LBO Model Interview Questions: What to Expect finance interview questions

by alsaCEMusic

In this tutorial, you’ll learn about the most common LBO modeling-related questions and some tricks and rules of thumb you can use to approximate the IRR and solve for assumptions like the purchase price and EBITDA growth in leveraged buyouts.

Table of Contents:

2:36 Question #1: LBO Model Walkthrough

5:34 Question #2: Ideal LBO Candidates

8:09 Question #3: How to Approximate IRR

11:46 Question #4: How to Solve for EBITDA or the Purchase Price

13:58 Question #5: How to Approximate the IRR in an IPO Exit

16:03 Recap, Summary, and Key Principles

Lesson Outline:

Will you get LBO-related questions in interviews?

Yes, possibly, but full case studies are unlikely unless you’re interviewing for PE roles or more advanced IB roles.

Interviewers now ask trickier questions about the fundamentals, they ask progressions of questions on the same topic or scenario, and they’re more likely to give you *simple* cases and numerical tests rather than complex ones.

A typical progression for LBO models might be as follows:

Question #1: LBO Model Walkthrough

“In a leveraged buyout, a PE firm acquires a company using a combination of Debt and Equity, operates it for several years, and then sells it; the math works because leverage amplifies returns; the PE firm earns a higher return if the deal does well because it uses less of its own money upfront.”

In Step 1, you make assumptions for the Purchase Price, Debt and Equity, Interest Rate on Debt, and Revenue Growth and Margins.

In Step 2, you create a Sources & Uses schedule to calculate the Investor Equity paid by the PE firm.

In Step 3, you adjust the Balance Sheet for the effects of the deal, such as the new Debt, Equity, and Goodwill.

In Step 4, you project the company’s statements, or at least its cash flow, and determine how much Debt it repays each year.

Finally, in Step 5, you make assumptions about the exit, usually using an EBITDA multiple, and calculate the MoM multiple and IRR.

Question #2: Ideal LBO Candidates

Price is the most important factor because almost any deal can work at the right price – but if the price is too high, the chances of failure increase substantially.

Beyond that, stable and predictable cash flows are important, there shouldn’t be a huge need for ongoing CapEx or other big investments, and there should be a realistic path to exit, with returns driven by EBITDA growth and Debt paydown instead of multiple expansion.

Question #3: Approximating IRR

“A PE firm acquires a $100 million EBITDA company for a 10x multiple using 60% Debt.

The company’s EBITDA grows to $150 million by Year 5, but the exit multiple drops to 9x. The company repays $250 million of Debt and generates no extra Cash. What’s the IRR?”

Initial Investor Equity = $100 million * 10 * 40% = $400 million

Exit Enterprise Value = $150 million * 9 = $1,350 million

Debt Remaining Upon Exit = $600 million – $250 million = $350 million

Exit Equity Proceeds = $1,350 million – $350 million = $1 billion

IRR: 2.5x multiple over 5 years; 2x = 15% and 3x = 25%, so it’s ~20%.

Question #4: Back-Solving for Assumptions

“You buy a $100 EBITDA business for a 10x multiple, and you believe that you can sell it again in 5 years for 10x EBITDA.

You use 5x Debt / EBITDA to fund the deal, and the company repays 50% of that Debt over 5 years, generating no extra Cash. How much EBITDA growth do you need to realize a 20% IRR?”

Initial Investor Equity = $100 * 10 * 50% = $500

20% IRR Over 5 Years = ~2.5x multiple (2x = ~15% and 3x = ~25%)

Exit Equity Proceeds = $500 * 2.5 = $1,250

Remaining Debt = $250, so Exit Enterprise Value = $1,500

Required EBITDA = $150, since $1,500 / 10 = $150

Question #5: Approximating IRR in an IPO Exit

“A PE firm acquires a $200 EBITDA company for an 8x multiple using 50% Debt.

The company’s EBITDA increases to $240 in 3 years, and it repays ALL the Debt. The PE firm takes it public and sells off its stake evenly over 3 years at a 10x multiple. What’s the IRR?”

Initial Investor Equity = $200 * 8 * 50% = $800

Exit Enterprise Value = Exit Equity Proceeds = $240 * 10 = $2,400

“Average Year” to Exit = 1/3 * 3 + 1/3 * 4 + 1/3 * 5 = 4 years

IRR: 3x over 3 years = ~45%, and 3x over 5 years = ~25%

Approximate IRR: ~35% (This one’s a bit off – see Excel.)



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Tejas Kashyap 22/12/2021 - 3:29 Chiều

How does the rule of 72 or 114 apply here?

Ardian sati 22/12/2021 - 3:29 Chiều

I am confused, is the IRR you are talking about more like an annualized rate of return or is it the discount rate at which NPV will equal to zero.

Kevin Francis Marcaida 22/12/2021 - 3:29 Chiều

I've never done an LBO model in my life and I understood the questions pretty clearly. Great video

Deepti Sharma 22/12/2021 - 3:29 Chiều

Hi, Both holding and exit periods should be 3,5,7 only to use these tricks. it won't work otherwise. Did I get it correct?

Igor Machado 22/12/2021 - 3:29 Chiều

Fernando Veiga Prata! Seja homem e me desbloqueie, está fazendo papel de moleque, desonesto e babaca. Espero seu contato caloteiro!!!

Ricardo Méndez López 22/12/2021 - 3:29 Chiều

Hi! in #4, how do you know from "5x Debt/EBITDA" that debt is 50% of the funding? Thanks!

Teodoro de Paula Slemenson 22/12/2021 - 3:29 Chiều

Do we need to memorize the IRR multiples or we'll be able to use excel =IRR() for the interview?

Ke Ming Yu 22/12/2021 - 3:29 Chiều

Got fucked by Blackstone first round with extra difficult irr qn with formulas I haven't seen in biws and anywhere in particular

EffingFailure 22/12/2021 - 3:29 Chiều

Hello! I just wanted to give you a massive massive sincere thank you. I have today secured the internship of my dreams at PJT partners, And it’s all off the back of my technical ability – made possible by all the videos of yours I binged! Your content is by far the best out there on the internet, and really helped me UNDERSTAND the logic behind these models. This channel and your time has given so much to me and I hope I can give back one day.

Mal Gray 22/12/2021 - 3:29 Chiều

thankyou bro

Bruno Franco 22/12/2021 - 3:29 Chiều

Hi Brian,

One question regarding Question #5: if the PE firm still has shares during the IPO, shouldn't we account the cash generated from the business as cash to the PE firm, multiplied by its current shares?
We might have to assume some value for that cash generated. However, I think it's a more realistic assumption that assuming no extra cash is generated by the company after it pays all its debt.
What do you think?

Thank you for your help,

Laura Sanders 22/12/2021 - 3:29 Chiều

Brian how are you doing these mental maths in your head so quickly? Are there any shortcuts or tips you have?

Jose Leon 22/12/2021 - 3:29 Chiều

Hey Brian, around the 15:52 mark. You show the excel calculation, but I was wondering why did you not include the cash out flow of repayment of the debt? So cash flow would look like: -8 0 0 0 8 8 (yr 3 I netted the 8 inflow from 33% sale and payment of the debt)

Marius Becker 22/12/2021 - 3:29 Chiều

Great video, thanks! Not to be too nit-picky but we didn't completely answer the 2nd question since it asked for a growth figure (50% over 5 years) not an EBITDA value.

Sergio Barreto 22/12/2021 - 3:29 Chiều

Would you be allowed to use a pen and paper for these sorts of questions?

Francis Monsada 22/12/2021 - 3:29 Chiều

Brian, where does the $500 in the "Exit Equity Proceeds = $500 * 2.5 = $1,250" come from? Did you just add up the 100EBITDA per year x 5?

James Avery 22/12/2021 - 3:29 Chiều

Can you please explain how you would calculate the average exit year with a dividend recap and an M&A exit? Also, you keep on assuming that no extra cash is generated…what is this is not the case?

Hercial Vitalis 22/12/2021 - 3:29 Chiều

learn a lot from the tutorial

Yoel Herman 22/12/2021 - 3:29 Chiều

Thanks a lot, Great Video!. Quick Questions: (1)in approximating IRR in question 3, how do you choose the most relevant "<100%" figure?

Betty QI 22/12/2021 - 3:29 Chiều

@15:29 If follow the equation exactly, you get the IRR 200/4*0.65=32.5%, which is pretty close to 32% in the excel
Also, what do you consider as a good answer if the interviewer asks why moving from IBD (where I summer interned) to private capital management firm? My initial intention is it's easier to break in.


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