PIK)
- Sponsor equity
Uses of Funds:
- Purchase equity of the target
- Pay transaction fees
- Refinance existing debt
- Fund cash on the balance sheet (if needed)
Sources must equal uses. This section helps verify that the transaction is fully financed and helps calculate the goodwill created.
Building the Debt Schedule
This is the heart of the LBO model.
Each debt tranche is tracked separately, with rows for:
- Beginning balance
- Interest expense (based on rate and average balance)
- Scheduled amortization
- Optional repayments (using excess cash flow)
- Ending balance
Cash available for debt repayment comes from the company’s free cash flow, which is calculated from operating cash flow minus capex and changes in working capital.
A cash sweep is built in to repay as much debt as possible each year after covering required payments.
Forecasting the Financials
LBO models usually use simplified financials:
- Revenue growth and EBITDA margin drive operating income
- Depreciation and amortization may be held constant or tied to capex
- Interest expense is linked to the debt schedule
- Taxes are calculated on pre-tax income
Net income and free cash flow are calculated each year. Free cash flow is used to pay down debt and determines the sponsor’s ability to exit with a return.
Forecasts usually span 5 to 7 years, long enough to show deleveraging and support an exit analysis.
Exit Assumptions and Equity Value
At the end of the forecast, assume an exit multiple (e.g., same as entry or slightly lower/higher). The exit enterprise value is:
Exit EV = Final Year EBITDA × Exit Multiple
Then subtract remaining debt and add excess cash to calculate the equity value at exit.
This amount is compared to the original sponsor equity to calculate the return.
IRR and Multiple of Invested Capital
Two key return metrics are used in every LBO model:
- Internal Rate of Return (IRR) — the annualized rate of return on equity
- Multiple of Invested Capital (MOIC) — exit equity ÷ entry equity
Both are calculated using the sponsor’s equity investment at entry and the equity proceeds at exit. These outputs help evaluate whether the deal meets the fund’s return target — often 20%+ IRR and 2.0x+ MOIC.
The model can also include a sensitivity table showing IRR across a range of exit multiples and EBITDA growth assumptions.
Optional Add-Ons in More Detailed Models
Advanced models may include:
- Management rollover equity
- PIK interest instruments
- Minimum cash balances
- Working capital schedules
- Fee capitalization and amortization
- Revolving credit facilities
- Debt covenant tests
But the core logic remains the same: forecast performance, track cash, repay debt, and calculate investor returns.
Closing Thought
LBO models are built for one purpose: to evaluate the return potential of a leveraged transaction. They focus on cash flow, not accounting profits. A clean LBO model allows investors to test different structures, assess risk, and make fast, informed decisions. When built carefully, it becomes a decision tool — not just a spreadsheet.