IB Interview Questions: LBO : Level 2 LBO Questions

- May 19, 2024

1. Walk me through an LBO?

There are six major steps to answer this question:

Calculate Purchase Price (or ‘Enterprise Value)

Determine Debt and Equity Funding

Project Cash Flows

Calculate Exit Sale Value (or ‘Enterprise Value’)

Work to Exit Owner Value (or ‘Equity Value’)

Assess Investor Returns (IRR or MOIC)

Remember to initially keep your answer high-level and let the interviewer pull you into the details.

2. If IRR is time-weighted, why do we use MOIC?

IRR can be easily distorted by factors like an early exit.

And at the end of the day, PE firms are paid based on absolute dollars returned to investors. So, PE firms look at the MOIC in conjunction with dollars invested to assess the absolute dollars returned for a deal.

3. How can you buy a company for $500M, then sell it for $500M 5 years later, but triple your investment?

I can borrow $400M of the Purchase Price and invest $100M of Equity.

Then I use the cash flows of the business to pay off $100M of debt.

I exit with a $500M Sale Price – $300M Debt = $200M Equity (2.0x Return).

4. All else equal, would you prefer to sell to a sponsor or strategic/corporate buyer?

You would typically prefer to sell to a Strategic/Corporate buyer because they can typically pay a higher price due to synergies.

5. What is Rollover Equity?

When management of a company sold in an LBO transaction retains ownership in a company following an LBO transaction.

6. What is LIBOR? What about SOFR?

The London Interbank Offered Rate (LIBOR) is the benchmark interest rate major global banks use to lend to one another.

LIBOR will be phased out in the coming years and will be replaced by the Secured Overnight Financing Rate (SOFR).

7. What is the difference between Loan (i.e. ‘Bank’) and bond debt?

Loan debt is typically more senior and consists of Revolving Credit Facility and Term Loan instruments.

Bond Debt is an entirely separate category of debt that is generally more junior in an LBO transaction.

8. What are Maintenance vs Incurrence covenants?

Maintenance covenants must be tested frequently (typically quarterly). If the company doesn’t meet the covenant, it’s typically an Event of Default.

Maintenance covenant arrangements are most common with Loan debt.

By contrast, Incurrence covenants are only tested when a company issues new debt (or has a major corporate action like an Acquisition).

Incurrence covenant arrangements are most common with Bond debt.

9. What is ‘Covenant Lite’ debt?

Covenant lite debt describes debt that has either lenient covenants or no covenants at all.

‘Covenant Lite’ debt arises when there exists significant competition among lenders.

10. What are the most common Leverage and Coverage Ratios for debt in an LBO transaction?

Leverage Ratio: Net Debt / EBITDA

Coverage Ratio: EBITDA / Interest Expense

11. What is PIK interest?

Paid-In-Kind (PIK) interest is non-cash interest that is added to the Debt principal balance in each period in lieu of the borrower paying cash interest.