The Baratelli LBO Reference

The LBO, In One Line

Sponsor IRR = f(Entry Multiple, Debt/EBITDA, FCF conversion, Exit Multiple, Hold Period)

Every LBO is a variation on five levers. The five practitioner questions are: (1) what's the entry multiple — and can we defend it, (2) how much debt does the capital structure support before covenants bind, (3) what's the cash flow available to repay debt over the hold, (4) what's the exit multiple — and does the story justify it, and (5) how sensitive is sponsor IRR to each. This page walks each.

Sources & Uses — The Anchor

Every LBO starts with a balanced Sources & Uses. Uses fund the transaction. Sources capitalize it. They must equal to the penny, and the sponsor equity check falls out as the plug.

Entry Multiple: Purchase equity + refi debt − existing cash = $1,150mm EV. At $115mm EBITDA, entry multiple is 10.0x. Total debt / EBITDA at close = 7.4x ($850mm / $115mm). This is the leverage the covenant package will govern for the next 5-7 years.

Capital Structure — The Layers

Debt Schedule — The Mechanics

The debt schedule is the operating heart of the model. It reconciles beginning debt, mandatory amortization, cash sweep, and ending debt for every tranche, every year. Interest expense on the income statement is a function of average balance and rate; the cash flow statement funds the paydown. Get this wrong and IRR moves 300-500 bps.

The deleveraging story: $184mm of cumulative debt paydown over five years brings leverage from 7.4x to 4.3x. That's the equity value creation engine when the exit multiple stays flat — every dollar of debt repaid is a dollar of equity value created. In this example, equity value walks from $353mm at close to ~$770mm at exit (assuming 10.0x flat multiple), for a 2.2x MOIC on $353mm of invested equity.

Sponsor Returns — MOIC and IRR

The two return metrics every LP tracks. MOIC (Multiple on Invested Capital) is the cash-on-cash multiple; IRR is the annualized rate. The relationship depends on hold period.

Sensitivity Table: Exit Multiple × Debt Ratio at Entry

Illustrative sponsor MOIC (5-year hold) for the base case above, with EBITDA growing at 6.3% CAGR to $156mm at exit, 100% of FCF sweeping to TLB, flat interest costs. Rows: exit EBITDA multiple; columns: total debt / EBITDA at entry.

The point of the grid isn't the specific multiples — it's the story it tells. A 1.0x turn of multiple expansion adds 30-40 basis points of MOIC. A 1.0x turn of additional entry leverage adds 40-70 basis points but doubles the covenant risk. Sponsor discipline is about not paying up on entry to buy a story you can't underwrite.

When to Trust the LBO Model — and When to Override

Trust the LBO when: EBITDA is defensible against a 3-5 year forecast, FCF conversion is stable (60%+ of EBITDA reaches FCF after capex, cash taxes, NWC), the debt package is committed with realistic terms, covenant headroom exists in the base case (typically 25-35% cushion), and exit multiple is at or below entry.

Override the LBO when: EBITDA is cyclical and the deal is being underwritten at the peak (normalize the entry), FCF conversion is optimistic because capex is being under-forecasted (compare to peers), covenant compliance in the downside case requires unrealistic paydown speed, or exit multiple is being pushed above entry to make the returns work ("multiple-arbitrage LBO" — the classic sponsor sin).

Worked Examples in the Baratelli Case Library

The Baratelli practitioner case memos walk full LBO and sponsor-backed deals end-to-end, with the specific conventions above applied:

Your Cost of Capital Inputs: Pre-Populated for 73 Companies