How to Answer “Walk me through sources and uses in an LBO.” in Private Equity Interviews
“Walk me through sources and uses in an LBO.” comes up frequently in LBO interview prep because it’s the fastest way to see whether you can translate a transaction headline into a closing-day cash reconciliation.
A strong associate-level answer explains sources and uses in LBO as a balanced table: what cash is needed at close (uses), where funding comes from (sources), and the specific conventions that prevent double-counting (EV vs equity value, treatment of target cash, fees and OID).
What Interviewers Test with Sources & Uses (Private Equity)
In private equity interview questions, this prompt tests structure and speed. Interviewers want to hear a clear definition of uses vs sources, a logical ordering of line items, and an explicit statement that total sources must equal total uses.
They’re also testing practical financial modeling judgment: which items are true cash at close (fees, debt repayment, OID) versus accounting items that get amortised later, and how enterprise value mechanics flow to equity value without errors.
Finally, it’s an entry point into broader LBO technical questions and an LBO case study discussion—how you size debt, when rollover equity makes sense, and what parts of the table are most sensitive (price, leverage/coverage constraints, and transaction/financing costs).
Sources and Uses in LBO: A Deal-Ready Walkthrough
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Step 1: Frame the table and confirm the pricing basis
Open by stating what the table represents: the closing-day cash flow for an LBO. Then define the terms in one breath:
- Uses are everything the buyer must pay or fund at close.
- Sources are the financing instruments and equity contributions that provide the cash.
Ask (or state) the valuation basis to avoid confusion: are we starting from enterprise value (EV) or directly from equity value? If EV, say you’ll bridge EV to equity value using net debt and other closing adjustments. This is often what the interviewer is really checking when they ask you to “walk through sources and uses in a leveraged buyout.”
Finish the setup with the core rule: the schedule must balance—total sources = total uses—and you’ll sanity-check it against the post-close balance sheet.
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Step 2: Build Uses in the order a model would reconcile cash at close
Walk through uses top-down and keep each line tied to a real cash outflow:
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Equity purchase / purchase price: If starting from EV, explain the bridge conceptually (EV adjusted for net debt and agreed closing items = equity value paid to shareholders). If starting from equity value, this is simply the cash paid for the shares.
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Repay/refinance existing debt: In many LBOs, target debt is taken out at close. State whether you’re assuming repayment at par and whether any prepayment premium/make-whole is included.
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Transaction fees & expenses: Advisory, legal, accounting, and other deal costs that are paid at close.
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Financing fees / OID: If debt is issued at a discount, cash proceeds are lower. You can show OID/upfront fees as a use (with gross debt sources) or net them in sources—either is acceptable if consistent.
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Incremental cash / minimum cash balance (deal-dependent): If the business needs a minimum cash balance post-close and you’re injecting cash to get there, it’s a use.
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Step 3: Lay out Sources as a credible capital stack (debt first, then equity)
Move to sources and present a plausible capital stack for a sponsor-backed deal:
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New debt tranches: Revolver (often undrawn at close), term loan(s), 2nd lien, mezzanine or high-yield—whatever fits the scenario. Mention sizing logic briefly (leverage/coverage constraints, business stability, and market terms).
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Sponsor equity cheque: The fund’s cash equity contribution. In many models this becomes the “plug” after setting debt capacity.
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Management rollover / co-invest: Equity rolled by management or existing owners. Call out that rollover reduces the sponsor cheque and improves alignment.
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Seller note / deferred consideration / earn-out (if applicable): Treated as a source because it reduces cash needed at close.
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Target cash (only if your convention allows it): If you’re effectively using balance sheet cash to help fund the transaction, state the convention clearly so you don’t double-count it in the EV-to-equity bridge.
If helpful, tie choices back to the investment thesis in LBO: more leverage can enhance equity returns but tightens downside flexibility; rollover can support retention and execution.
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Step 4: State the balancing checks and what you’d reconcile next in an LBO case study
Close with quick checks that signal strong sources and uses analysis in private equity interviews:
- Balance check: total sources = total uses, with no missing fees and no sign errors.
- EV-to-equity consistency: if you start from EV, confirm you’re not “paying for cash twice” and that debt you repay is included exactly once.
- Gross vs net debt proceeds: confirm whether OID/fees are in uses with gross sources, or netted in the relevant debt source.
- Post-close balance sheet logic: repaid target debt should be gone; any cash used as a source should reduce ending cash.
Then transition cleanly: once it balances, you can move to ownership (including rollover), entry leverage/multiples, and the return drivers you’d sensitise in an LBO case study (price, leverage, and operating performance).
Model Answer for LBO Technical Questions (Associate)
Sources and uses is the closing-day cash reconciliation in an LBO: uses are the cash outflows required to close the deal, sources are the funding inflows, and the table must balance—total sources equals total uses.
On the uses side, I start with the purchase price. If the headline is an enterprise value, I bridge to equity value by adjusting for net debt and any agreed closing items, and that equity value is what’s paid to shareholders. Then I add repayment or refinancing of any existing target debt that’s being taken out at close, plus cash transaction expenses like advisory and legal fees. I also include financing-related cash costs such as upfront lender fees or OID—either as a separate use if I’m showing gross debt proceeds, or netted against the relevant debt source, as long as I’m consistent. If the deal assumes a minimum cash balance post-close and we need to inject incremental cash, that’s another use.
On the sources side, I lay out the new capital stack: typically new term debt sized to leverage and coverage constraints, with the revolver often undrawn at close. Then I include equity funding—any management rollover or co-invest first, and the sponsor equity cheque as the remaining plug. Depending on structure, a seller note or deferred consideration can also be a source. If I’m treating target cash as a funding source, I’m explicit about the convention so I don’t double-count it in the EV-to-equity bridge.
I finish by checking sources equal uses and reconciling that repaid debt and fees are treated correctly before moving on to ownership and return sensitivities.
- Define uses vs sources first and state the balancing rule before listing line items.
- Flag the EV vs equity value basis early; most errors come from inconsistent treatment of debt and cash.
- Mention OID/fees as a consistency choice (gross vs net debt proceeds), not a memorised detail.
- Show associate-level judgment by briefly linking the capital stack to risk and downside flexibility.
- End with two quick checks (balance + post-close balance sheet) to demonstrate financial modeling discipline.
Common Pitfalls in Private Equity Interview Questions
- Starting from enterprise value but then also listing target debt repayment as an extra cost without adjusting the EV-to-equity bridge (double-counting).
- Forgetting to include repayment/refinancing of existing debt, especially when the interviewer expects a “debt-free” closing.
- Treating non-cash amortisation (e.g., financing fee amortisation) as a cash use at close, or omitting cash fees that are paid on day one.
- Handling OID inconsistently (showing gross debt proceeds in sources while also netting the same discount somewhere else).
- Assuming the revolver is drawn at close by default without explaining the need (e.g., to fund fees or minimum cash).
- Not doing the basic reconciliation: failing to explicitly state or verify that total sources equals total uses.
LBO Case Study Follow-Ups: Leverage, Fees, Rollover
What usually goes in “uses” besides the equity purchase price?
Common items are repayment/refinancing of existing debt, cash transaction fees (advisory/legal), and financing costs such as upfront lender fees or OID; sometimes incremental cash to reach a minimum balance.
How do you treat target cash in sources and uses?
You can treat target cash as a source only if your purchase price convention supports it; the key is being consistent in the EV-to-equity bridge so you don’t both pay for the cash and also use it to fund the deal.
Is OID a source or a use in an LBO model?
Either presentation works: show gross debt in sources with OID as a use, or show net debt proceeds in sources; consistency is what keeps the table balanced.
How do you decide how much leverage to use in an LBO case study?
You size debt based on market leverage and coverage constraints, business stability and cash flow visibility, and lender appetite; sponsor equity then fills the gap to balance sources and uses.
How does management rollover affect sponsor returns?
Rollover reduces the sponsor’s cash equity cheque and increases alignment; it can mechanically improve sponsor IRR/MoM, but it doesn’t change enterprise-level value creation.
Financial Modeling Interview Prep Drills for This Question
- Practise a 60–90 second “LBO interview question breakdown”: define uses/sources, list 5–7 core lines, and end with the balance check.
- Drill the EV-to-equity bridge verbally (EV, adjust for net debt and closing items, equals equity value) so you can explain it without numbers.
- Rehearse two conventions for OID/fees (gross sources vs net proceeds) and be ready to state which one you’re using.
- In AceTheRound, run this as a live prompt: deliver the structured answer, then practise going one level deeper on a single line (debt sizing, rollover, or fee treatment) without losing the table structure.
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