The Paper LBO in Ten Minutes

The paper LBO is the interview exercise with the most fearsome reputation and the most learnable structure. No Excel, no calculator: just you, clean assumptions and four blocks of arithmetic spoken aloud. It appears in private equity processes, increasingly in leveraged finance and sponsors interviews on the banking side and occasionally as a superday curveball. Here is one worked end to end, with the scoring commentary.

The four blocks, worked

Worked paper LBO · every number reconciles

SETUP · A sponsor buys a company with US$100m of EBITDA at 8.0x: enterprise value US$800m. Financed with 5.0x debt, US$500m, so the equity cheque is US$300m. Hold: five years.

OPERATIONS · EBITDA grows 10% a year. Shortcut: 1.1 to the fifth power is roughly 1.6, so year-five EBITDA is about US$160m. The company generates US$50m a year of free cash flow, all used to repay debt: US$250m repaid, leaving US$250m at exit.

EXIT · Sell at the same 8.0x on US$160m: enterprise value US$1,280m. Subtract remaining debt of US$250m: exit equity of US$1,030m.

RETURNS · US$1,030m on US$300m is roughly 3.4x money-on-money. Over five years, 3x is about a 25% IRR and 2x is about 15%, so 3.4x lands in the high twenties: call it 28%.

Where the marks actually sit

Structure spoken first. Before touching a number, say the map: entry, operations, exit, returns. Interviewers score the scaffolding as much as the arithmetic, because the scaffolding is what survives when they change an assumption mid-exercise and they will.
Assumptions stated, then used. Repeat each given back before computing with it. It buys thinking time legitimately and catches the misheard number before it poisons ten minutes of work.
Mental-maths hygiene. Round early and say you are rounding. The approximations that carry the exercise: 1.1 to the fifth is about 1.6; doubling in five years is roughly 15% a year; tripling is roughly 25%. Nobody wants decimals; they want controlled magnitudes.
Attribution at the end. The strongest finish is unprompted: 'returns came from three sources, EBITDA growth, debt paydown and multiple and here the multiple was flat, so growth did most of the work with deleveraging behind it.' That sentence is the entire theory of leveraged buyouts, delivered in one breath.

The follow-ups and what they test

The standard escalation: what if exit is at 7.0x instead? Recompute calmly, US$1,120m less US$250m is US$870m, call it 2.9x, roughly 24% and note the lesson, one turn of multiple cost about four points of IRR. What is the maximum debt this company could carry? Now you are in coverage and leverage constraints, which is the LevFin article's territory on this site. Why does debt amplify returns at all? Because the equity cheque shrinks while the enterprise gains accrue to it, the same whose-cash logic that runs from the DCF anchor article through this entire series. And the honest curveball, would you do this deal, wants judgement: at full price with flat multiples, the deal depends entirely on the growth being real.

How to train it

Not by reading: by reps. Generate random clean setups, entry multiple, leverage, growth, hold and run the four blocks aloud against a timer until ten minutes feels roomy. Then have someone change an assumption at block three, because recovering gracefully mid-flight is the actual examined skill, in this exercise and in the modelling tests it often accompanies. Context helps too: the PE versus VC article explains whose interview this is natively and why banking increasingly borrows it. Running it live against pushback is a standard segment of the IBD Recruiting Review.

FAQ

How do I solve a paper LBO?

Four blocks aloud: entry, operations, exit, returns. State assumptions before using them, round early and finish by attributing returns across growth, deleveraging and multiple.