What Is an LBO Model? A Step-by-Step Beginner’s Guide

the The LBO model is one of the most widely used tools in private equity. If you're preparing for a private equity or investment banking interview, chances are high you'll be asked to build or analyze one. It's a test of financial logic, accuracy, and speed. But more importantly, it's how real deals get evaluated.

In this guide, we’ll explain what an LBO model is, how it works, and how to build one from the ground up using plain, direct language. Whether you're new to modeling or need a refresher, this article gives you the structure and clarity to move forward.

What Is an LBO Model?

An LBO model is a type of financial model used to evaluate a leveraged buyout, a transaction where a private equity firm acquires a target company using a significant amount of debt financing, combined with a smaller equity investment. The purpose of the model is to forecast how the business will perform after the acquisition, how quickly it can generate free cash flow, and whether the investment will meet the sponsor’s required return, typically measured as internal rate of return (IRR) and multiple on invested capital (MOIC).

In a leveraged buyout, the acquired company’s own cash flow is used to repay debt over time. This structure allows the private equity firm (also known as the financial sponsor) to put up less sponsor equity at the beginning while still keeping a large share of the upside if the company performs well. The LBO model helps assess how much debt the deal can support, when the firm can exit the investment, and what the expected equity value will be at that point.

Why LBO Modeling Matters in Finance Careers

If you're applying to private equity or investment banking, you’ll need to show you can build or explain an LBO model under pressure. Common uses include:

• Take-home modeling tests during recruiting
• Live modeling tests during superdays
• Building models for deal memos and internal investment committees

Note: Understanding how much debt a company can take on, how fast it can pay it back, and what return the sponsor will get is core to private equity logic.

Why Private Equity Firms Use LBO Models

• To determine the maximum purchase price they can pay while still hitting their return targets
• To decide how to structure the capital stack, including how much debt and equity to use
• To measure how sensitive the returns are to changes in operating assumptions, exit multiples, or interest rates
• To evaluate how quickly the business can generate cash flow to pay off outstanding debt

What the Model Includes

An LBO model typically forecasts:

• The company’s income statement, focusing on EBITDA and net income
• The cash flow statement calculates free cash flow after expenses, taxes, capital expenditures, and changes in net working capital
• A debt schedule with repayment terms, interest expense, and mandatory amortization
• An exit analysis estimating the exit enterprise value, remaining net debt, and projected exit equity value

Key Features of an LBO Model

Note: The LBO model is not just about math, it's about using structure and timing to make an investment work. It’s a core tool in private equity because it helps align deal terms with realistic business performance and lender expectations.

Key Components of an LBO Model

A well-structured LBO model has five core components. Together, these areas help the financial sponsor understand how much debt the company can handle, how much equity investment is required, and what kind of returns can be expected.

1. Sources and Uses Table

The Sources and Uses table shows how much capital is needed to acquire the target company and how that capital will be funded. It helps ensure that the capital structure is balanced and that the total funding sources match the total uses.

Example: Sources & Uses Breakdown

Purchase enterprise value is calculated using an entry multiple applied to LTM EBITDA. Transaction fees include legal, advisory, and due diligence costs. Financing fees are costs related to raising debt financing and are typically amortized over the life of the loans. The minimum cash balance ensures the business has enough liquidity after closing. The sponsor equity fills any remaining gap after calculating all available debt tranches.

2. Debt Schedule

The debt schedule tracks all debt used in the transaction, including each debt tranche and its repayment terms. This is where the model captures the impact of interest expense, mandatory amortization, and optional repayments over time.

Key elements include:

• Beginning balance and ending balance for each year
• Annual mandatory amortization (e.g., 5% for Term Loan B)
• Optional early repayments if there’s excess free cash flow
• Interest rates and fees for each term loan, revolver, or senior note

Debt is usually structured with senior secured loans at the top (e.g., term loan B), followed by unsecured or subordinated debt like senior notes. Each has different repayment schedules and pricing.

3. Financial Projections

To evaluate whether the company can support the debt, the model includes projected financial statements for the holding period (typically 5 years).

These projections focus on:

A. Income Statement

• Revenue growth applied to base-year sales
• EBITDA margins to calculate EBITDA
• Depreciation and interest expense to estimate net income

B. Cash Flow Statement

• Starts from net income
• Adds back non-cash expenses like depreciation and amortized fees
• Subtracts capital expenditures and changes in net working capital
• The resulting free cash flow is used for debt repayment

C. Balance Sheet (Simplified)

• Tracks changes to the cash balance
• Calculates net debt (total debt minus cash)
• Monitors the company’s ability to meet obligations without full detail

4. Returns Calculation

Returns are what matter most to the private equity firm. These are calculated after estimating the exit enterprise value, which is based on the exit multiple applied to the final-year EBITDA.

The model typically assumes a cash-free, debt-free sale. Exit equity value is what’s returned to the equity investors. IRR reflects the annualized return over the hold period. MOIC shows total return relative to the initial invested capital

5. Sensitivity Tables (Optional)

More advanced models include sensitivity analysis to test how the returns change with different assumptions. For example:

Note: These tables help evaluate how sensitive the internal rate of return is to changes in: Entry multiple, Exit multiple, Revenue growth, Amount of debt financing, Capital expenditures or transaction assumptions.

Step-by-Step: How to Build an LBO Model in Excel

You don’t need a fancy Excel template to get started. Most modeling tests only give you 30–90 minutes. Here's the structure I follow to build a basic but functional LBO model from scratch.

Step 1: Make Key Assumptions

Use this table to lay out the core model assumptions:

Step 2: Sources & Uses Table

Step 3: Project Financial Statements

Step 4: Build the Debt Schedule

The debt schedule is where you model how the company pays down its outstanding debt over the holding period. It includes the beginning balance, required payments, optional repayments using excess cash, and the resulting ending balance. Interest expense is calculated based on the average debt balance for the year.

Key Concepts to Include

• Beginning Balance: Carried over from the prior year’s ending balance (or original debt issuance in Year 1).
• Mandatory Amortization: A fixed portion of the debt that must be repaid each year. Often 5% of the original Term Loan B amount.
• Optional Repayment: Any excess free cash flow available after covering capex, working capital, taxes, and maintaining the minimum cash balance.
• Ending Balance: Beginning Balance – Mandatory Amortization – Optional Repayment.
• Interest Expense: Calculated using the average of the beginning and ending balance × stated interest rate.

Debt tranches like Term Loan B often require annual amortization, while senior notes may be interest-only with a bullet repayment at exit. The revolver is used only if cash is insufficient.

Sample Debt Schedule (5-Year Term Loan B)

Notes:

• Mandatory amortization is fixed at $30M per year, which is 5% of the original Term Loan B value of $600M.
• Optional repayments are determined based on the company’s free cash flow after operations, capex, and required payments. In modeling tests, this is often a manual input or calculated from a simplified cash sweep.
• Interest expense is based on the average of beginning and ending balances × 8% interest rate.
• The remaining debt at the end of Year 5 is included in the exit calculation to determine net equity value.

Step 5: Model the Exit

Step 6: Calculate Returns

• IRR measures the annualized return over the holding period
• MOIC shows total cash returned compared to the initial sponsor equity

Example: Simplified LBO Model

This example outlines a basic 5-year leveraged buyout scenario using straightforward numbers. It assumes constant EBITDA, simple debt repayment, and a single exit multiple to calculate returns.

Assumptions

Step-by-Step Exit Calculation

1. Exit Enterprise Value
   Final-Year EBITDA × Exit Multiple =$10M × 5.0x = $50 million
2. Assumed Remaining Debt
   If ~$40M of the $60M debt was repaid over 5 years, remaining debt = $20 million
3. Exit Equity Value
   $50M – $20M = $30 million
4. Return to Sponsor
   Initial Equity = $40M → Exit Equity = $30M(This shows a loss, so we’ll assume better performance or more debt was repaid.)

Updated Return Scenario (With Full Repayment)

Let’s assume the full $60M of debt was repaid using free cash flow over 5 years. In that case:

Updated Return Scenario (Better Exit)

Let’s say EBITDA grows to $15M by year 5, and the exit multiple remains at 5.0x:

Note: This version reflects a stronger deal outcome and better represents a successful private equity exit.

Tools to Learn and Practice LBO Modeling

Building skill in LBO modeling takes repeated practice with real examples. These resources offer hands-on training, templates, and tests that align closely with what private equity firms and investment banks expect.

Recommended Resources

How to Practice

Start With Templates

Begin with pre-built Excel templates from platforms like Wall Street Prep or Breaking Into Wall Street. These templates show how different parts of the LBO model connect, from the sources and uses table to free cash flow, debt tranches, and IRR calculations. Walk through each tab slowly to understand the structure and formulas before building your own.

Build From Scratch

After learning the structure, practice building a full LBO model from a blank Excel file. Start with basic model assumptions, build your transaction funding, then project the financial statements, create the debt schedule, and calculate returns. This helps you internalize the mechanics and improves your speed for case interviews and technical exams.

Practice With a Timer

Most LBO modeling tests are timed, with 30 to 90 minutes to complete. Simulate this environment by setting a one-hour timer and working through a simplified LBO case. Use clean formulas and stick to essential components. Practicing under pressure helps prepare for real-world interview settings.

Study Case Examples

Use mock investment memos or summaries of past private equity deals to test your modeling skills. Try to rebuild a version of the model using only the transaction details and key assumptions. Test different capital structures, exit multiples, and operating assumptions to see how changes affect returns.

Want to Practice with Expert Feedback?

Leland’s Investment Banking Bootcamp and Private Equity Recruiting Bootcamp include LBO modeling modules and support from real professionals.

The Bottom Line

An LBO model shows how a financial sponsor can use debt financing and a smaller equity investment to acquire a target company, operate it efficiently, and exit with a return. It breaks down how much debt the company can handle, how free cash flow supports debt repayment, and how equity value builds over time. If you're preparing for private equity, investment banking, or corporate development roles, learning to build an LBO model from scratch, without relying on a pre-built Excel template, is one of the most practical skills you can develop. It sharpens your understanding of cash flow, capital structure, and return mechanics, all of which are core to deal analysis.

Prep Smarter With an Expert Coach

Want to master LBO modeling for interviews or your next role? Work with a Leland coach who’s built real models at top private equity firms and investment banks. Get personalized feedback, mock modeling tests, and insider guidance to level up faster.

Read these next:

• From No Offers to Multiple Offers–How to Take Your Casing to the Next Level
• The Expert Guide to Market Sizing Questions (With Examples)
• What It (Actually) Takes to Land Your First Job
• BCG Interview Guide – Process, Case & Behavioral Overview, & How to Prepare
• Average Variable Cost Formula: Definition & How to Calculate

FAQs

What is the LBO model?

• An LBO model is a financial tool used to analyze leveraged buyouts by projecting returns from a mix of debt and equity.

What is the difference between LBO and DCF models?

• A DCF estimates value from intrinsic future cash flows. An LBO model focuses on IRR and returns from leverage and equity structure.

What is the LBO method?

• The LBO method involves acquiring a company using mostly debt, managing operations, and selling the company later at a higher value.

Is LBO modeling difficult?

• LBO modeling can be complex, but starting with a simple Excel build and clear steps makes the process easier to follow.