Leveraged buyout

A leveraged buyout (LBO) is the purchase of a company, a division or a set of assets using borrowed money for a large part of the price, with the rest put in as equity by a financial sponsor[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.], which is the industry’s name for the buyer, typically a private equity fund[2Source 2Kenneth H. Marks, Robert T. Slee, Christian W. Blees and Michael R. Nall, Middle Market M&A: Handbook for Investment Banking and Business Consulting, 2nd ed. (Wiley, 2022), “Buyouts”, pp. 237–238.]. The debt is not the sponsor’s; it is raised by the company being bought, through loans and bonds, and it is paid back over the following years from that company’s own cash flow[3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.]. That is the trick the name points at. The sponsor puts in a small amount of its own money relative to the price, and if the plan works, the company pays for most of itself.

The house analogy

The textbook comparison is a mortgage. A buyer puts down a fraction of the price of a house and borrows the rest against the house. In a buyout the equity is the down payment, the debt is the mortgage, and some of the debt is secured on the company’s assets the way the loan is secured on the house. The difference is that a house does not earn money to pay off its own mortgage, and a company does: “the acquired company helps pay for itself”[2Source 2Kenneth H. Marks, Robert T. Slee, Christian W. Blees and Michael R. Nall, Middle Market M&A: Handbook for Investment Banking and Business Consulting, 2nd ed. (Wiley, 2022), “Buyouts”, pp. 237–238.]. A corporate finance text lists the two things that make an LBO different from an ordinary acquisition: the target goes private, so its shares no longer trade, and a large fraction of the price is financed with bank loans and bonds secured by the target’s assets and cash flows, some of the bonds below investment grade[4Source 4Richard A. Brealey, Stewart C. Myers and Franklin Allen, Principles of Corporate Finance, 13th ed. (McGraw-Hill, 2019), §32-1, “Leveraged Buyouts”, pp. 863–864.].

How much debt

In a traditional deal, debt makes up about 60 to 70 percent of the financing and equity the remaining 30 to 40 percent[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. Another text puts the debt at around 65 to 70 percent of the purchase price and notes that it reached about 90 percent on some deals in the peak years[3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.]. The corporate finance text records a swing of its own: debt ratios of 90 percent were not uncommon in the early LBOs, while recent deals, as of its 2019 edition, have been financed with nearly equal amounts of debt and equity[4Source 4Richard A. Brealey, Stewart C. Myers and Franklin Allen, Principles of Corporate Finance, 13th ed. (McGraw-Hill, 2019), §32-1, “Leveraged Buyouts”, pp. 863–864.]. How much debt a deal carries is a function of the target’s EBITDA, the collateral value of its tangible assets and the size of the deal; in a 2021 sample drawn from 243 private equity funds, on deals valued between $10 million and $250 million, average total debt was 3.9 times EBITDA[2Source 2Kenneth H. Marks, Robert T. Slee, Christian W. Blees and Michael R. Nall, Middle Market M&A: Handbook for Investment Banking and Business Consulting, 2nd ed. (Wiley, 2022), “Buyouts”, pp. 237–238.].

The debt comes in layers. There is almost always a senior, secured loan portion arranged by a bank or an investment bank, and often a junior, unsecured portion funded with high-yield bonds or mezzanine debt, which ranks below the senior debt[3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.]. The equity comes from a private equity fund, a partnership of limited partners who supply the money and general partners who manage it for a management fee and a share of the gains called carried interest; the target’s management team usually puts in a small amount of its own[3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.].

What makes a good target

Because the company has to carry the debt, the ideal target is boring in a good way: stable, predictable cash flow, and substantial assets. Cash flow is needed to pay the interest and repay the principal over the life of the investment, and a large base of tangible assets increases the amount of secured debt, the cheapest kind, that lenders will provide[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. Interest is tax-deductible, which adds a tax saving to the arithmetic[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. Sponsors also look for growth, organic or through add-on acquisitions, because growth raises the cash available to repay debt and raises EBITDA and equity value at the same time[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.].

How the sponsor makes money

The sponsor’s whole objective is to sell the company later for more equity than it put in, typically at an annualised return of 15 to 20 percent, with an exit within five years[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. Two things can produce that, and the standard text shows them with one pair of examples.

The first is paying down debt. If the company generates cash and uses it to repay principal, every dollar repaid moves a dollar from the lenders’ claim to the sponsor’s, even if the company is worth exactly the same at exit. In the worked example, a company bought for $1 billion with $300 million of equity generates $500 million of cumulative cash flow, repays that much debt, and is sold for the same $1 billion; the sponsor’s equity has gone from $300 million to $800 million, an internal rate of return of 21.7 percent over five years and 2.7 times its money[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.].

The second is growing the business, so that it sells for more. In the companion example, no debt is repaid at all, but the company is sold for $1.5 billion instead of $1 billion. Because the debt is a fixed claim, the extra $500 million goes entirely to the equity, and the result is the same 21.7 percent and 2.7 times[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. The growth can come from higher EBITDA, through organic growth, acquisitions or streamlined operations, or from selling at a higher multiple of EBITDA than was paid, which the trade calls multiple expansion[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. A private equity textbook lists the same objectives to reach before exit: an increase in EBITDA, reduced debt, and a higher exit multiple[3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.]. The exit multiple depends partly on what the market will pay on the day of the sale, though both texts list what a sponsor can do to earn a higher one: greater size and scale, operational improvement, faster growth, a move toward more highly valued segments, and timing the cycle[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.][3Source 3Eli Talmor and Florin Vasvari, International Private Equity (Wiley, 2011), §12.1, “Introduction”, p. 255, and “Objectives to achieve before exit”, p. 268.].

Line	Repay debt	Grow the business
Purchase price	1,000	1,000
Debt at purchase	700	700
Equity at purchase	300	300
Debt repaid from cash flow	500	0
Sale price at exit	1,000	1,500
Debt at exit	200	700
= Equity at exit	800	800
Internal rate of return	21.7%	21.7%
Multiple of money	2.7x	2.7x

Source: The two scenarios in the standard textbook cited below, restated in the same round numbers over a five-year hold.

The exit

Most sponsors aim to get out within about five years, to return money to their fund’s backers on time. The exit is a sale to another company (a strategic sale), a sale to another sponsor, or an initial public offering. Sponsors may also take money out earlier with a dividend, sometimes funded with new debt, which is called a dividend recapitalisation[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.]. The timing depends on how the company has done and what the market will pay; a strong performer may be sold within a year or two, and a weak one, or a weak market, may mean a longer hold than anyone wanted[1Source 1Joshua Rosenbaum and Joshua Pearl, Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd ed. (Wiley, 2020), ch. 4: the definition and the financing structure, p. 169; growth, p. 178; how LBOs generate returns, pp. 182–183; exit strategies, p. 187.].

The model

All of the above is what an LBO model computes. It projects the company’s cash flows, runs them through a debt schedule that repays the loans in order, and computes the equity left at exit under an assumed sale multiple. The enterprise valueEnterprise value and equity valueEquity value is what the shares are worth; enterprise value is what the whole business is worth to all who fund it. How they link, and why cash is subtracted.Terms and methods · revised 28 September 2026 · 921 words · 4 sources · 5 min at exit, less whatever debt remains, is the sponsor’s proceeds; EBITDAEBITDAEBITDA is earnings before interest, taxes, depreciation and amortization: how it is calculated, why bankers compare firms with it, and why it is not cash flow.Terms and methods · revised 28 September 2026 · 1,060 words · 4 sources · 5 min is the number the entry and exit multiples are applied to; and the cash that repays the debt is the same free cash flow a discounted cash flowDiscounted cash flow analysisA discounted cash flow analysis values a business as the present value of the cash it should produce: the five steps, the discount rate and the terminal value.Terms and methods · revised 28 September 2026 · 1,128 words · 4 sources · 5 min analysis discounts. The xlsx.dev builder produces a model of this shape.

@misc{xlsxdev-2026-leveraged-buyout,
  author       = {{xlsx.dev}},
  title        = {{Leveraged buyout}},
  howpublished = {xlsx.dev Wiki},
  year         = {2026},
  month        = sep,
  url          = {https://xlsx.dev/wiki/leveraged-buyout}
}