How to Answer “Walk me through an LBO.” in Private Equity Interviews
“Walk me through an LBO.” is the core LBO interview question for private equity associate roles because it combines valuation, credit thinking, and investment judgment in one explanation.
A strong answer sounds like how you’d actually build and sanity-check an LBO model: start with the goal (returns), lay out assumptions (purchase price and financing), show how cash flow de-levers the business, then explain exit and IRR drivers—clearly and in order.
What This LBO Interview Question Tests at Associate Level
In a private equity associate interview, this prompt tests whether you understand an LBO as a returns framework, not just a spreadsheet. Interviewers are listening for clear linkage between price, leverage, cash generation, and exit value—and whether you can explain that linkage without getting lost in mechanics.
They’re also assessing credit instincts: what makes the debt “work” (coverage, amortisation, covenants, downside resilience) and what breaks it (margin compression, working capital drag, higher rates, slower growth). A good walkthrough naturally includes risk checks and tells them you can think like both an investor and a lender.
Finally, it’s a communication test under time pressure. You need a structured, top-down narrative that you can scale: a 90-second overview first, then deeper detail on drivers and sensitivities when prompted—exactly how you’d handle LBO technical questions in a live case discussion.
Step-by-Step Guide to LBO Technical Questions
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Step 1: Define the LBO objective and set the key assumptions
Start with the purpose: an LBO values a company based on the equity returns achievable when you buy it using a mix of debt and equity, then pay down debt with free cash flow and exit later.
Then state the minimum assumptions you need to proceed: purchase price (often framed as an entry EBITDA multiple), target capital structure (how much leverage by tranche and what equity cheque), forecast period (usually 5 years), and an exit approach (exit multiple on EBITDA or an exit valuation).
To sound “associate-level”, anchor assumptions to business quality and market reality: stable cash flows support more leverage; cyclicality, customer concentration, or high capex reduces sustainable debt; and entry/exit multiples should be consistent with the sector and the company’s growth and margin profile. This frames the rest of your walkthrough as judgment-driven, not rote.
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Step 2: Build operating projections to arrive at unlevered free cash flow
Next, explain what you forecast and why: revenue growth and margins drive EBITDA; then you bridge to unlevered free cash flow by subtracting taxes, capex, and changes in net working capital (and adding back non-cash D&A, if you’re describing the bridge).
Call out what matters in an LBO context: lenders and sponsors care about cash, so you focus on cash conversion, maintenance vs growth capex, working capital seasonality, and any one-offs. If the business has material capex cycles or working capital swings, mention how that affects debt capacity and required liquidity.
This is also where you can nod to LBO valuation techniques: the operating model isn’t separate from valuation—your cash flow profile determines how quickly leverage comes down, which is a primary driver of equity IRR and downside protection.
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Step 3: Layer in the financing and model the debt schedule (de-leveraging)
Then describe the sources & uses at close: uses include purchase equity value, refinancing existing debt, fees, and any cash to balance; sources include each debt tranche and sponsor equity.
Walk through the debt schedule at a high level: interest expense is based on average debt balances and pricing (base rate + spread), mandatory amortisation where applicable, and optional repayments using excess cash flow after operating needs. Make it clear you understand the order of operations: cash flow after interest and required items goes to pay down debt, often prioritising the most expensive or most restrictive tranche.
Add the key credit checks interviewers expect: leverage (Debt/EBITDA), coverage (EBITDA/interest), and the trajectory of both over time. Mention that you’d test whether the structure survives a downside case (lower EBITDA, higher rates, weaker cash conversion) without breaching covenants or running out of liquidity.
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Step 4: Determine exit value and compute equity returns (IRR/MoM)
At exit (commonly year 5), you value the company using an exit EBITDA multiple applied to year-5 EBITDA (or an alternative valuation if relevant), giving you enterprise value. Subtract net debt at exit (including any remaining debt minus cash) to get equity value.
From there, equity returns are straightforward: compare equity proceeds to the original equity cheque to get money-on-money (MoM), and calculate IRR based on timing (including any dividends/recaps if assumed).
To demonstrate investor thinking, explicitly name the return drivers: (1) multiple expansion/contraction, (2) EBITDA growth (revenue and margin), and (3) de-leveraging from free cash flow. Emphasise that leverage boosts returns if the business can reliably generate cash and the entry price isn’t too high—otherwise it magnifies downside.
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Step 5: Sanity-check the output and run sensitivities like a mini LBO case study
Close with reasonableness checks and a sensitivity grid—this is where many strong candidates separate themselves in an LBO case study setting.
Sanity-check the implied leverage path (does it de-lever to a plausible level by exit?), the exit assumptions (is the multiple consistent with the business quality and market environment?), and the implied returns (are you getting, say, sponsor-like returns without unrealistic growth or aggressive leverage?).
Then describe the standard sensitivities: entry/exit multiples, revenue growth, EBITDA margin, capex intensity, working capital, and interest rates. If you want one sentence that sounds practical: “I’d focus first on the two biggest levers—exit multiple and EBITDA—and then confirm the deal still clears the hurdle rate in a conservative downside case.” This shows you can prioritise and communicate like an associate.
Model Answer: Walk Me Through an LBO (Private Equity)
An LBO is a way to evaluate whether buying a company with a meaningful amount of debt can generate attractive equity returns. I’d start by setting entry assumptions—purchase price as an EBITDA multiple, the sources & uses with a target leverage level by tranche, and a 5-year hold period with an exit multiple.
Next I’d build operating projections to get to unlevered free cash flow: forecast revenue and margins to EBITDA, then subtract cash taxes, capex, and changes in net working capital. In an LBO, I’m especially focused on cash conversion and what’s truly maintenance capex versus growth capex, because that determines how quickly we can de-lever.
Then I’d layer in the financing and model the debt schedule. I calculate interest based on the tranche pricing and average balances, include any mandatory amortisation, and use excess cash flow to repay debt—typically prioritising the most expensive or tightest tranche. Along the way I’d track leverage and interest coverage to make sure the structure is sustainable and survives a downside case.
At exit, I’d value the business using an exit EBITDA multiple on year-5 EBITDA to get enterprise value, subtract net debt to get equity value, and then compute equity MoM and IRR versus the initial equity cheque. Finally, I’d run sensitivities around exit multiple and EBITDA performance, plus capex, working capital, and rates, to see what really drives returns and whether the deal still works under conservative assumptions.
- Keep the narrative return-driven: entry → cash flow → de-leveraging → exit → IRR.
- Name the three core value drivers (EBITDA growth, multiple, de-leveraging) explicitly.
- Show credit awareness with leverage/coverage and a downside case, not just a base case.
- Avoid reciting every line item; offer detail only when the interviewer goes deeper.
- Use consistent terminology (enterprise value vs equity value; net debt at exit).
Common Pitfalls in LBO Valuation Techniques Explanations
- Starting with debt schedules and formulas instead of stating the goal (equity returns driven by leverage + cash flow + exit value).
- Treating projections as accounting earnings rather than cash flow (ignoring working capital and capex dynamics).
- Forgetting to connect sources & uses to sustainable leverage (no mention of coverage, covenants, or liquidity).
- Assuming the exit multiple will always be the same or higher without acknowledging multiple risk and the need for sensitivities.
- Mixing up enterprise value and equity value at entry or exit, leading to an incorrect equity cheque or proceeds.
- Overbuilding the explanation: too many tranches, too many edge cases, not enough prioritisation of what moves IRR.
Follow-Ups in a Private Equity Associate Interview (LBO)
What are the main drivers of IRR in an LBO?
The big three are EBITDA growth, exit multiple, and de-leveraging from free cash flow; leverage amplifies returns but increases downside and refinancing risk.
How do you determine how much leverage a business can support?
I look at stability of cash flows, capex and working capital needs, cyclicality, and then test leverage/coverage under downside scenarios to see if liquidity and covenants still hold.
If IRR is too low, what can you do to improve it?
Lower the entry price, increase operational performance (growth/margins/cash conversion), optimise the financing structure responsibly, or find a credible path to a higher exit value—then re-check risk.
How would higher interest rates flow through an LBO model?
They increase interest expense, reduce free cash flow available for paydown, slow de-leveraging, and can pressure coverage ratios—often lowering both MoM and IRR.
Why might an LBO be attractive versus an all-equity acquisition?
Debt can increase equity returns through de-leveraging and tax shields, but only if the business can service the debt comfortably and the purchase price is justified.
Private Equity Interview Prep: Sharpen Your LBO Walkthrough بسرعة
- Practise a clean 90-second version of the walkthrough, then a 3–4 minute version with leverage/coverage and sensitivities for deeper probing.
- Use a consistent “entry → cash flow → debt paydown → exit → returns → sensitivities” script so you don’t jump around under pressure.
- For LBO modeling interview preparation tips, rehearse explaining your debt schedule order of operations (interest, mandatory amortisation, optional paydown) without referencing a spreadsheet.
- Do two mock runs where the interviewer interrupts: once on financing (covenants/coverage) and once on valuation (entry/exit multiples), so you can go deeper smoothly.
- In AceTheRound, practise delivering the answer out loud and iterate based on feedback on structure, clarity, and whether you tied assumptions to business risk.
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