Anatomy of a Leveraged Buyout: Breaking Down a PE Deal From Start to Exit

The term sheet shows a $500 million enterprise value. The PE fund will write a $200 million equity check. Five years later, they expect to sell for $1 billion and return $600 million to investors—a 3x return.

How does that math work? Where does the value come from? What happens between closing and exit?

Understanding LBO mechanics matters for anyone working in or around private equity—whether you're modeling deals, advising sponsors, or evaluating PE as a career. The LBO is the core product. Everything else flows from it.

Here's how a leveraged buyout actually works, from deal sourcing through exit.

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Stage 1: Sourcing and Screening

Finding Deals

PE firms source deals through multiple channels:

Proprietary sourcing: Direct outreach to companies and owners. The firm's investment team identifies targets and builds relationships before any formal process.

Investment banking processes: Sell-side banks run competitive auctions. Most larger deals come through these marketed processes.

Relationships: Management teams, operating partners, industry contacts, and advisors bring opportunities.

Portfolio adjacencies: Existing portfolio companies identify acquisition targets in their markets.

The Screening Funnel

Stage	Volume	Description
Initial review	500+ annually	Brief assessment of opportunity
Preliminary analysis	100+	Basic financial review and thesis development
Deep dive	30-50	Detailed analysis, management meetings
Formal bidding	10-15	Submitted bids with supporting analysis
Closed deals	3-5	Completed acquisitions

Most opportunities don't make it through the funnel. The filtering happens against investment criteria.

Investment Criteria

Typical PE investment screens:

Size: Does the deal fit our fund size? (Rule of thumb: individual deals are 10-15% of fund.)

Industry: Is this a sector we understand and can add value to?

Growth profile: Is there a path to value creation beyond financial engineering?

Market position: Does the company have competitive advantages?

Management: Is there a capable team—or can we bring one?

Exit visibility: Can we see a realistic path to selling in 3-7 years?

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Stage 2: Due Diligence and Bidding

The Diligence Process

Once a firm decides to pursue a deal seriously, diligence begins:

Financial diligence:

• Quality of earnings analysis
• Working capital normalization
• EBITDA adjustments
• Historical performance trends
• Revenue sustainability

Commercial diligence:

• Market size and growth
• Competitive dynamics
• Customer relationships
• Pricing power
• Go-to-market effectiveness

Operational diligence:

• Cost structure analysis
• Margin improvement opportunities
• Technology infrastructure
• Supply chain assessment
• Manufacturing capabilities

Legal diligence:

• Contract review
• Litigation assessment
• Regulatory compliance
• IP ownership
• Employment matters

Management assessment:

• Leadership capabilities
• Retention risk
• Organizational gaps
• Cultural alignment
• Incentive structure

Building the Investment Thesis

Diligence produces an investment thesis—the core argument for why this deal creates value.

A strong thesis includes:

The opportunity: What makes this company attractive? Market position, growth trajectory, competitive advantages.

The value creation plan: How will we make this company worth more? Revenue growth, margin expansion, multiple arbitrage.

The risks: What could go wrong? Customer concentration, competitive threats, execution challenges.

The exit: Who buys this company? At what valuation? In what timeframe?

The Bidding Process

In competitive processes, bidding determines who wins.

Indicative bid: Early-stage indication of interest and preliminary value range. Gets you into later rounds.

Final bid: Detailed offer with purchase price, structure, financing plan, and key terms.

Management presentation: In-person meeting where the company's leadership presents to potential buyers.

Exclusivity: The winning bidder receives exclusivity—a period where no other buyers can negotiate.

Bid Strategy

Winning bids balance aggressiveness with discipline:

Price: Higher prices win deals. But overpaying destroys returns.

Certainty: Sellers value financing certainty, diligence completion, and speed to close.

Terms: Equity rollover treatment, management arrangements, representations and warranties.

Relationship: Sellers (especially founder-owners) care who will own their company.

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Stage 3: Financing and Structure

The Capital Structure

LBOs use leverage to amplify equity returns. Typical capital structure:

Source	% of Capital	Typical Terms
Senior debt (Term Loan B)	40-50%	SOFR + 400-600bps, 7-year maturity
Second lien / Mezzanine	0-15%	10-15% interest rate
Equity	35-50%	PE fund contribution
Management rollover	5-10%	Existing management reinvestment

Leverage ratios: Current market: 4-6x EBITDA total leverage is typical for quality companies.

Debt Components

Senior secured debt (Term Loan B): First lien on assets. Sold to institutional investors (CLOs, credit funds). Floating rate, typically 7-year term.

Revolving credit facility: Working capital facility, usually undrawn at close. Banks provide this.

Second lien debt: Subordinated to senior debt. Higher rate to compensate for junior position.

Mezzanine / PIK: Subordinated debt, often with equity features (warrants). Higher rate, may include payment-in-kind interest.

Sources and Uses

Every LBO model starts with sources and uses:

Uses of funds:

Item	Amount	Notes
Purchase equity	$350M	What sellers receive
Refinance existing debt	$100M	Paying off old debt
Transaction fees	$25M	Advisory, legal, financing
Cash to balance sheet	$25M	Minimum operating cash
Total uses	$500M

Sources of funds:

Item	Amount	Notes
Senior term loan	$250M	5x EBITDA
Sponsor equity	$180M	PE fund investment
Management rollover	$20M	Existing owners reinvest
Cash on balance sheet	$50M	Company's existing cash
Total sources	$500M

Deal Documentation

Definitive agreement: The purchase agreement specifying price, representations, warranties, and indemnities.

Debt commitment letters: Lender commitments for financing, subject to limited conditions.

Management agreements: Employment contracts, equity incentive plans, and governance arrangements.

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Stage 4: Value Creation

The Value Creation Framework

PE returns come from three sources:

1. EBITDA growth: Making the company more profitable through revenue growth and margin expansion.

2. Multiple expansion: Selling the company at a higher multiple than acquisition.

3. Debt paydown: Using cash flow to reduce debt, increasing equity value.

The math:

Source	Entry	Exit	Impact
EBITDA	$50M	$80M	60% growth
Multiple	10x	11x	10% expansion
Enterprise value	$500M	$880M	76% increase
Net debt	$250M	$150M	$100M paydown
Equity value	$250M	$730M	2.9x return

In this example, EBITDA growth drives most of the value. Multiple expansion and debt paydown contribute additionally.

Operational Value Creation

PE firms drive EBITDA growth through operational improvements:

Revenue growth initiatives:

• New customer acquisition
• Pricing optimization
• Geographic expansion
• Product line extensions
• Cross-selling across channels

Margin improvement:

• Procurement savings
• Operational efficiency
• Workforce optimization
• Facility rationalization
• Technology enablement

Add-on acquisitions:

• Buying complementary businesses
• Consolidating fragmented industries
• Acquiring capabilities
• Gaining scale advantages

The 100-Day Plan

Post-acquisition, PE firms typically execute a structured plan:

Days 1-30:

• Integrate financial reporting
• Assess management team
• Identify quick wins
• Refine strategy
• Build relationships with customers and suppliers

Days 31-60:

• Launch operational initiatives
• Implement financial controls
• Begin organizational changes
• Pursue immediate cost savings
• Develop detailed strategic plan

Days 61-100:

• Execute on strategic priorities
• Track initiative progress
• Report to board and lenders
• Address emerging issues
• Refine go-forward plan

Governance and Board Role

PE boards are active, not passive:

Board composition:

• PE deal partners (2-3 seats)
• CEO (1 seat)
• Independent directors (1-2 seats)
• Operating partners (as needed)

Meeting cadence: Monthly or quarterly board meetings with detailed operational reviews.

Management partnership: PE firms work closely with management—supporting strategy, providing resources, holding accountable.

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Stage 5: Exit

Exit Timing

Typical holding period: 3-7 years. Optimal timing depends on:

Company readiness: Has the value creation plan been executed? Is the company positioned for the next owner?

Market conditions: Are buyers active? Are multiples attractive? Is financing available?

Fund lifecycle: How much time remains in the fund's investment period and term?

Exit optimization: Sometimes waiting another year significantly improves outcome. Sometimes exiting sooner captures value before risks materialize.

Exit Routes

Strategic sale: Sale to a corporation. Often achieves highest valuations due to synergy expectations.

Pros: Premium pricing, definitive exit Cons: Requires strategic fit, regulatory risk

Secondary sale (sponsor-to-sponsor): Sale to another PE firm. Common for platform companies with continuing growth runway.

Pros: Familiar buyer type, continuation of PE playbook Cons: Buyers also seek returns, limiting price

IPO: Taking the company public. Provides partial exit and ongoing liquidity.

Pros: Potential premium valuation, ongoing participation Cons: Lock-up period, market risk, ongoing obligations

Dividend recapitalization: Borrowing against the company to return capital to equity holders.

Pros: Return capital without selling, retain upside Cons: Increases leverage, not a true exit

Exit Process

Preparation:

• Management presentation development
• Data room preparation
• Vendor diligence reports
• Financial projections
• Growth story articulation

Marketing:

• Banker selection
• Buyer identification
• Initial outreach
• Management presentations
• Site visits

Execution:

• Bid collection
• Final negotiations
• Definitive agreement
• Regulatory approvals
• Closing

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The Returns Math

Key Return Metrics

IRR (Internal Rate of Return): Time-weighted return. Accounts for when cash flows occur. PE targets 20%+ gross IRR.

MOIC (Multiple of Invested Capital): Simple return multiple. Exit proceeds divided by invested capital. PE targets 2-3x+ MOIC.

The relationship: Short holds can generate high IRRs with lower MOICs. Long holds need higher MOICs to achieve target IRRs.

Hold Period	MOIC	IRR
3 years	2.0x	26%
5 years	2.5x	20%
7 years	3.0x	17%

Return Attribution

Understanding where returns come from:

Sample attribution:

Source	Contribution	Notes
Revenue growth	+40%	Top-line expansion
Margin expansion	+30%	EBITDA margin improvement
Multiple expansion	+20%	Exit multiple vs. entry
Debt paydown	+20%	Leverage reduction
Fees and leakage	-10%	Transaction costs, monitoring fees
Total equity return	2.5x

The best deals generate returns from operations, not just financial engineering.

Fund-Level Returns

Individual deal returns aggregate to fund returns:

Portfolio construction:

• Winners compensate for losers
• Power law dynamics (a few deals drive most returns)
• Diversification across sectors and deal types

Fee drag:

• Management fees: ~2% annually
• Carry: 20% of profits above hurdle
• GP economics reduce LP returns vs. gross returns

Typical fund returns:

Performance	Gross IRR	Net IRR	MOIC
Top quartile	25%+	18%+	2.0x+
Median	15-20%	12-15%	1.5-2.0x
Bottom quartile	<12%	<10%	<1.5x

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A Complete Deal Example

The Opportunity

Target: Regional specialty packaging company Revenue: $150M EBITDA: $25M Industry: Stable, fragmented, consolidation opportunity

The Investment

Purchase price: $250M (10x EBITDA) Financing:

• Senior debt: $125M (5x EBITDA)
• Equity: $110M
• Management rollover: $15M

The Value Creation Plan

Year 1-2:

• Implement operational improvements (target: 200bps margin improvement)
• Pursue two add-on acquisitions ($30M combined)
• Upgrade sales organization

Year 3-4:

• Continue operational focus
• Geographic expansion
• Product line extension

Year 5:

• Prepare for exit
• Position for strategic sale

The Outcome

At exit (Year 5):

• Revenue: $250M (including acquisitions and organic growth)
• EBITDA: $50M (margin improved to 20%)
• Exit multiple: 11x (reflecting improved scale and quality)
• Enterprise value: $550M
• Net debt: $75M (after paydown and acquisition debt)
• Equity value: $475M

Returns:

• Invested equity: $145M (initial $125M + $20M for acquisitions)
• Exit equity value: $475M
• MOIC: 3.3x
• IRR: ~27%

Attribution

Source	Contribution
Organic EBITDA growth	$10M (40% of gain)
Acquisition EBITDA	$10M (40% of gain)
Multiple expansion	$50M (1x on $50M EBITDA)
Debt paydown	$50M
Total equity gain	$330M

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Key Takeaways

The LBO is a complete business transformation, not just a financial transaction.

The mechanics:

1. Source and screen opportunities against investment criteria
2. Conduct rigorous diligence and develop investment thesis
3. Structure financing to optimize returns while maintaining flexibility
4. Execute value creation plan through operational improvement
5. Exit through optimal channel at appropriate timing

Value creation drivers:

• EBITDA growth (revenue and margins)
• Multiple expansion (improved quality and positioning)
• Debt paydown (leverage reduction)

Success factors:

• Disciplined entry pricing
• Realistic value creation plan
• Strong management partnership
• Operational expertise
• Patient capital with clear exit path

The honest truth:

LBOs look simple on paper. The math is straightforward. The execution is not. The firms that generate consistent returns do the hard work of operational improvement—not just financial engineering.

Understanding how LBOs actually work—from sourcing through exit—is essential for anyone pursuing PE careers, advising PE clients, or evaluating this asset class.

The deal structure is the foundation. The value creation is the work. The exit is the reward.