Paper LBO Model Example: How To Rip Through A Paper LBO in 5 Minutes - PRIVATE EQUITY INTERVIEWS: THE OFFICIAL GUIDE

Paper LBO Model Example: How to rip through a paper LBO in 5 minutes - PRIVATE EQUITY INTERVIEWS: THE OFFICIAL
GUIDE 03/02/2022, 21:07
Private Equity Interviews: The OAcial

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Paper LBO Model Example:

How to rip through a paper
LBO in 5 minutes
Andrew C.
Alrighty campers. Today, I’m gonna teach you all
about paper LBOs. Get Our FREE
I’ll show you how to develop a gut instinct for 10-Part Email
whether a PE deal is attractive or not. Mini-Course
On How To
If you follow along and practice a few times on your
own afterward, you’ll soon develop an instinct Break Into
within 5 minutes of looking at a deal / company. Private
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Paper LBO Model Example: How to rip through a paper LBO in 5 minutes - PRIVATE EQUITY INTERVIEWS: THE OFFICIAL GUIDE 03/02/2022, 21:07
Why is this important? Equity:

Because you WILL be asked to do this on the fly in Networking,
interviews by just about all PE firms. Interviewing,
And LBOs
So developing this instinct and judgment on your
own and searing it into your brain is critical. (No spam or BS,
ever. Unsubscribe
anytime.)
What is a paper LBO?
A paper LBO is exactly what it sounds like: modeling Enter your email
an LBO and calculating returns using only a paper
and pencil.
Let's Do This
You might be allowed to use a calculator, but you
might not. So it’s best to assume you’ll have to do
all the math in your head.
Given that, I have 2 guidelines:
One, SIMPLIFY your assumptions as much as

possible. But be transparent and call out when
Products
you simplify something. You can say it’s 3 Statement,
something you would go into more detail if you DCF, and LBO
had more time (or a computer). Modeling Online
Training Videos:
Two, use round numbers to make estimates Combo Packages
easier to compute in your head. If you are
Financial
dealing with decimals, round them. Say you’re
Modeling Online
doing this to simplify calculations and it
Video Training
shouldn’t change the answer about whether to
Course: 3
invest. Again, you can say you’d go into more
Statement and
detail if you had more time, or a computer.
DCF Modeling
PE and LBO
It’s definitely OK to use round numbers and simplify
Modeling
assumptions. In fact, it’s highly recommended.
Training Videos
That is MUCH better than trying to be a superhero
Private Equity
and calculate to the 2nd decimal place on everything
Interview Guide:
and then making MISTAKES.
How to Nail Your
Mistakes in a paper LBO easily snowball and blow up Private Equity

your calculations. Interview
(whether you
You can end up with results that make no sense. And
have finance
that’ll just make you look stupid. Those situations
training or not)
don’t result in o!ers.
How to Break
Don’t do that… into Private
Equity: Forward
Keep things simple. Focus only on the key stats you
need.
The key stats you need to calculate returns / deal

attractiveness are:
The entry multiple Popular

The exit multiple
posts
What the multiple is keyed o! of (typically
EBITDA, but you should confirm) What Do Private
Revenue, if EBITDA is not given to you directly Equity Investors
EBITDA margin, if the amount is not given to Actually Do?
you directly
Types of Private
Depreciation & Amortization amounts or %
Equity Funds
CapEx amounts or %
Starting debt amount Top Private
Interest % Equity Firms in
Terms of any mandatory debt repayment New York City
schedule (e.g., linear repayment, bullet
How Private
payment)
Equity Firms
Estimated change in net working capital (if not
Really Make
given, you’ll have to deduce the di!erence
Money: The
between non-cash current assets and non-debt
Carried Interest
current liabilities, then compute the change in
Distribution
net working capital for each period)
Waterfall
Cash taxes
Paper LBO Model
Example: How to
Focus like a laser beam on extracting these stats
rip through a
from the problem and you’ll be well-positioned to
paper LBO in 5
evaluate the deal e"ciently.
minutes
Let’s jump into our example to show you what we Why Can You
mean. Make So Much
Money In Private
Let’s say PE Capital Partners is evaluating whether
Equity?
to invest in TargetCo, a regional brick and mortar
retail chain with 50 stores across 8 states. Private Equity
LBO Modeling
The company sells general purpose merchandise just Tests: Who gets
like Wal-Mart does, but it’s less than 10 years old them? What are
and appeals to younger shoppers who want a cleaner they?
shopping experience.
Private Equity
PE Capital is considering a purchase for 5.0x LTM LBO Modeling
EBITDA. LTM Revenue is $500M. PE Capital will Tests: Key
borrow 60% of the purchase price and invest 40% Components of
equity capital. The weighted average interest rate for the LBO
all debt is estimated at 8%. Modeling Test
Presentation
The credit agreement provides that $30M must be
amortized annually. PE Capital plans to use all excess Who are the top
free cash to pay down principal. headhunters for
private equity
TargetCo’s revenue is expected to grow organically jobs?
7% annually for the next 5 years, at which time PE
How Are Private
Capital plans to sell the company. The company’s
Equity Firms
biggest revenue drivers are electronics and
Structured?
household products.
So Who Gets
Over the last few years, TargetCo has fairly
Private Equity
consistently booked EBITDA margins of ~20%.
Jobs Anyway?
Capital expenditure hovers around 5% of revenue
annually. Net working capital is roughly 3% of Private Equity
revenue per year. The company depreciates ~80% of LBO Modeling
its CapEx each year. The company’s tax rate is 40%. Tests: The
Interview
Whew! I just threw a lot of facts at you. Presentation,
How to Practice,
In your PE interview, your paper LBO case might be
and How the
simpler, or it might be more complicated. It might
Test is Evaluated
have lots of extraneous information. It might be a 3-
page print out with 80% irrelevant details. How Do You Get
The point is, it can take lots of di!erent forms. So a Private Equity
whatever it is, you’re gonna have to quickly organize Job? (Series)
the facts and pull out the critical pieces of info you
How Does the
need.
Recruiting
To use your time e"ciently, I strongly urge you to Process for
work backward
backward. Start with the END RESULT you Private Equity
want, and then back into the data you need to Jobs Work?
compute that result. Private Equity
and LBO
In this case, it’s easy to determine the ENTRY
Modeling
purchase price.
Training Course
But to evaluate the EXIT price and equity return,
What Is Private
you’ll have to know what final year EBITDA is, and
Equity?
how much debt is left at the end of the holding
period. What are pre-
MBA private
After you know that, the equity return is easily equity associate
calculated as: interviews like?
(Total exit price – remaining debt) / Original What are Bain

entry equity Capital pre-MBA
private equity
That is the formula for determining your multiple-
associate
of-money return. interviews like?
Burn that formula into your BRAIN BRAIN, because you When Should
are going to ruthlessly solve for each piece of that You Start
formula. Looking for a
Private Equity
The most computationally intensive piece is by far
Job?
the remaining debt amount after 5 years. That
will always be the variable that takes the most Why did you
arithmetic to solve. leave the private
equity
You can solve for the other pieces fairly easily. profession?
To solve for the entry purchase price, you just need
the purchase multiple and the starting EBITDA
amount.
To solve for exit price, you need the purchase

multiple and the ending EBITDA amount.
So let’s start with those.
For the entry price, we take LTM revenue of $500M,

compute LTM EBITDA of 20% which is $100M, and
multiply by the entry multiple of 5.0x.
That’s a $500M purchase price.
Since we know the debt vs. equity split is 60 / 40, we

determine right away that the transaction is $300M
debt, $200M equity.
So our original entry equity is $200M.
For the exit price, absent other information, you

should always assume you’ll use the same
multiple you purchased at
at, in this case 5.0x LTM
EBITDA.
Why?
Because, even if we did nothing during the time we

own the company, as long as we paid a FAIR price for
it, we should be able to assume the next buyer will
also pay a fair price for it — as reflected in the
purchase multiple.
Of course, that assumes we did not overvalue the

company in the first place!
And assuming we as PE investors actually IMPROVE

the company, say, by growing revenue above organic
rates or by optimizing costs, then we may arguably
get an even HIGHER purchase multiple at exit
because we’ve actually done the hard work of
improving the company.
For now, let’s calculate the exit price by taking Year

5 EBITDA and simply multiplying it by our original
5.0x multiple.
It’s gonna take a bit of math, so let’s work quickly

through it.
Revenue grows at 7% annually and EBITDA is 20%.
So, starting with $500M LTM revenue, quickly

calculate Year 5 revenue. (Remember: no
calculators.)
I like to use this little shortcut:
First, I know 10% of $500M is $50M, so half that is

$25M, which is 5%.
Second, I know 1% of $500M is $5M, and double that

is $10M, which is 2%.
5% + 2% = 7% (annual revenue growth). So that

means $25M + $10M + $500M is Year 1 revenue
growth.
Scribble that onto your paper, like this:
At end of year…
Y0 Y1 Y2 Y3 Y4 Y5
500 535 ? ? ? ?
Now I do the same shortcut for Year 2.
10% of $535M is $53.5M. Half that is $26.75, which a

double decimal, which makes my head want to
explode.
So I’m gonna round up to $54M and take half that

instead, which is $27M. That’s close to 5%.
Good enough for government work, as they say.
When I do this, I’ll probably orally call out my

rounding move to be transparent about why I’m
making this simplification (i.e., it’s good enough for
an estimate, it’ll yield the same answer, and it’s
faster to compute).
1% of $535M is $5.35M. Double that is $10.7M.

Decimals make my head want to explode. So I’m
gonna simplify and round up to $11M, which is my
2% estimate.
Now I’ll just add $27M + $11M + $535M:
Y0 Y1 Y2 Y3 Y4 Y5
500 535 573 ? ? ?
Keep going.
10% of $573M is $57.3M. Half that is $28.65M. My

head wants to explode. Round up to $29M for 5%.
1% of $573M is $5.73M, double that is ~$11.4M. My

head wants to explode. Simplify and round down to
$11M for 2%.
Add it up: $29M + $11M + $573M.
Y0 Y1 Y2 Y3 Y4 Y5
500 535 573 613 ? ?
Keep ripping through.
10% of $613M = $61.3M, half that rounded down is

$30M.
1% of $613M = $6.13M, double that is $12.26.

Explode. Round down to $12M.
$30M + $12M + $613M:
Y0 Y1 Y2 Y3 Y4 Y5
500 535 573 613 655 ?
Last lap.
10% of $655M = $65.5M, half that rounded up is

$33M.
1% of $655M = $6.55M, double that is ~$13M.
$33M + $13M + $655M:
Y0 Y1 Y2 Y3 Y4 Y5
500 535 573 613 655 701
Voila.
Now you have revenue estimates for 5 years. It’s not

decimal accurate, but it’s good enough for a paper
LBO for sure.
Don’t get complicated and try to do decimals unless

you are a FREAK OF NATURE whiz at doing quick
math.
Be open and transparent about your rounding moves

and your interviewer will be fine with it.
In fact, some people only round to units of 10 or 5,

like this:
Y0 Y1 Y2 Y3 Y4 Y5
500 535 570 610 655 700
That will create slightly larger computation errors,

but is largely still correct.
The fact that we’re at least calculating to the single

integer level means our analysis is already pretty
sophisticated.
Anyway, final year LTM revenue of $701M means

final year LTM EBITDA at 20% margin is ~$140M
(rounding for simplicity).
$140M at a 5.0x multiple is $700M.
So ~$700M is our exit price

price.
Now, remember the key stats we said you should

focus like a laser beam on earlier?
You can now cross some items o! that list.
The entry multiple

The exit multiple
What the multiple is keyed o! of (typically
EBITDA, but you should confirm)
Revenue, if EBITDA is not given to you directly
EBITDA margin, if the amount is not given to
you directly
Depreciation & Amortization amounts or %
CapEx amounts or %
Starting debt amount
Interest %
Terms of any mandatory debt repayment
schedule (e.g., linear repayment, bullet
payment)
Estimated change in net working capital (if not
given, you’ll have to deduce the di!erence
between non-cash current assets and non-debt
current liabilities — which is net working
capital; then figure the change in NWC for each
period)
Cash taxes
We’ve used all those pieces to calculate our exit

price.
Now we just need to know how much debt is left at

the end of Year 5 to calculate our multiple-of-money
return.
We’re gonna need our EBITDA numbers for all the

interim years to compute our debt paydown, so let’s
fill those in now (rounding where appropriate).
EBITDA is 20% per year, so:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
With our EBITDA numbers in place, we now have to
compute annual free cash flow to determine how

much debt to pay down each year.
Free cash flow is:
EBITDA
Less: CapEx
Less: Interest expense
Less: Cash taxes
Less: Change in net working capital
To compute interest expense, you’ll need to know

how much debt is paid o! each year. ‘Cause the way
we’re going to compute interest is as a simple
percent of beginning of year debt (to keep things
simple).
To compute cash taxes using the 40% tax rate, we

first need to know the interest expense amount and
the depreciation / amortization amount, since both
are tax-deductible.
Finally, computing CapEx and net working capital is

straightforward. We know CapEx is 5% of revenue
and NWC is 3%. We also know depreciation is 80% of
CapEx.
So let’s just estimate these statistics and fill them

into our paper chart quickly, using round numbers,
no decimals:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
Depreciation 20 21 23 25 26 28
CapEx 25 27 29 31 33 35
NWC 15 16 17 18 20 21
Now let’s compute interest expense, which is 8% of

beginning of year debt. We’ll have to compute this
simultaneously with calculating each year’s debt
paydown.
That’s because the amount of debt we amortize each

year determines next year’s beginning of year debt
balance.
In turn, that determines the year’s interest expense,

cash taxes, and free cash available for debt
repayment. There is a corkscrew-like circularity in
the formula, which you should Google if you’re not
familiar with it.
So we have:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
Interest – ? ? ? ? ?
Cash taxes 32 ? ? ? ? ?
CapEx 25 27 29 31 33 35
NWC 15 16 17 18 20 21
Beg. debt – 300 ? ? ? ?
Cash taxes are computed as:
(EBITDA – Depreciation – Interest expense) * 40%
For Year 0 (LTM), cash taxes are: (100 – 20 – 0) *

40% = $32M.
We won’t compute free cash for Year 0 because we

don’t know what the change in NWC was from the
prior year. But it doesn’t matter ‘cause we only need
to start our analysis from Year 1.
So in Year 1, let’s now compute interest expense,

cash taxes, and free cash flow.
Interest expense is 8% of $300M, or $24M.
So pre-tax earnings are: (107 – 21 – 24) = $62M.
Cash taxes are 40%, or $24.8M, but let’s round up to

$25M for simplicity.
Now we can compute free cash flow for Year 1. It’s:
EBITDA 107
Less: CapEx 27
Less: Interest payments 24
Less: Cash taxes 25
Less: Change in NWC 1
$31M in free cash. Let’s fill that in:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
Interest – 24 ? ? ? ?
Cash taxes 32 25 ? ? ? ?
CapEx 25 27 29 31 33 35
NWC 15 16 17 18 20 21
Beg. debt – 300 ? ? ? ?
FCF – 31 ? ? ? ?
End debt 300 269 ? ? ? ?
As you can see, we also went ahead and reconciled

beginning to ending debt amounts.
We know we have to pay back $30M o! the debt note

each year, and we use all excess cash to pay down
additional principal.
In this case, we’ll amortize $31M o! the note in Year

1, leaving a balance of $269M at the end of Year 1.
Let’s crank through Year 2:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
Interest – 24 22 ? ? ?
Cash taxes 32 25 28 ? ? ?
CapEx 25 27 29 31 33 35
NWC 15 16 17 18 20 21
Beg. debt – 300 269 ? ? ?
FCF – 31 35 ? ? ?
End debt 300 269 234 ? ? ?
We first calculate interest as 8% of $269M, or

~$22M.
Then we compute cash taxes: (115 – 23 – 22) * 40%

= $28M.
Then we compute free cash flow:
EBITDA 115
Less: CapEx 29
Less: Interest payments 22
Less: Cash taxes 28
Less: Change in NWC 1
We get: $35M.
Backing that out from our debt balance leaves $234M

in debt left.
As you can see, there’s a fair amount of arithmetic to

solve the debt paydown amount for each year.
Being able to work quickly, accurately, and

e!ciently with pencil on paper, and without having
to rely on a calculator, is a very critical skill.
Repeating the computation process for each
remaining year, and rounding to whole numbers

where appropriate, leaves us at the end of Year 5
with:
Y0 Y1 Y2 Y3 Y4 Y5
Revenue 500 535 573 613 655 701
EBITDA 100 107 115 123 131 140
Interest – 24 22 19 16 12
Cash taxes 32 25 28 32 36 40
CapEx 25 27 29 31 33 35
NWC 15 16 17 18 20 21
Beg. debt – 300 269 234 194 148
FCF – 31 35 40 46 52
End debt 300 269 234 194 148 96
Final year ending debt is $96M.
So now we can finish our formula:
(Total exit price – remaining debt) / Original

entry equity
Our entry was $500M, $300M debt and $200M

equity.
Our exit is $700M

$700M.
Remaining debt is $96M.
The multiple-of-money is:
(700 – 96) / 200 = ~3.0x.
So, in 5 years, we triple our money by investing in

TargetoCo with 60% debt and just riding the
company’s organic momentum. (Remember: we
haven’t suggested anything to improve the company
and accelerate sales or cut costs yet.)
We have a good idea of the IRR as well, which will be

~25% annually.
I know that because I’ve already memorized that,

over a 5-year hold, the following multiples of money
translate approximately into the following IRRs:
2.0x MoM → ~15% IRR
2.5x MoM → ~20% IRR
3.0x MoM → ~25% IRR
3.7x MoM → ~30% IRR
You should do the math yourself to validate these

numbers, and then once you do, burn them into
your BRAIN so you don’t have to think about them
anymore when you’re doing your analysis.
Now, this paper LBO also shows you exactly how

much of the value is created from the company’s
operations vs. from juicing returns using leverage /
debt.
If we used zero debt in the transaction, we would

have spent $500M in equity capital upfront, and
received ~$700M at exit, for a net return of $200M
which is a 40% return over 5 years, or an IRR of ~7%
annually.
With debt financing, our IRR is ~25%, and we take

home a net return of ~$400M after 5 years.
So leverage can create value.
But generally speaking, if that’s the ONLY card to

play in a deal, the deal may not be worth doing. (In
real life, it’ll be haaaaard to book a 25% IRR
using leverage alone.)
There might be other places to deploy capital that

will yield a higher risk-adjusted return — especially
considering that private equity is pretty much
illiquid until the fund retires.
Based on personal experience, a 3.0x MoM (~25%

IRR) over 5 years is generally the target you have to
try and hit for a PE deal to be attractive.
And to hit a 3.0x return, you’re usually gonna have to

truly create some value by rolling up your sleeves
and getting involved operationally.
You’ll have to grow EBITDA. In fact, one heuristic

I’ve internalized is that you should basically shoot to
roughly double EBITDA over 5 years to achieve a
worthwhile return.
Double EBITDA.
Now, how can you do that?
Well, there’s really only 2 ways: increase sales, or

decrease costs.
You can:
Grow revenue by volume (desirable)

Grow revenue by price (not desirable, because
not sustainable)
Reduce costs without adversely impacting
revenue (by trimming fat / operating costs,
optimizing supplier relationships / reducing

COGS, managing working capital more
e"ciently)
Whether through one of these methods or a

combination of them, the truly value-added PE
investors, the top-quartile ones, will proactively
grow EBITDA beyond organic levels.
In doing so, they generate a higher return and IRR

for their LPs than mediocre PE investors.
You want to be able to vocalize THESE kind of

insights when you tear down paper LBOs in your
interview.
It shows your interviewer you not only have a strong

grasp of the financial analytics. But you also see the
big picture of where private equity returns come
from: how much from organic lift, how much from
leverage, how much from operational
improvements, how much from multiple expansion,
etc.
Demonstrating mastery of these concepts, along

with the financial details, is what will set you
apart and get you to the next round.
So, study what I’ve shown you in this lesson and do a

bunch more practice problems to get REALLY
FAMILIAR with it.
It is a learnable skill.
If you put in the time and thought and diligence, you

WILL be able to crank through paper LBOs like this in
about 5 minutes, and then sit up and carry an
insightful and thoughtful discussion about the
company / deal for another 15.
That’s what it means to crush a paper LBO.
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Paper LBO Model Example: How to rip through a paper LBO in 5 minutes - PRIVATE EQUITY INTERVIEWS: THE OFFICIAL

GUIDE 03/02/2022, 21:07

Private Equity Interviews: The OAcial

Training Videos: PE Modeling E-book: PE Interview Guide

Paper LBO Model Example:

Why is this important? Equity:

Given that, I have 2 guidelines:

One, SIMPLIFY your assumptions as much as

Mistakes in a paper LBO easily snowball and blow up Private Equity

The key stats you need to calculate returns / deal

The entry multiple Popular

(Total exit price – remaining debt) / Original What are Bain

To solve for exit price, you need the purchase

So let’s start with those.

For the entry price, we take LTM revenue of $500M,

That’s a $500M purchase price.

Since we know the debt vs. equity split is 60 / 40, we

So our original entry equity is $200M.

For the exit price, absent other information, you

Because, even if we did nothing during the time we

Of course, that assumes we did not overvalue the

And assuming we as PE investors actually IMPROVE

For now, let’s calculate the exit price by taking Year

It’s gonna take a bit of math, so let’s work quickly

Revenue grows at 7% annually and EBITDA is 20%.

So, starting with $500M LTM revenue, quickly

I like to use this little shortcut:

First, I know 10% of $500M is $50M, so half that is

Second, I know 1% of $500M is $5M, and double that

5% + 2% = 7% (annual revenue growth). So that

Scribble that onto your paper, like this:

Now I do the same shortcut for Year 2.

10% of $535M is $53.5M. Half that is $26.75, which a

So I’m gonna round up to $54M and take half that

Good enough for government work, as they say.

When I do this, I’ll probably orally call out my

1% of $535M is $5.35M. Double that is $10.7M.

Now I’ll just add $27M + $11M + $535M:

500 535 573 ? ? ?

10% of $573M is $57.3M. Half that is $28.65M. My

1% of $573M is $5.73M, double that is ~$11.4M. My

Add it up: $29M + $11M + $573M.

500 535 573 613 ? ?

Keep ripping through.

10% of $613M = $61.3M, half that rounded down is

1% of $613M = $6.13M, double that is $12.26.

$30M + $12M + $613M:

500 535 573 613 655 ?

10% of $655M = $65.5M, half that rounded up is

1% of $655M = $6.55M, double that is ~$13M.

$33M + $13M + $655M:

500 535 573 613 655 701

Now you have revenue estimates for 5 years. It’s not

Don’t get complicated and try to do decimals unless

Be open and transparent about your rounding moves

In fact, some people only round to units of 10 or 5,

500 535 570 610 655 700

That will create slightly larger computation errors,

The fact that we’re at least calculating to the single