Building Leveraged Buyout Models

When To Use

• Modeling a sponsor-backed acquisition to evaluate feasibility and returns
• Sizing debt capacity and structuring capital across tranches (senior, sub, mezzanine)
• Stress-testing leverage and coverage ratios under downside scenarios
• Comparing entry/exit multiple assumptions to derive IRR and MOIC targets
• Evaluating management rollover, co-invest, or earnout structures alongside sponsor equity

Inputs To Gather

• Target financials: Last 3 years of revenue, EBITDA, capex, working capital; current-year budget or LTM figures
• Transaction terms: Purchase price or EV/EBITDA entry multiple, transaction fees (advisory, financing, legal), minimum cash on balance sheet
• Debt terms: Tranche sizes (revolver, Term Loan A/B, senior notes, mezzanine), interest rates (fixed vs. floating + spread), amortization schedules, mandatory prepayment sweep percentages, commitment fees
• Operating projections: Revenue growth rates, margin assumptions, capex as % of revenue, working capital days (DSO, DIO, DPO), tax rate [VERIFY jurisdiction-specific rates]
• Exit assumptions: Holding period (typically 3–7 years), exit multiple range, expected dividend recaps if applicable
• Equity structure: Sponsor equity contribution, management rollover %, option pool or incentive equity allocation

Workflow

1. Build sources & uses table

   • Uses: enterprise value, refinanced debt, transaction fees (banker, legal, financing), cash to balance sheet
   • Sources: each debt tranche sized to leverage multiple (e.g., Senior at 4.0x EBITDA, Sub at 1.5x), sponsor equity as residual plug
   • Cross-check total sources = total uses

2. Construct the debt schedule

   • For each tranche: opening balance, mandatory amortization, optional prepayments (from excess cash flow sweep), closing balance
   • Calculate interest expense per tranche per period (handle PIK vs. cash-pay separately)
   • Model revolver draws/paydowns based on minimum cash balance constraint
   • Track total leverage (Total Debt / EBITDA) and senior leverage through the hold

3. Build operating model projections

   • Project revenue, EBITDA, and EBIT from base-case growth and margin assumptions
   • Derive unlevered free cash flow: EBITDA − taxes on EBIT − capex − change in net working capital
   • Apply mandatory debt service and sweep mechanics to determine cash available for optional prepayment
   • Confirm debt service coverage ratio (DSCR) exceeds covenant minimums each period [VERIFY lender covenant thresholds]

4. Calculate returns at exit

   • Apply exit multiple to projected EBITDA at end of hold period
   • Subtract net debt at exit to derive equity value to sponsors
   • Compute gross IRR and MOIC on sponsor equity (include any interim dividends or recap proceeds)
   • Back into implied entry vs. exit multiple arbitrage contribution to returns

5. Run sensitivity and scenario analysis

   • Two-way sensitivity tables: entry multiple vs. exit multiple, revenue growth vs. margin, leverage vs. exit multiple
   • Downside case: revenue miss of 10–20%, margin compression of 100–200 bps, no multiple expansion — confirm no covenant breach and positive equity value
   • Upside case: outperformance + earlier exit or dividend recap — show max returns
   • Flag any scenario where leverage ratio exceeds typical market thresholds (>6.0x total for middle-market, >7.0x for large-cap) [VERIFY current market leverage norms]

6. Document the model package

   • Assumption summary page: entry multiple, leverage, growth, margins, exit multiple
   • Key outputs page: IRR/MOIC at base/down/up, credit statistics through the hold, FCF conversion
   • Clearly label cells as input (blue font), formula (black), or linked (green) per modeling convention

Output

• Sources & Uses table with complete reconciliation
• Debt schedule showing each tranche's balance, interest, amortization, and covenants through the hold
• Operating projections (income statement through unlevered FCF) for the hold period
• Returns summary: IRR, MOIC, and cash-on-cash at base, upside, and downside
• Sensitivity tables: two-way grids on key return drivers
• Credit statistics: leverage ratios, coverage ratios, and FCF yield by year

Quality Checks

• Sources exactly equal uses — no unresolved plugs
• Debt balances never go negative; revolver does not exceed commitment size
• Balance sheet balances in every period (if full three-statement model)
• IRR and MOIC are internally consistent (cross-check IRR via XIRR against discrete cash flows)
• DSCR and leverage ratios are within stated covenant limits in the base case
• Circular references from cash sweep → interest → net income → cash sweep are resolved with an iteration toggle or copy-paste macro
• All hard-coded assumptions are isolated on a single inputs tab, not buried in formulas
• Tax rate, amortization of financing fees, and D&A treatment are consistent with target jurisdiction [VERIFY]