LBO Series · Guide 06

Paper LBO Guide

Do a full LBO on paper in 5 minutes. The shortcuts, the mental math tricks, and the exact sequence to use when an interviewer hands you a blank piece of paper and a case.

What Is a Paper LBO?

A paper LBO is a simplified leveraged buyout analysis done by hand, without a spreadsheet, in roughly 5 minutes. You'll see it in first-round PE interviews and sometimes in investment banking interviews as well.

The goal is not precision — it's showing you understand the mechanics well enough to work through the problem quickly and arrive at a defensible IRR estimate. You're being tested on your thought process as much as the answer.

The Paper LBO Myth

Candidates spend too much time trying to be exact. A paper LBO done to ±3% IRR accuracy in 4 minutes beats a perfect one delivered in 8 minutes. Work fast, round aggressively, and explain your shortcuts as you go. Interviewers know the real answer — they want to watch how you think.

The Worked Example

Here's a real case prompt in the format you'll receive it:

Case Prompt

"You're looking at a manufacturing company with $200M of LTM revenue and a 25% EBITDA margin. You expect the company to grow revenue at 5% per year with margins improving 50 basis points annually. You can acquire it at 8x EBITDA with 4.5x in debt financing. Assume a 5-year hold and exit at the same 8x multiple. What's your IRR?"

Step-by-Step Solution

~0:30 Step 1 — Parse the Entry Numbers

LTM EBITDA = $200M × 25% = $50M

Purchase Price = $50M × 8x = $400M

Debt = $50M × 4.5x = $225M

Equity = $400M − $225M = $175M

~1:00 Step 2 — Project Exit EBITDA

Revenue grows at 5%/year for 5 years: $200M × (1.05)^5 ≈ $200M × 1.28 = $255M

Mental Math Shortcut

(1.05)^5 ≈ 1.28. Memorize: (1.05)^5 = 1.276 ≈ 1.28. Similarly (1.05)^3 = 1.16, (1.05)^7 = 1.41. Write these on paper before your interview.

EBITDA Margin starts at 25%, improves 50bps/year × 5 years = 27.5% at exit.

Exit EBITDA = $255M × 27.5% ≈ $70M

Exit EV = $70M × 8x = $560M

~2:00 Step 3 — Estimate Debt Paydown

Estimate FCF available to pay debt each year. Simplified: FCF ≈ EBITDA × (1 − effective cash rate) minus maintenance capex.

Simple approximation: FCF = ~40–50% of EBITDA after interest and taxes at these leverage levels.

Approx FCF/year = ~$25–$30M (using 50% of ~$55M avg EBITDA)

Total FCF over 5 years ≈ $25M × 5 = $125M in debt paydown

Exit Debt = $225M − $125M = $100M

Exit Equity = $560M − $100M = $460M

~3:00 Step 4 — Calculate MOIC and IRR

MOIC = $460M / $175M = 2.6x

Now convert to IRR. Use the MOIC → IRR approximation table:

MOIC to IRR Conversion (5-Year Hold) — Memorize This

MOIC	Approx IRR	Memory Trick
2.0x	15%	Minimum acceptable
2.5x	20%	Institutional floor
3.0x	25%	Target return
3.5x	29%	Good deal
4.0x	32%	Great deal
5.0x	38%	Excellent deal
6.0x	43%	Exceptional

At 2.6x MOIC over 5 years, IRR ≈ 21%. The formula: IRR = MOIC^(1/n) − 1.

IRR = 2.6^(1/5) − 1 = 2.6^0.2 − 1 ≈ 21%

~4:00 Step 5 — State Your Answer and Return Attribution

Say: "Based on my estimates, this deal generates roughly a 2.6x MOIC and ~21% IRR over 5 years. That clears a 20% hurdle but doesn't leave much cushion. The returns are driven primarily by EBITDA growth — going from $50M to $70M — and the debt paydown of ~$125M. If the margin improvement thesis holds, we're in institutional return territory. The key risk is execution on the operating improvement plan."

Paper LBO on a Single Page — What to Write

Your Paper — What Goes on the Page

Section	What to Write
Entry	EBITDA → Purchase Price → Debt → Equity (Sources & Uses)
Exit EBITDA	Revenue × (1+g)^5 × Exit Margin
Exit EV	Exit EBITDA × Exit Multiple
Debt Paydown	~40–50% of avg EBITDA × 5 years
Exit Equity	Exit EV − Remaining Debt
MOIC	Exit Equity / Entry Equity
IRR	From MOIC table or MOIC^0.2 − 1

Common Mistakes in Paper LBOs

Forgetting that EBITDA grows in the denominator of FCF — Your interest costs stay roughly flat (or decline), but EBITDA grows, so FCF per year increases. Estimate FCF on average EBITDA, not Year 1 EBITDA.
Using EBITDA as a proxy for FCF without deducting interest and taxes — At 4.5x leverage with ~8% interest rate, you're paying ~$18M/year in interest on $225M of debt. That's a big number on $50M EBITDA.
Computing IRR by dividing MOIC by hold period — (2.6x / 5 years ≠ IRR). Use the exponential formula or the table above.
Assuming all FCF goes to debt paydown in year 1 — It doesn't. Debt paydown builds as cash flow improves. Spread it evenly across 5 years as a first approximation.
Forgetting transaction fees in sources & uses — In a real interview case, fees are usually given. If not, assume 1–2% of deal value.

Faster Mental Math Shortcuts

EBITDA × (1 − total tax-equivalent rate) ≈ FCF. Effective rate at 4.5x leverage is roughly 50–55% of EBITDA.
Compound growth: For 5% × 5 years, use 1.28. For 7% × 5 years, use 1.40. For 10% × 5 years, use 1.61.
Quick IRR check: MOIC^(0.2) − 1. So 3.0^0.2 = 1.246, IRR ≈ 24.6%.

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