A simple LBO model example, from entry to IRR

Step 1: sources and uses

Every deal starts with a table that must balance: where the money goes (uses) and where it comes from (sources). The purchase price is entry EBITDA × the entry multiple: $50m × 8.0 = $400m. Add $12m of fees and the total uses are $412m.

Lenders will provide about 5.0× EBITDA, so debt is $250m. Sponsor equity is the plug: total uses − debt = $162m, about 39% of the total. If the bank lends less, the sponsor has to put in more, and returns fall.

Step 2: cash flow and the debt schedule

Each year, EBITDA pays for interest, taxes and capex. Whatever is left repays debt:

Free cash flow for debt repayment = EBITDA − interest − taxes − capex

Taxes are charged on EBITDA − D&A − interest, so the interest tax shield is included. Interest is calculated on the opening debt balance. Interest on the average balance would depend on this year's repayment, which depends on cash flow, which depends on interest: a circular reference. The repayment is =MIN(C22,C23), so the model never repays more than is owed. Over five years the company repays $112.8m, and the shrinking debt means less interest every year.

Real LBOs split debt into tranches (a senior term loan with a cash sweep, notes repaid at exit) and include working capital. The logic is the same, just with more rows.

Worked example: a five-year LBO on one sheet

Inputs are yellow. The year columns use the same formulas copied across; the list below shows Year 1.

Worked example: a five-year LBO on one sheet

	A	B	C	D	E	F	G
1	Assumptions ($m)	Value
2	Entry EBITDA	50.0
3	Entry and exit multiple (x EBITDA)	8.0
4	Fees and expenses	12.0
5	Debt (x EBITDA)	5.0
6	Interest rate	8.0%
7	EBITDA growth per year	6.0%
8	Tax rate	25%
9	D&A per year	10.0
10	Capex per year	12.0
11
12	Purchase enterprise value	400.0
13	Total uses (EV + fees)	412.0
14	Debt raised	250.0
15	Sponsor equity (the plug)	162.0
16
17	$m	Entry	Year 1	Year 2	Year 3	Year 4	Year 5
18	EBITDA	50.0	53.0	56.2	59.6	63.1	66.9
19	− Interest (on opening debt)		20.0	18.8	17.3	15.5	13.4
20	− Taxes		5.8	6.9	8.1	9.4	10.9
21	− Capex		12.0	12.0	12.0	12.0	12.0
22	Free cash flow for debt repayment		15.3	18.5	22.2	26.2	30.6
23	Opening debt		250.0	234.8	216.2	194.0	167.8
24	− Repayment		15.3	18.5	22.2	26.2	30.6
25	Closing debt	250.0	234.8	216.2	194.0	167.8	137.2
26
27	Exit enterprise value	535.3
28	− Debt at exit	137.2
29	Equity value at exit	398.1
30	MOIC	2.46x
31	Sponsor cash flows	-162.0	0.0	0.0	0.0	0.0	398.1
32	IRR	19.7%

Step 3: exit value and equity proceeds

At exit, the sponsor sells the company. A careful model assumes the exit multiple equals the entry multiple, so it does not rely on the market paying more later. Exit EV = year-5 EBITDA $66.9m × 8.0 = $535.3m. Subtract the debt still outstanding ($137.2m) and the sponsor's equity is worth $398.1m.

Step 4: MOIC and IRR

MOIC (multiple on invested capital) = exit equity ÷ equity invested = $398.1m ÷ $162m = 2.46x. It shows how many times the money came back, but not how fast.

IRR adds time. Put the sponsor's cash flows in a row (the investment as a negative number in year 0, the proceeds in year 5) and use =IRR(B31:G31): 19.7%. With no cash in between, the IRR is simply =MOIC^(1/5)-1, which gives the same answer and is a handy mental check.

Where did the gain come from? With a constant multiple, EBITDA growth added $135.3m of enterprise value and debt paydown $112.8m. Together that is $248.1m: the $236.1m gain on the sponsor's equity plus the $12m of fees paid at entry.

Step 5: test what moves the return

Change one input at a time and watch the IRR. If the sponsor has to sell at 7.0x instead of 8.0x, the MOIC falls to 2.04x and the IRR to 15.4%. If lenders provide only 4.0x EBITDA, the sponsor must put in more equity, and even though there is less interest to pay, the MOIC drops to 2.19x and the IRR to 17.0%. Leverage magnifies returns in both directions, which is the whole point of an LBO and also its main risk.

A two-way data table of exit multiple against leverage is the usual way to show this to an investment committee.

Common mistakes

• Sources that do not equal uses. Make sponsor equity a formula (uses − debt), never a typed number, and the table always balances.
• Interest on the average balance without enabling iterative calculation. It creates a circular reference. Opening-balance interest is the simple, stable choice.
• Forgetting fees in the uses. They are real cash the sponsor pays and they lower the return.
• Assuming multiple expansion. Exiting at a higher multiple than you paid can make any deal look good. Test returns at the entry multiple first.
• Taxing EBITDA instead of EBT. Taxes are due on profit after D&A and interest, so tax on EBITDA overstates them.
• Reading MOIC without time. 2.0x in three years and 2.0x in seven years are very different results. Always show the IRR next to it.