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 approximately 17.6%, derived from a 2.25x MOIC ($1,800mm exit equity on $800mm invested) over a 5-year holding period: (2.25)^(1/5) − 1 ≈ 17.6%.

Yes — even with no change in enterprise value or multiple, the PE firm can achieve a return through debt paydown during the holding period, which increases the equity value at exit relative to the initial equity invested.

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 approximately 20%: $400mm entry equity grows to $1,000mm exit equity (2.5x MOIC) over 5 years, driven by EBITDA growth (+$450mm), debt paydown (+$250mm), partially offset by multiple contraction (−$150mm).

Under the standard interview simplification, adding $100mm to EBITDA has the bigger impact because it is capitalized at the exit multiple, while paying down $100mm of debt increases equity value by exactly $100mm. For example, at an 8.0× exit multiple, $100mm of incremental EBITDA would increase enterprise value — and therefore equity value, assuming no other changes — by about $800mm, versus only $100mm from debt paydown.

Sources include debt tranches (for example, revolver if drawn, term loans, senior notes, mezzanine), rollover equity or seller financing, excess target cash if it is used to fund the deal, and sponsor equity as the plug. Uses include the equity purchase price paid to shareholders, repayment or refinancing of existing debt, transaction fees, financing fees, and any minimum cash left on the balance sheet.

The terminal value is 772.5, calculated by growing the last discrete period's UFCF of 75 by 3% to get 77.25, then dividing by (13% − 3%) = 10% using the Gordon Growth Model.

The LBO method is highly sensitive to leverage, exit multiple, and cash flow assumptions, uses a subjective IRR target, only reflects a financial buyer's perspective (producing a valuation floor), and depends on an assumed hold period.

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.