Why does more debt raise the IRR?

The same company is bought with less equity, so any gain in value is spread over a smaller equity check. It helps as long as the business earns more than the cost of the debt. It stops helping when interest eats the cash needed for paydown, covenants bind, or default risk makes the equity worth less.

What is the difference between IRR and MOIC?

MOIC is how many times your money you got back, with no regard to time. IRR is the annual return that gets you there, so it rewards speed. 2 times in three years is about 26 percent IRR; 2 times in five is about 15 percent.

Why is an LBO a floor on valuation?

It shows what a financial buyer could pay and still earn its target return with the debt the market will lend. A strategic buyer with synergies can usually pay more, so in a sale process the LBO price tends to set the minimum.

Do I need to know LBOs for a banking interview?

Yes, at the level of this guide: the five step walk through, sources of return, and a paper LBO. Full model builds are for PE interviews, but bankers advise sponsors every day and ask about it.

What happens to the company's existing debt in an LBO?

It is usually refinanced, because lenders often have the right to be repaid on a change of control and the sponsor wants its own structure. The payoff shows up in the uses of funds.

How an LBO works: the interview answer and a paper LBO

In a leveraged buyout, a private equity firm buys a company using mostly debt and a smaller slice of its own equity, uses the company's cash flow to pay the debt down over a hold of three to seven years, then sells. Returns come from three places: paying down debt, growing EBITDA, and selling at a higher multiple than you bought at.

Updated November 6, 2026. Live data checked against each firm's own careers site 1m ago.

What is the answer you give out loud?

Walk me through an LBO is a first round question at most banks, and a near certainty for anyone mentioning private equity as a goal. Give five steps in under a minute, then let the interviewer push on any of them.

A sponsor buys a company at a multiple of EBITDA, funding the price mostly with debt and the rest with its own equity.
It projects the company's cash flows over a three to seven year hold.
Each year, free cash flow after interest and taxes pays down the debt, while the sponsor works to grow EBITDA.
At exit, the company is sold or taken public at a multiple of EBITDA; the remaining debt is repaid and the rest belongs to the equity.
Returns are measured as multiple of invested capital (MOIC) and internal rate of return (IRR), and come from debt paydown, EBITDA growth, and any multiple expansion.

How do you do a paper LBO with round numbers?

A paper LBO is the same model done by hand in a few minutes. Assumptions for this one: buy a company with 100 of EBITDA at 10 times, so the price is 1,000. Fund it with 60 percent debt (600) at 7 percent interest and 40 percent equity (400). EBITDA grows by 10 a year to 150 in year five. D&A and capex are both 10 a year, working capital does not change, the tax rate is 25 percent, every dollar of free cash flow repays debt, interest is charged on the debt at the start of each year, and fees are ignored.

Each year, free cash flow equals net income, because D&A and capex cancel. Year one: EBITDA 110, less 10 of D&A, is EBIT of 100. Interest is 7 percent of 600, or 42, leaving 58 of pre tax income. Tax at 25 percent is 14.5, so net income and free cash flow are 43.5, and debt falls to 556.5.

Year one: EBITDA 110, interest 42.0, free cash flow 43.5, debt at year end 556.5.
Year two: EBITDA 120, interest 39.0, free cash flow 53.3, debt 503.2.
Year three: EBITDA 130, interest 35.2, free cash flow 63.6, debt 439.6.
Year four: EBITDA 140, interest 30.8, free cash flow 74.4, debt 365.2.
Year five: EBITDA 150, interest 25.6, free cash flow 85.8, debt 279.4.
Exit: 150 of EBITDA at the same 10 times is 1,500 of enterprise value. Repay 279.4 of debt and the equity is worth about 1,220.6.
Returns: 1,220.6 divided by 400 is about 3.05 times the money in five years, which is an IRR of about 25 percent.

Where did the return come from?

Equity went from 400 to about 1,221, a gain of about 821. Split it by source and you see what a sponsor is really underwriting. Interviewers like this attribution because it shows you understand the model, not just the arithmetic.

Contrast it with a deal where EBITDA stays flat. Buy at 5 times 100 of EBITDA for 500 with 300 of debt, repay 150 of debt from cash flow over five years, and exit at 5 times: equity goes from 200 to 350, only 1.75 times, about 12 percent a year. Debt paydown alone gives a modest return; good deals need growth.

EBITDA growth: 50 of extra EBITDA at a 10 times multiple adds 500 of value.
Debt paydown: about 321 of debt repaid, every dollar of which moves to the equity.
Multiple expansion: none here, since entry and exit are both 10 times. Good sponsors treat it as upside, not the plan.

How do you estimate IRR in your head?

You will not have a calculator, so memorize a few anchors and interpolate. These are exact enough for any interview, and they let you check your paper LBO in seconds.

2 times in 3 years: about 26 percent.
2 times in 5 years: about 15 percent.
2.5 times in 5 years: about 20 percent.
3 times in 5 years: about 25 percent.
Rule of 72: divide 72 by the annual return to get the years to double, so 24 percent doubles in about three years.

What makes a good LBO candidate, and what follow ups come next?

A good candidate has stable, predictable cash flow to service debt, low capex needs, a strong market position, room to improve operations, assets lenders can lend against, and a plausible exit. The follow ups that come next test leverage and returns: why more debt raises IRR, and when it stops helping. Drill the live questions below; they use the same numbers and conventions as this guide.

1.Walk me through a merger model.
2.In an LBO, what happens to the target's existing debt?
3.How does a share buyback compare with an acquisition as a use of excess cash, on EPS?
4.The acquirer contributes 70% of combined net income but its shareholders will own 60% after an all stock deal. What does that tell you?
5.Why does a target's board care whether the consideration is cash or stock?
6.What does covenant lite mean, and why does it matter for sponsors and lenders?
7.Walk me through how you would do a paper LBO on a single sheet in ten minutes.
8.A board asks whether an offer for their company is fair. How would an adviser frame the answer?

Drill these with answers

Questions students ask

Why does more debt raise the IRR?: The same company is bought with less equity, so any gain in value is spread over a smaller equity check. It helps as long as the business earns more than the cost of the debt. It stops helping when interest eats the cash needed for paydown, covenants bind, or default risk makes the equity worth less.
What is the difference between IRR and MOIC?: MOIC is how many times your money you got back, with no regard to time. IRR is the annual return that gets you there, so it rewards speed. 2 times in three years is about 26 percent IRR; 2 times in five is about 15 percent.
Why is an LBO a floor on valuation?: It shows what a financial buyer could pay and still earn its target return with the debt the market will lend. A strategic buyer with synergies can usually pay more, so in a sale process the LBO price tends to set the minimum.
Do I need to know LBOs for a banking interview?: Yes, at the level of this guide: the five step walk through, sources of return, and a paper LBO. Full model builds are for PE interviews, but bankers advise sponsors every day and ask about it.
What happens to the company's existing debt in an LBO?: It is usually refinanced, because lenders often have the right to be repaid on a change of control and the sponsor wants its own structure. The payoff shows up in the uses of funds.