LBO Interview Questions

The sponsor is the private equity firm itself, acting as the general partner (GP) of the fund: it raises the money, sources and negotiates deals, arranges the financing, and governs the companies it buys. The limited partners (LPs) are the outside investors who supply the money. Pensions, endowments, foundations, insurers, sovereign wealth funds, family offices. They typically stay passive on individual deals and take most of the profits, since they put up the large majority of the capital. The GP normally commits a small slice of its own money alongside the LPs, often a low single-digit percentage of the fund, and gets paid a management fee plus carried interest, a share of the gains that is commonly around twenty percent.

Price-to-book equals P/E multiplied by return on equity: P/B = P/E × ROE. Earnings per share (EPS) cancels out of the product. So a company trades at a high multiple of its book value when investors pay a high multiple for its earnings, when it earns a high return on its equity, or both. Book value is the shareholders' equity on the balance sheet. ROE is net income divided by that equity.

The main short-term levers are to turn owned assets into cash, spend less cash on assets, and hold less cash in working capital. In practice: do sale-leasebacks on owned property or equipment, defer discretionary capex, and tighten working capital by collecting from customers faster, paying suppliers later, and holding less inventory. Each lever costs something later, such as new lease payments or older equipment, so use it with care.

The IRR is about 18%. The purchase price is 10x $200mm = $2.0bn, funded with $1.2bn of debt (6x EBITDA) and $800mm of equity. At exit the company is worth 10x $300mm = $3.0bn. Repay the $1.2bn of debt and the sponsor keeps $1.8bn of equity, 2.25x its $800mm. The question gives no holding period, so use the standard 5-year hold and assume the debt stays at $1.2bn. Over 5 years, 2.25x works out to roughly 17-18% a year.

Yes. Say enterprise value (what the whole business is worth to lenders and owners together) stays at $1mm. The PE firm still earns a return, because the company's cash flow pays down the acquisition debt over the holding period. At exit, less of the $1mm goes to lenders and more goes to the equity, so the firm gets back more than it put in.

IRR (internal rate of return) is the annual discount rate at which the net present value (NPV) of all of an investment's cash flows is zero. A discount rate is the yearly rate you use to turn future cash into today's dollars. NPV is the sum of every cash flow after that conversion. To calculate IRR, list the cash out at entry as a negative and the cash back each year and at exit as positives. Then solve for the rate where their present values add up to zero. There is usually no direct formula. You try rates and interpolate between them, or you use Excel's IRR function.

The IRR is about 20%. The firm pays $1,000mm ($100mm EBITDA x 10x) and funds it with $600mm of debt and $400mm of equity. At exit the company is worth $1,350mm ($150mm x 9x). Debt is down to $350mm, so equity is worth $1,000mm. That is 2.5x over 5 years, or an IRR of about 20%.

Adding $100mm to EBITDA has far more impact. At exit, buyers value the business at a multiple of EBITDA. At an 8.0x exit multiple, the extra $100mm of EBITDA adds about $800mm of enterprise value. Debt stays the same, so the full $800mm goes to the equity. Paying down $100mm of debt adds only $100mm to the equity at exit.

A sources and uses table shows where the money for a leveraged buyout (LBO, a purchase paid for largely with borrowed money) comes from and where it goes. Total sources must equal total uses. Sources are the new debt, split into tranches (layers of debt with different terms, such as a term loan and senior notes), any rollover equity (stock that existing owners or management put back into the deal instead of taking cash), sometimes excess cash already on the target's balance sheet, and the sponsor equity (the private equity firm's own cash check). The sponsor equity is typically the plug that makes the two sides balance. Uses are the purchase price for the target's equity, repayment of the target's existing debt (called refinancing), and the transaction and financing fees.

The terminal value is 772.5. Unlevered free cash flow in the last discrete period is 75. EBIT is 100 (EBITDA of 125 minus D&A of 25), which is 75 after 25% tax. Add back D&A of 25, subtract CapEx of 25, and subtract a working capital change of 0. Grow that 75 by 3% to 77.25, then divide by the 10% spread between the 13% required return and the 3% growth rate.

An LBO analysis (leveraged buyout: a purchase funded mostly with borrowed money) works backward to the price a private equity buyer can pay and still earn its target return. The answer rests on three assumptions: how much debt lenders will provide, the exit multiple the buyer expects to sell at, and the IRR hurdle (the minimum annual return the buyer demands). It is usually built on a standalone basis, without the synergies (cost savings or extra revenue from combining two companies) a strategic buyer could capture. So it typically reads as a floor on value, below the full price the company could fetch.

Common errors include mixing equity value and enterprise value across methodologies, using inconsistent share counts or bridge assumptions, including outlier comps, double-counting control premiums, misaligned axes, stale inputs, and unexplained ordering differences such as precedents screening below trading comps.