The LBO and the paper LBO
By SuperdayReps · Michigan Ross Undergrad | Wharton MBA · ex-Citi | ex-Greenhill · Former Head Mentor at a Leading IB Prep Service
4 min read · updated June 29, 2026
A leveraged buyout is exactly what it sounds like: a private equity firm buys a company using mostly borrowed money, then uses the company's own cash flow to pay that debt down. The sponsor puts in a thin slice of equity, the company carries the rest as debt, and over a five-year hold the debt shrinks while (hopefully) the business grows. Sell at the end, and the equity that's left is the prize.
Reason from the sponsor's seat. They don't care about EPS or accounting niceties. They care about one thing: how much cash do I get back versus how much I put in, and how fast? Everything in an LBO serves that return.
Sources and uses
Every LBO starts here. Uses is what you have to pay for (the purchase price plus fees). Sources is where the money comes from (debt plus the sponsor's equity). They must equal, and the equity check is just the plug.
Pay $480 for a company, borrow $300 of it, and the sponsor writes a $180 equity check. That's the entire setup: more debt means a smaller check today, and a bigger return multiple if it works.
Keep reading
The rest of this lesson is free with an account
There's about 2 more minutes of The LBO and the paper LBO below this, plus every other lesson in LBO. Free account, no card.
Any partner school .edu
Frequently asked
- What is a leveraged buyout?
- A leveraged buyout is when a private equity firm buys a company using mostly borrowed money, then uses the company's own cash flow to pay that debt down. The sponsor puts in a thin slice of equity, the company carries the rest as debt, and over a five-year hold the debt shrinks while the business hopefully grows.
- Why does leverage juice returns in an LBO?
- Debt is cheaper than equity and the lenders do not share in the upside. They take fixed interest and their principal back, and everything above that flows to the equity. So the more of the purchase funded with debt, the more concentrated the gains on the sponsor's small slice. The downside is amplified the same way.
- How do you run a paper LBO?
- Take a company earning 60 of EBITDA and pay 8x, a 480 price. Borrow 300, five turns of EBITDA, so the sponsor's check is 180. Over five years EBITDA climbs to 75 and free cash flow halves the debt to 150. Sell at the same 8x for 600, repay the 150, and 450 is left for the sponsor: 2.5x the 180 it put in, about a 20% IRR.
LearnAI