The Paper LBO: A Step-by-Step Interview Walkthrough

Why PE Firms Test Paper LBOs

A paper LBO is not about building a spreadsheet. It is about demonstrating that you can think like a private equity investor — quickly estimating whether a deal generates acceptable returns using mental arithmetic and a structured framework.

Interviewers are testing three things: can you structure the problem, can you do rough maths under pressure, and do you understand what drives returns in a leveraged buyout.

The Four-Step Framework

Step 1: Entry

Start with the company's EBITDA and the entry multiple. Multiply to get enterprise value. Then split into debt and equity based on the leverage ratio.

Example: Company has £100M EBITDA. Entry at 8x. EV = £800M. Debt at 60% = £480M. Equity at 40% = £320M.

Step 2: Hold Period

Project EBITDA growth over the hold period (typically 5 years). A simple compound growth assumption works.

Example: 5% annual EBITDA growth over 5 years. Exit EBITDA = £100M × (1.05)^5 ≈ £128M. Shortcut: at 5% for 5 years, multiply by 1.28.

Also estimate how much debt is paid down from free cash flow during the hold.

Step 3: Exit

Apply an exit multiple to the projected EBITDA. In a base case, assume the same multiple as entry (no multiple expansion). Calculate exit EV and subtract remaining debt to get exit equity.

Example: Exit at 8x on £128M EBITDA = £1,024M EV. Assume £80M of debt paid down, so remaining debt = £400M. Exit equity = £1,024M - £400M = £624M.

Step 4: Returns

MOIC = Exit Equity / Entry Equity. IRR is approximated from MOIC and hold period.

Example: MOIC = £624M / £320M = 1.95x. For 5 years, use the approximation: IRR ≈ (MOIC)^(1/5) - 1 ≈ 14%. This is below the 20% target — the deal does not work at these assumptions.

IRR Approximation Shortcuts

Memorise these anchor points:

• 2x in 5 years = ~15% IRR
• 3x in 5 years = ~25% IRR
• 2x in 3 years = ~26% IRR
• 3x in 3 years = ~44% IRR

The Rule of 72 also helps: divide 72 by the IRR to get the doubling time. 72 / 15 ≈ 5 years to double your money.

What Drives Returns in an LBO

Returns come from three sources:

• EBITDA growth — organic revenue growth or margin improvement increases exit enterprise value
• Multiple expansion — exiting at a higher multiple than entry (never assume this in a base case)
• Debt paydown — as the company generates cash and repays debt, equity value increases pound-for-pound

Common Mistakes

• Assuming multiple expansion in the base case — interviewers will challenge this immediately
• Forgetting to subtract remaining debt from exit EV — you are calculating equity returns, not enterprise returns
• Using overly optimistic growth rates without justifying them
• Not knowing the IRR shortcuts — fumbling with mental maths wastes time and confidence

Take Your Preparation Further

For a complete PE interview preparation including paper LBOs, integrated models, deal experience frameworks, and investment memo structure, see the PE Interview Masterclass. Practice building full LBO models with our LBO Model Template.

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