Leveraged Buyouts and How to Model Them

Introduction

You're evaluating or building an LBO model to decide buy, hold, or pass, so you need a tight view of cash flow, leverage capacity, and exit scenarios; start with the deal math, then test sensitivity to leverage and exit multiple. A leveraged buyout (LBO) is an acquisition financed with significant debt secured against the target's assets and cash flow, and typical sponsor goals are clear: target a 20-30% IRR (internal rate of return) and a 2.0-4.0x equity multiple over a 3-7 year hold by combining debt paydown, operational improvement, and multiple expansion. In the 2025 market, sponsors commonly structure total debt around 4.0-7.0x EBITDA (earnings before interest, taxes, depreciation, and amortization) in middle-market deals and 6.0-8.0x EBITDA for larger buyouts, with purchase-price multiples often near 8-12x EBITDA for mid-market and 10-14x for large-cap; one-line LBO logic: buy cash flow, load debt, then extract returns on equity. If covenants bite, returns will defintely compress, so model covenant breaches and a ±1 turn exit-multiple sensitivity as your first stress tests.

Key Takeaways

• Target returns: aim for ~20-30% IRR and 2.0-4.0x MOIC over a 3-7 year hold when sizing the deal.
• Leverage magnifies equity returns but increases risk-typical total debt ~4-7x EBITDA (mid‑market) and ~6-8x (large deals); always model covenants and amortization.
• Modeling discipline: link revenue/margin drivers to free cash flow, then layer financing (drawdowns, interest schedules, mandatory paydown) to forecast debt capacity.
• Exit and sensitivity testing: value exits with EBITDA multiples or DCF, run ±1 turn exit‑multiple and multi‑variable sensitivity grids-small multiple/margin moves can swing IRR by ~5-15 pts.
• Prepare for downside: stress‑test covenant breaches, refinancing failures, and recession scenarios; set governance, management incentives, and a failing‑path plan before signing.

LBO fundamentals: rationale and players

Roles: sponsor, target company, lenders, and management

You're sizing an LBO and need to map who does what before the model - that matters more than perfect growth assumptions.

Sponsor (private equity): sources equity, sets return hurdles (usually target IRR), negotiates structure, hires advisors, and leads governance post-close. Sponsors typically aim for a 3-5x equity multiple or a 20-30% IRR on deals they buy and improve.

Target company: provides the cash flow that services debt and funds growth. Evaluate stability of EBITDA, capex needs, and working capital cycles - these feed the debt serviceability test in year-by-year modeling.

Lenders: supply the debt tranches and set covenants. Expect a mix of banks (senior secured), institutional loan funds (syndicated term loans), and credit funds (mezzanine). Pricing and covenants vary with risk - in the model, translate their interest, amortization, and covenant triggers into explicit cash drains and breakpoints.

Management: runs day-to-day operations and often takes rolled or new equity. Common best practice: align management with a 5-20% carried equity stake or incentive plan tied to exit multiples and cash-on-cash targets. Keep incentives measurable and time-bound.

• Confirm sponsor IRR target and holding period
• Stress-test EBITDA consistency for 3-7 years
• Model lender amortization and covenant triggers explicitly
• Design management roll for retention and alignment

One-liner: know who takes risk, who provides cash flow, and how incentives align - that frames every model assumption.

Why debt boosts equity returns but raises default risk

Debt magnifies returns because fixed interest payments leave residual upside to a smaller equity base; but the same fixed obligations increase the chance of default when cash flow falls.

Here's the quick math in plain terms: buy a company for an enterprise value of $1,000 with EBITDA of $125 (8x). If equity funds $300 and debt $700, a 20% EBITDA rise to $150 and constant multiple gives exit EV $1,200. After repaying $700 debt, equity is $500, a 1.67x multiple on $300. Without debt, the same EBITDA growth yields much lower equity leverage. What this hides: higher debt increases sensitivity - a 20% EBITDA drop can wipe equity faster and breach covenants.

Practical steps to manage the trade-off:

• Target conservative net leverage: aim for 4-5x EBITDA in base-case for cyclical businesses; tolerate up to 6x only for very stable cash flows.
• Model interest rate sensitivity: use base-rate plus spread; run scenarios at +200-500 bps to reflect tightening.
• Include mandatory amortization and one heavy refinancing scenario in year 3-5.
• Proactively set covenant cushions: maintain 1.2-1.5x interest coverage buffer in downside cases.

One-liner: debt helps returns only if cash flow covers fixed obligations through the cycle - otherwise it accelerates failure.

Typical time horizon and common exit paths

Most private equity sponsors plan a 3-7 year hold to implement operational fixes and reposition the business for sale - shorter for quick fixes, longer for transformation plays.

Common exit routes and modeling notes:

• Strategic sale - model buyer synergies and assume a premium multiple; often the highest multiple but timing depends on market consolidation.
• Secondary buyout (sale to another PE) - model similar multiple range but expect tighter pricing and longer closing timelines.
• IPO - model market timing risk; use market-adjusted multiples and factor lock-up discounts and IPO costs (legal, underwriting, 1-5% of proceeds).
• Dividend recapitalization - model as an interim return of capital funded by new debt; include upfront fees and increased leverage consequences.

Best practices for exit planning:

• Set target exit year in the model and run multiples-of-EBITDA and DCF exit scenarios
• Keep three exit multiples (base, downside, upside) spaced by ±1.0x EBITDA
• Plan governance milestones that enable sale readiness (clean financials, CPU, customer contracts) by year 2-4
• Maintain optionality: preserve room for dividend recap only if covenant and leverage allow

One-liner: plan the exit from day one - pick the most likely path and stress-test timing and multiple moves so you can act, not react.

Deal structure and financing mechanics

Quick takeaway: the financing stack defines cash demand, covenant risk, and the pace at which equity value is created. Use a clear tranche map and a tight interest/amort schedule to link operating targets to debt paydown.

Financing tranches: senior bank debt, mezzanine, PIK, and equity contribution

Start by mapping the capital stack from safest/cheapest to riskiest/most expensive. For an illustrative FY2025 example assume a $1,000 million enterprise purchase funded with $600 million senior bank debt, $150 million mezzanine, and $250 million equity.

Practical steps

• Size senior debt to sustainable EBITDA coverage - target 3.5x-5.0x gross leverage for stable businesses.
• Use mezzanine to bridge the gap if sponsor wants higher leverage but can handle higher coupons or PIK (payment-in-kind) interest.
• Keep equity at least 20-30% of purchase price in aggressive deals; more conservative sponsors push to 35-40%.

Why this matters: senior debt sets cash interest and mandatory amortization; mezzanine raises cash interest and optional PIK increases deferred cash burden; equity absorbs the first loss and drives sponsor IRR sensitivity.

One clean line: design the stack so required equity upside matches operational improvements you can realistically deliver - not wishful thinking.

Covenants, amortization, interest types, and fees

Covenants: split into maintenance covenants (ongoing tests) and incurrence covenants (tests triggered by take-actions). Typical FY2025 covenants

• Maintenance: net leverage (total debt / EBITDA) cap at 6.0x in aggressive deals; healthy deals 3.5x-4.5x.
• Maintenance: fixed charge coverage ratio (FCCR) floor around 1.0x.
• Incurrence: limits on new debt, dividends, or asset sales unless pro forma leverage is below a threshold.

Amortization: map mandatory paydown by tranche. Example schedule

• Senior term loan: tenor 5-7 years, mandatory amortization 2-5% of initial principal/year, with a bullet at maturity.
• Revolver: revolver facility used for working capital, fees on unused commitments, typically renewed or refinanced at exit.
• Mezzanine: longer-dated, limited amortization, often paid down at exit or refinanced.

Interest types and hedging

• Floating-rate bank debt priced as SOFR (Secured Overnight Financing Rate) + margin. Consider swapping part to fixed - hedge if cash flow sensitivity to rate shocks > tolerance.
• Fixed-rate mezzanine or bonds carry higher coupons; PIK interest compounds and is added to principal rather than paid in cash.
• Example FY2025 coupons: senior at SOFR + 300 bps, mezzanine at 10-14% cash, PIK at 8-12% (accrued).

Fees and upfront costs

• Upfront arranger/structuring fees commonly 0.5-1.5% of debt; on a $750 million debt stack, that's roughly $3.75-$11.25 million.
• Commitment fees on revolvers (20-50 bps on unused capacity) and legal/closing costs of $1-3 million for mid-market deals.

Best practices and checks

• Model both cash and P&L interest under base and stress cases.
• Include step-up interest triggers (increased spreads on covenant breaches) and model their impact.
• Document refinancing windows and prepayment penalties; these matter for exit timing.

One clean line: covenants and amortization rules determine how fast cash must go to debt service versus growth - so map them to your ops plan before signing.

How financing mix drives required operational improvement and exit IRR

Translate capital structure to targets: for a FY2025 example deal with $600 million senior and $150 million mezzanine, first-year cash interest (approx) = senior cash interest (~7.5% assumed) + mezzanine cash coupon (~12%) = roughly $63 million. Here's the quick math: $600m × 7.5% = $45m; $150m × 12% = $18m.

Actionable steps to link ops to returns

• Calculate annual free cash flow after capex and working capital; allocate to interest, mandatory amortization, and optional pre-payments.
• Set operational KPIs that directly reduce leverage: EBITDA margin expansion, working capital turns, and capex efficiency.
• Run a break-even analysis: incremental EBITDA required to meet debt service and hit target exit IRR (e.g., target equity IRR of 20-25% over 5 years).

Example sensitivity: in a 5-year hold, a 0.5x move in entry or exit EBITDA multiple or a 200 bps swing in margin can change equity IRR by 5-15 percentage points depending on leverage.

Governance and contingency

• Attach clear management incentives tied to deleveraging milestones (equity/options cliff at 2x debt/EBITDA reduction points).
• Create waterfall rules for excess cash: recommend split after mandatory amortization - reinvest 30%, prepay debt 50%, dividends 20% (example governance structure).
• Pre-agree material adverse change (MAC) triggers and limited waiver mechanics to avoid surprise default pathways.

One clean line: financing mix drives required operational improvement and exit IRR - so size debt to what you can defintely operationally deliver, not to max leverage available.

Step-by-step LBO model build

You're building an LBO model to decide buy, hold, or pass - focus on inputs, a clean pro forma, a disciplined financing layer, and a transparent returns bridge. Below I walk you through concrete steps, exact calculations, and a worked example using 2025-style market assumptions.

Inputs and pro forma: historicals, working capital, capex, and forecasts

Start by collecting three to five years of audited or management-adjusted statements and reconcile GAAP to deal economics. You need P&L, balance sheet line-items that drive net working capital (accounts receivable, inventory, payables), and fixed asset roll-forwards for capex and depreciation.

• Normalize EBITDA: remove one-offs and non-operating items.
• Compute NWC days: AR days, Inventory days, AP days and convert to dollars.
• Set trailing twelve-month (TTM) and fiscal-2025 baselines explicitly.

Practical checklist: verify FY2025 EBITDA, capex, and NWC from source schedules, not a single summary table. If management provides forecasts, split assumptions into volume, price, and mix - don't accept a top-line growth percent alone.

Here's the quick math on working capital: if FY2025 revenue is $200.0m, AR days = 45 → AR = 45/365 200 = $24.7m. If inventory days = 60 → inventory = $32.9m. If AP days = 50 → AP = $27.4m. Net working capital = AR + Inventory - AP = $30.2m.

Project revenue drivers explicitly (units × price, or customers × ARPU) and translate margin improvement into EBITDA dollars. For example, convert a 300-basis-point (3.0%) EBITDA margin improvement on $200.0m revenue into an incremental $6.0m EBITDA.

What to watch: capex smoothing (don't assume capex falls to zero), seasonality in NWC, and any customer-concentration collections risk. If a line-item is unclear, flag it and model a sensitivity.

Build the operating model: revenue drivers, margins, OPEX, and free cash flow to firm

Construct a monthly or annual P&L that ties back to your driver assumptions. Translate EBIT or EBITDA to free cash flow to firm (FCFF) using standard formulas and consistent tax treatment.

• Revenue by driver: units, price, churn, upsell.
• Gross margin → EBITDA: map direct costs and fixed/variable split.
• OPEX: separate growth-linked SG&A from fixed G&A.
• FCFF = EBIT(1 - tax rate) + Depreciation - Capex - ΔNWC.

Example five-year pro forma (rounded): FY2025 revenue $200.0m, EBITDA $40.0m (20.0% margin). Assume D&A $8.0m, tax rate 21%, capex $8.0m, ΔNWC -$2.0m (release). Then FCFF = (40-8)(1-0.21) + 8 - 8 - (-2) = (320.79) + 2 = 25.28 + 2 = $27.3m.

Best practices: link every operating lever to cash - a 1% price increase should show both revenue and potential mix effects on variable costs and EBITDA. Keep a separate schedule for non-cash add-backs (stock comp, one-time restructuring) and test removal impact on free cash flow.

What this estimate hides: tax timing differences, working-capital seasonality, and capital leases can move near-term cash by multiple millions; model them explicitly if material.

Financing layer, debt schedules, amortization, and returns

Structure the financing waterfall in a Sources & Uses schedule, then build per-tranche debt schedules that roll forward principal, cash interest, PIK interest, and fees. Use mid-2025 market assumptions for pricing.

• Example transaction: Enterprise Value $500.0m. Equity contribution $150.0m (30%). Debt = $350.0m.
• Financing split (example): Term A senior $200.0m at SOFR+225bp (~7.0% cash coupon), Term B $75.0m at 8.5%, Mezzanine $50.0m at 12.0% (cash), Revolver commitment $25.0m (drawn only as needed).
• Fees and upfront costs: underwriting fees 1.0% of debt (~$3.5m), legal/closing expenses $2.0m.

Model mechanics step-by-step:

• Set opening balances at close (Sources & Uses). Deduct fees from cash or increase debt per term.
• Build interest schedule: cash interest = rate × outstanding principal; PIK interest compounding adds to principal.
• Apply mandatory amortization: e.g., Term A amortizes 5.0% of initial principal per year years 1-4, with a bullet at exit.
• Model revolver usage intra-period and interest on average daily balance or month-end approximation.
• Check covenants each period: Net Leverage = Net Debt / LTM EBITDA; Interest Coverage = LTM EBITDA / Cash Interest.

Example debt roll (year-end, simplified): Opening total debt $350.0m. Annual FCFF used for debt paydown after tax, capex, and working capital generates $27.3m in year 1; mandatory amortization = $12.5m (5% of term A + fixed payments), voluntary paydown = $10.0m, leaving year-end debt ~$327.5m. Cash interest year 1 ≈ $26.3m (weighted average coupon ~7.5%).

Returns calculation (step-by-step):

• Project EBITDA in exit year (yr 5) - e.g., grow 50% to $60.0m.
• Apply exit multiple - e.g., 8.0x → Exit EV = $480.0m.
• Subtract net debt at exit (assume reduced to $150.0m) → Equity exit value = $330.0m.
• Equity cash flows to the sponsor = exit equity value + any dividends paid during hold - initial equity $150.0m.

Here's the quick math for returns: equity multiple (MOIC) = 330 / 150 = 2.20x. IRR ≈ (2.20)^(1/5)-1 ≈ 17.5%. If you assume an exit multiple of 9.0x, EV = $540.0m, equity = 540 - 150 = $390.0m → MOIC = 2.60x, IRR ≈ 21.0%.

Model should link operating levers directly to debt paydown.

Sensitivity note: small moves matter. A 0.5x change in exit multiple or a 200-bp swing in EBITDA margin can alter IRR by multiple percentage points - run a grid immediately. Also run covenant breach scenarios: if Net Leverage spikes above a covenant (e.g., > 5.5x), model the likely cures: restricted dividends, equity cure, or short-term revolver draw.

Next steps for your model: build the Sources & Uses, then a per-tranche amortization table, then run three scenarios base/bear/bull and a covenant-stress case so you can show the IC a clear path to the target IRR or the failure modes.

Valuation, returns and exit planning

You're sizing the purchase price and need a clear path to the IRR and cash-on-cash multiple that will satisfy the investment committee. Here's the direct takeaway: set entry EV off conservative FY2025 EBITDA, stress-test exit multiples, and link operating improvement to debt paydown so returns are driven by both multiple expansion and deleveraging.

Set entry valuation via purchase price and implied enterprise value

Start by locking a reliable FY2025 baseline: reported EBITDA, net working capital (NWC), capex, and closing net debt. Then compute enterprise value (EV) with a clear purchase multiple and adjust for transaction items (cash, existing debt, fees, NWC step-ups).

Steps and practical checks:

• Use FY2025 EBITDA as the primary anchor; if FY2025 is transitional, use a 12-month run-rate.
• Pick an entry multiple informed by precedent deals in the sector; assume a conservative range (low/likely/high) for sensitivity.
• Calculate EV = FY2025 EBITDA × Entry multiple.
• Derive equity value = EV - Net debt at close + Transaction adjustments (closing cash, fees, earnout expectations).
• Confirm sponsor equity check = equity value + any rollover by management - seller financing.

Example quick math (assumptions): FY2025 EBITDA $100m, entry multiple 7.0x → EV = $700m. If net debt at close = $400m, equity check = $300m.

What this hides: allocation between refinancing existing debt and new debt, and post-close working capital true-ups - model these as line items so the purchase price ties to the cash required at close. Defintely map fees (legal, banking) into the uses line.

One line: set EV off conservative FY2025 EBITDA, then reconcile to an exact equity check.

Exit valuation: apply EBITDA multiple or DCF to forecast year of sale

Decide your exit year (typical hold 3-7 years), forecast the company's FY of sale EBITDA, then value the business either with a multiple or by a DCF of cash flows beyond the hold period. Use both and compare.

Practical steps:

• Project operating model to the exit year: revenue, margins, capex, and NWC to get exit-year EBITDA and net debt.
• Exit-multiple approach: Exit EV = Exit-year EBITDA × Exit multiple (pick a conservative base, a stressed low, and optimistic high).
• DCF approach: estimate terminal value from a Gordon Growth model or exit multiple equivalent and discount free cash flows (FCFF) using a forward-looking WACC.
• Reconcile: if multiple-derived terminal value diverges materially from DCF, recheck growth, margins, or WACC assumptions.
• Incorporate exit costs: transaction fees, tax on sale, and estimated working capital release into equity proceeds.

Example quick math (assumptions): hold 5 years, exit EBITDA grows to $140m. Exit multiple 7.5x → Exit EV = $1,050m. If net debt at exit = $150m, equity proceeds = $900m.

What this hides: cyclical multiple compression, macro-driven WACC shifts, and buyer-specific strategic premiums - model a low multiple case that assumes mean reversion to sector averages.

One line: value the company both by multiple and DCF, and force-check divergence before you sign.

Calculate IRR, MOIC, and sensitivity to purchase multiple and exit multiple

Translate the cash flows into equity returns: initial equity outflow at close, then interim dividends or recap cash flows, and final equity proceeds at exit. Compute MOIC (multiple on invested capital) and annualized IRR from those cash flows.

Concrete steps and best practices:

• Build an equity cash-flow waterfall: initial equity paid (negative), periodic distributions (if any), final equity sale proceeds (positive).
• Calculate MOIC = Total equity proceeds / Initial equity invested.
• Calculate IRR using the standard internal rate of return on the equity cash-flow timeline.
• Run two-dimensional sensitivity grids across entry multiple and exit multiple, and across EBITDA margin and revenue growth. Highlight cells that breach lender covenants or produce IRR below hurdle rates.
• Report scenario pack: base, downside (contracting EBITDA or lower exit multiple), upside (margin recovery, multiple expansion), and a stressed covenant-failure case.

Example quick math (continuing prior example): initial equity = $300m, exit equity = $900m after 5 years → MOIC = 3.0x. The 5-year IRR solves (1+IRR)^5 = 3 → IRR ≈ 24.6%.

Sensitivity note: if exit multiple falls to 6.0x, exit EV = $840m, equity proceeds ≈ $690m, MOIC ≈ 2.3x, 5-year IRR ≈ 18.5%. If EBITDA at exit is only $120m (margin miss), IRR falls ~5-6 percentage points; if multiples compress and margin slips, IRR can drop by 10-15 percentage points.

What this hides: interim cash sweeps, covenant-triggered amortization, and refinancing costs can materially lower equity proceeds - model mandatory amortization and potential PIK interest builds explicitly.

One line: small multiple or margin moves can swing IRR by 5-15 percentage points.

Next step: you-build the base-case using FY2025 EBITDA, then run a 3×3 grid (low/base/high entry multiple × low/base/high exit multiple). Owner: Finance team to deliver the sensitivity workbook by Friday.

Sensitivities, downside tests, and governance

You're building an LBO model and need to know how fragile returns are and what to do if things break; run tight sensitivity grids, stress covenants and refinancing, and lock governance that forces action. The direct takeaway: map operating levers to debt paydown, then codify a failing-path plan before term sheets are signed.

Run sensitivity grid: revenue growth, EBITDA margin, capex, and exit multiple

Start with a clean base case and then stress each driver across a realistic band. Use a 3×3 to 7×7 grid but keep it readable: rows = revenue growth scenarios, columns = exit multiples, and separate grids for EBITDA margin and capex flows.

Practical ranges to model (use as defaults and adjust to the sector):

• Revenue growth baseline +5%, downside -10%, upside +20%
• EBITDA margin baseline 25%, test -5pp to +5pp (e.g., 20%-30%)
• Capex baseline 3% of revenue, test 1%-8%
• Exit multiple baseline 8.5x EBITDA, test 6x-12x

Steps to build the grid:

• Populate base forecast for years 0-5 with revenue, margins, capex, WC.
• Calculate FCF to equity after interest, mandatory amort, and tax.
• Loop exit EV = EBITDA × exit multiple and compute equity proceeds (EV minus net debt at exit).
• Compute MOIC and IRR for each cell; color-code outcomes (green > target IRR, amber borderline, red fail).

Here's the quick math: assume EBITDA $50m, purchase multiple 8.5x → EV = $425m; 60% debt = $255m, equity = $170m. Exit EBITDA rises to $70m at sale multiple 9x → EV = $630m; net debt $200m → equity proceeds $430m. MOIC = 2.53x; IRR over 5 years ≈ 20.4%. What this estimate hides: fees, taxes, working capital swings, and covenant cures.

One-liner: a well-built grid shows which 1-2 drivers swing your IRR, so start there.

Stress test covenant breaches, refinancing failures, and recession scenarios

Assume covenants will bite in stress. Build rule-based alerts: if Net Leverage (Senior Debt / trailing EBITDA) > 4.5x or Interest Coverage (EBITDA / cash interest) 2.5x, mark as breach. Model three breach responses: waiver, covenant cure, or accelerated default.

Construct these stress scenarios and quantify outcomes:

• Recession: revenue -15% in year 1, margin hit -400 bps, slower recovery over 3 years.
• Interest shock: all-in cost +300 bps (adds cash interest burden).
• Refinance fail: forced to roll 60%-100% of maturing debt at tighter terms or sell at distressed multiple 4x-6x.

Forced-action playbook (automate into model):

• Trigger waivers: quantify one-off fees (estimate 1%-3% of outstanding debt).
• Cash cure: model sponsor equity top-up amounts and timing.
• Asset sale: model partial asset sale proceeds and EBITDA loss impact.
• Dividend restrictions: simulate blocked recap distributions and effect on sponsor IRR.

Account for timing: covenant breaches often occur in the first 12-24 months post-close when leverage is highest and synergies haven't arrived. If onboarding takes > 14 days for a B2B SaaS churn spike, churn risk rises and you must model faster covenant stress. If you need capital quickly, defintely model a cash cure scenario and owner decision points.

One-liner: assume refinancing will be harder than optimistic debt markets suggest and plan for a +300 bps cost of debt shock.

Plan governance: board seats, earnouts, management incentives, and contingency exits

Set governance so actions are fast and aligned. Typical governance terms to include in the model package:

• Board composition: sponsor 3-5 seats on a 7-seat board; management 2-3.
• Veto rights: major decisions (sale, dividend recap, additional debt) require sponsor and at least one independent director sign-off.
• Management rollover: 10%-20% equity rollover aligns incentives; smaller founders may keep 5%-10%.
• Earnouts: cap at 10%-30% of equity payout, paid on multi-year EBITDA/ revenue targets, with clear measurement windows (e.g., 24-36 months).
• Key man triggers: if CEO departs, control adjustments or cash retention kicks in.

Implement incentive mechanics in the finance model:

• Option/equity pool dilution: model a 5%-15% option pool and its vesting schedule (typically 3-4 years, cliff 12 months).
• Earnout sensitivity: show sponsor IRR net of earnout paid at each target cell.
• Clawbacks and holdbacks: retain 5%-10% of equity value in escrow for 12-24 months against reps/recs.

Design contingency exits and decision rules:

• Sale if IRR < sponsor hurdle after year 3.
• Dividend recap only if Net Leverage < target 2.0x-2.5x and interest coverage > 3.5x.
• Pre-agree auction mechanics and break fees to speed sale process in distress.

One-liner: prepare a failing-path plan before signing term sheets - name triggers, owners, and cash amounts for cures.

Next step: Finance build a 5-year model with the sensitivity grids and the three stress scenarios listed above; Sponsor or Deal Lead: prepare the covenant waiver and a $10-30m cash cure template by Friday.

Conclusion - checklist and next steps for your LBO decision

You're deciding whether to buy, hold, or pass on a sponsored leveraged buyout and need a tight checklist plus clear next actions. Bottom line: demand a realistic forecast, conservative financing, and stress-tested exits before you sign.

Checklist to decide: realistic forecast, conservative financing, clear exit, stress tests

Start by validating assumptions against FY2025 reality: confirm trailing twelve months (TTM) and FY2025 EBITDA, working capital trends, and capex cadence. If revenue growth or margin improvements rely on one-time items, mark them out and stress the forecast.

• Validate FY2025 EBITDA, revenue, capex, and working capital
• Require management to justify top-line drivers with customer-level metrics
• Set minimum equity cushion 25-35% of purchase price
• Limit total leverage to 5-7x EBITDA for cyclical businesses; 3-5x for stable cash-flows
• Insist on covenant headroom: interest coverage > 1.5-2.0x
• Plan for mandatory amortization and a refinancing buffer (reserve 12-18 months of interest + capex)
• Define a credible exit path and timing: sale, IPO, or dividend recap in 3-7 years
• Run at least a downside stress: -20% revenue and -300 bps EBITDA margin to test covenant breach

Here's the quick math example: a FY2025 EBITDA of $40.0m at an entry multiple of 8.0x implies an enterprise value of $320.0m; with a 30% equity check you need $96.0m equity and $224.0m debt. What this estimate hides: fees, working capital draw, and mandatory amortization that cut free cash available for debt paydown.

Next steps: build base model, run three scenarios, present to investment committee

Organize a short, prioritized playbook so you can move from diligence to decision in under two weeks. Focus on clean inputs, a financing schedule, and three scenarios (base, downside, upside) that feed a single waterfall of cash flows to equity.

• Collect model inputs: FY2023-FY2025 historicals, FY2025 closing balance sheet, customer-level churn, and contract terms
• Build a 5-year pro forma: revenue drivers, gross margin, opex line-items, working capital, capex, and FCF to firm
• Model financing layer: initial draw, interest (fixed vs floating), PIK toggles, fees, and mandatory amortization schedule
• Compute returns: annual equity cash flows, exit equity value at sale year, IRR and MOIC
• Run sensitivities: entry/exit multiples, revenue growth ±200-400 bps, margin ±200-500 bps, capex shock
• Prepare an IC packet: 1-page decision memo, 5-slide model summary, covenant heat-map, downside-trigger actions

Assign owners and deadlines: Modeling: build base model and sensitivity tabs by end of week; Finance: draft 13-week cash view and covenant schedule by Friday; M&A: prepare IC packet and schedule presentation within 10 business days. This is high-priority-defintely escalate liquidity risks to the CFO immediately.

Modeling principle one-liner

Model the downside first, then size upside around realistic operational fixes.