IB Interview Questions: LBO : Level 1 LBO Questions

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1. What is an LBO?

LBO stands for ‘Leveraged’ Buyout which is an acquisition of a company in which a meaningful portion of the deal funding comes from Debt.

2. Why do PE firms acquire with Debt as opposed to purchasing outright with equity?

By using leverage, Private firms can increase the return on the money they invest by putting less money upfront, while still capturing the cash flow and appreciation of the business over time.

3. What are the underlying value creation drivers in an LBO?

The primary value creation drivers are Purchase Price, EBITDA growth, and Cash Flow.

Secondary drivers include the level of Debt at purchase, the interest rate on the Debt, and the Exit multiple.

The latter group are secondary as they are all typically not within the control of the PE firm.

4. What is the difference between a levered and unlevered return?

The Unlevered return on any asset reflects the pure profit (ideally Cash Flow), excluding the impact of Debt, generated by the Asset relative to the Purchase Price/Value of that asset.

Conversely, the Levered return on any Asset takes into account the impact of Interest payments on Debt on Cash Flow relative to Equity Purchase Price/Value.

5. What makes an ideal LBO candidate?

The ideal LBO Candidate has: 1) Steady/Recurring Cash Flows, 2) Low Reinvestment Needs, 3) Strong Management, and 4) Strong Exit Options

6. What metrics are typically used to measure returns in an LBO?

The Internal Rate of Return (IRR) or the Multiple of Invested Capital (MOIC).

7. What is an Internal Rate of Return (IRR)?

IRR reflects the underlying rate of return for a set of future cash flows.

More formally, the IRR reflects the discount rate at which the Net Present Value of a set of cash flows equals zero.

8. What is the typical target return for PE funds?

Most PE funds target between a 15-25%+ annual rate of return.

The targeted rate of return varies significantly depending on the size and riskiness of each investment.

9. What is a ‘platform’ or ‘roll-up’ strategy?

With a platform or roll-up strategy, a Private Equity firm will acquire an initial (or ‘Platform’) business and then acquire multiple additional (‘add-ons’ or ‘tuck-ins’) businesses combing into a single company with an aim to generate synergies and to drive increased growth.

10. What are the typical options for exiting an LBO transaction?

Private Equity firms can either sell the company to a strategic buyer, sell the company to another PE firm (a ‘Secondary Buyout’), or take the company public through an IPO.

11. What is a dividend recapitalization (or ‘Dividend Recap’)?

In a Dividend recapitalization, a Private Equity firm takes out additional debt and pays itself a dividend.

This usually occurs when a company has performed well and has extra debt capacity, but the Private Equity firm isn’t yet ready to sell the business.

12. Where does LBO fit into the overall PE Landscape?

Leveraged Buyouts are considered ‘Late Stage’ as most LBOs acquisitions involve more mature businesses.


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