What are the three primary sources of returns in an LBO, and how does each contribute to IRR and MOIC?
A core Private Equity interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
The three sources are: 1) Debt repayment or deleveraging – using free cash flow to pay down debt, which increases equity value. 2) EBITDA growth – operational improvements or revenue growth that boost EBITDA. 3) Multiple expansion – selling the company at a higher EBITDA multiple than purchase. Each drives both IRR and MOIC, but IRR is more sensitive to the timing of cash flows, while MOIC is a simple multiple of invested capital. For example, deleveraging is a steady contributor, while multiple expansion can be volatile.
WHAT INTERVIEWERS LISTEN FOR
- ✓Debt repayment/deleveraging
- ✓EBITDA growth
- ✓Multiple expansion
- ✓Impact on IRR vs MOIC
COMMON MISTAKES
- ✗Only mentioning two sources
- ✗Confusing IRR and MOIC
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