"Walk me through an LBO" is arguably the single most important technical question in investment banking interviews. It appears in first rounds, superdays, and final interviews at virtually every bank, from bulge brackets to elite boutiques. Unlike many technical questions that test isolated concepts, the LBO walkthrough tests whether you understand how an entire transaction works from start to finish, connecting valuation, capital structure, cash flows, and returns into one coherent framework.
The challenge is that most candidates either give answers that are too short and superficial (missing critical details that show real understanding) or too long and disorganized (rambling through concepts without clear structure). The best answers are structured, concise, and demonstrate genuine understanding of why each step matters, not just what the steps are. This guide gives you three versions of the answer (30-second, 2-minute, and detailed), explains what interviewers are really evaluating, walks through common follow-up questions, and covers the mistakes that cost candidates offers.
What makes this question particularly tricky is that interviewers can probe any part of your answer in depth. If you mention debt paydown, they might ask how you'd calculate free cash flow. If you mention exit multiples, they might ask what drives multiple expansion versus contraction. Your initial walkthrough is just the opening; the real test is whether you can defend and expand on every concept you mention. Prepare accordingly by understanding not just the sequence of steps, but the reasoning behind each one.
What Interviewers Are Really Testing
Before diving into the answer frameworks, understand what this question evaluates so you can emphasize the right elements.
The Five Dimensions of Assessment
Conceptual understanding: Do you grasp the fundamental logic of why LBOs work? The core insight is that using debt to finance an acquisition amplifies equity returns because debt is cheaper than equity and the company's cash flows service that debt over time. Candidates who understand this principle can adapt their answers to any variation of the question.
Technical accuracy: Are the mechanics correct? Interviewers will notice if you confuse enterprise value with equity value, forget to account for transaction fees in your sources and uses, or describe cash flow incorrectly. Precision matters because small technical errors compound in actual models.
Structured communication: Can you present a complex, multi-step concept in a clear, logical sequence that a listener can follow? This previews how you'll communicate with clients and senior bankers. The best answers feel like a story with a clear beginning, middle, and end rather than a random collection of facts.
Business judgment: Do you understand what makes a good LBO candidate and why? Can you connect the mechanics to real-world considerations like what types of companies private equity firms target and what drives returns? This separates candidates who memorized steps from those who truly understand the strategy.
Depth of knowledge: How well can you handle follow-up questions? Interviewers often let candidates give their prepared walkthrough, then probe specific areas to test whether understanding goes beyond surface level. Your initial answer should be tight enough to invite follow-ups on topics you're prepared to discuss in depth.
The 30-Second Elevator Answer
Use this version when time is limited, when an interviewer asks for a "quick overview," or as your opening before elaborating. This answer hits every critical point without unnecessary detail.
The Script:
"In an LBO, a private equity firm acquires a company using a combination of debt and equity, typically with debt representing 60-70% of the purchase price and equity representing 30-40%. The PE firm targets companies with strong, predictable cash flows because those cash flows are used to pay down the debt over a 3-5 year holding period. The firm creates returns through three primary levers: paying down debt using the company's free cash flow, which increases the equity value; growing EBITDA through revenue growth or operational improvements; and multiple expansion, where they sell at a higher valuation multiple than they paid. At exit, the firm sells the company, repays remaining debt, and the difference between the sale proceeds and original equity investment determines the return, typically targeting a 20%+ IRR or 2.0x+ return on equity."
This answer takes about 30 seconds to deliver and covers the complete LBO lifecycle. Every sentence serves a purpose, and there's enough specificity (the percentage ranges, the three return drivers, the target returns) to demonstrate real knowledge rather than vague familiarity.
The 2-Minute Interview Answer
This is the standard answer you should deliver in most interview settings. It expands on the elevator version with enough detail to demonstrate depth while remaining concise enough to maintain the interviewer's attention and leave room for follow-up questions.
Step 1: Set Up the Transaction
"An LBO, or leveraged buyout, is when a private equity firm acquires a company using a significant amount of debt to finance the purchase, amplifying potential equity returns. The typical LBO capital structure uses 60-70% debt and 30-40% equity from the PE fund.
The process starts with the sources and uses of funds. The uses side represents the total capital needed: the purchase price of the company (usually calculated as an EBITDA multiple times the target's EBITDA, plus net debt being refinanced) and transaction fees for bankers, lawyers, and financing costs. The sources side shows where that capital comes from: senior secured debt (typically 3-4x EBITDA from banks), potentially subordinated or mezzanine debt (another 1-2x EBITDA at higher interest rates), and the PE firm's equity contribution which plugs the remaining gap."
Step 2: Operating Period and Cash Flow
"During the 3-5 year holding period, the company generates cash flow that is used to pay down the outstanding debt, which is called deleveraging. The key metric here is free cash flow, calculated as EBITDA minus cash interest expense, minus taxes, minus capital expenditures, minus changes in working capital. This free cash flow goes toward mandatory debt amortization and potentially voluntary prepayments of term loans.
As the company pays down debt, the equity value increases dollar-for-dollar because the enterprise value (which equals equity plus debt) stays roughly the same or grows, but the debt portion shrinks. This is the core mechanic of how leverage amplifies returns. Meanwhile, the PE firm works with management to grow EBITDA through revenue expansion, margin improvements, add-on acquisitions, or operational efficiencies."
Step 3: Exit and Returns
"At the end of the holding period, the PE firm exits the investment by selling the company, typically through a sale to a strategic buyer, a sale to another PE firm (secondary buyout), or an IPO. The exit enterprise value is calculated by applying an exit multiple to the company's EBITDA at that future point.
To calculate returns, you take the exit enterprise value, subtract the remaining debt at that point (original debt minus all principal payments made during the hold period), and the result is the exit equity value. The return to the PE firm is then measured two ways:
The multiple of invested capital (MOIC) divides exit equity by initial equity:
And the internal rate of return (IRR) is the annualized return rate that accounts for the time value of money over the holding period. PE firms typically target a 20-25% IRR and a 2.0-3.0x MOIC depending on the strategy and risk profile."
This 2-minute version gives a complete, technically accurate walkthrough that demonstrates genuine understanding. It's structured in three clear steps (set up, operate, exit) making it easy for the interviewer to follow and ask targeted follow-ups.
The Three Value Creation Levers in Detail
After your initial walkthrough, interviewers often ask you to elaborate on how PE firms actually create value. Understanding these three levers deeply separates strong candidates from those who only memorized the basic framework.
Lever 1: Debt Paydown (Deleveraging)
Debt paydown is the most mechanical and predictable source of returns. As the company uses free cash flow to repay debt, the equity value grows by the exact amount of debt retired, assuming enterprise value stays constant.
Example: A PE firm buys a company for $1 billion enterprise value with $600M debt and $400M equity. Over 5 years, the company pays down $200M in debt. Even if the enterprise value doesn't change at all, the equity value grows from $400M to $600M, delivering a 1.5x MOIC purely from deleveraging.
This is why LBO candidates need strong, predictable free cash flow. If the company can't generate consistent cash to service and pay down debt, the entire LBO thesis falls apart. The critical cash flow metric is:
Industries with stable demand, recurring revenue, low capex requirements, and limited working capital needs produce the most reliable debt paydown and therefore the most predictable base case returns.
For more on what makes a good LBO candidate, see our dedicated guide covering the characteristics PE firms look for in target companies.
Lever 2: EBITDA Growth
EBITDA growth is the most impactful return lever because it affects enterprise value at exit. If the PE firm can grow EBITDA from $100M to $150M during the hold period, and the exit multiple stays constant at 10x, the enterprise value grows from $1 billion to $1.5 billion, creating $500M of additional value.
PE firms drive EBITDA growth through several strategies:
Revenue growth initiatives: Expanding into new markets, launching new products, investing in sales and marketing, and pricing optimization. Revenue growth is the highest-quality source of EBITDA improvement because it represents genuine business expansion rather than cost-cutting that may not be sustainable.
Operational improvements: Implementing better processes, upgrading technology systems, optimizing supply chains, and improving procurement. PE firms with dedicated operating partners or portfolio support teams often bring specific operational playbooks they've refined across multiple investments.
Add-on acquisitions (buy-and-build): Acquiring smaller competitors at lower multiples and integrating them into the platform company. If the platform trades at 10x EBITDA but acquires smaller companies at 6-7x, the EBITDA from those acquisitions is immediately valued at the higher platform multiple, creating instant value. This strategy has become increasingly important as standalone returns from financial engineering have compressed.
Margin expansion: Reducing costs as a percentage of revenue through economies of scale, shared services, renegotiated vendor contracts, or workforce optimization. Margin improvements flow directly to EBITDA and multiply through the exit valuation.
Master interview fundamentals: Practice 400+ technical and behavioral questions including LBO mechanics and PE concepts, download our iOS app for comprehensive interview preparation.
Lever 3: Multiple Expansion
Multiple expansion occurs when the exit multiple exceeds the entry multiple, meaning the company is valued more richly per dollar of EBITDA at sale than at purchase. If the PE firm buys at 8x EBITDA and sells at 10x EBITDA, the multiple expansion of 2x on a company with $100M EBITDA creates $200M of additional enterprise value.
Multiple expansion can result from:
Business quality improvements: Transforming a company from a lower-quality business (volatile revenue, customer concentration, operational issues) into a higher-quality platform (diversified revenue, recurring contracts, professional management) that buyers will pay a premium for.
Market conditions: If credit markets are loose, interest rates are low, and buyer demand is strong at exit (compared to entry), multiples may be higher simply due to market dynamics. This is the least controllable lever and PE firms generally don't underwrite returns based on multiple expansion.
Size premium: Larger companies trade at higher multiples because they offer more scale, diversification, and institutional quality. A company that grows from $50M EBITDA to $150M through organic growth and acquisitions may command a materially higher multiple simply due to its increased size and reduced risk profile.
Sector rotation: If the company's industry becomes more attractive to buyers (for example, healthcare services have seen significant multiple expansion as PE interest increased), the company benefits from broader market dynamics.
Most sophisticated PE firms model their base case at the same exit multiple as entry (no expansion) and treat any expansion as upside. This conservative approach ensures the investment thesis works without relying on favorable market conditions at exit.
Common Follow-Up Questions and How to Answer
After your initial walkthrough, expect 5-10 minutes of probing questions. Here are the most common follow-ups and how to handle them.
"What makes a good LBO candidate?"
Focus on the characteristics that support debt service and value creation: stable, predictable cash flows (not cyclical or project-based revenue); strong market position with competitive advantages protecting margins; low capital expenditure requirements leaving more cash for debt paydown; opportunities for operational improvement or EBITDA growth; experienced management team or clear operational improvements available; and a fragmented market offering add-on acquisition opportunities.
The underlying principle is that good LBO candidates generate reliable free cash flow in base and downside scenarios, giving lenders confidence they'll be repaid and giving the PE firm a foundation for creating value.
"How does leverage amplify returns?"
This is testing whether you understand the core financial logic of LBOs. Explain with a simple example: if you buy a $100 asset with $100 cash and it appreciates to $120, your return is 20%. But if you buy the same asset with $30 of your own money and $70 of debt, and it appreciates to $120, you repay the $70 debt and keep $50, earning a 67% return on your $30 equity. Leverage multiplies returns because the same dollar amount of appreciation is measured against a smaller equity base.
The flip side is that leverage amplifies losses equally. If that $100 asset drops to $80, the all-cash investor loses 20%, but the levered investor has only $10 of equity remaining (a 67% loss). This is why LBOs require stable cash flows and why PE firms are selective about targets.
"Walk me through the sources and uses"
Detail the components on each side. Uses include: the equity purchase price (share price times diluted shares outstanding), the refinancing of existing debt, and transaction fees (advisory fees typically 1-2% of enterprise value, financing fees typically 2-3% of debt raised, and legal/accounting fees). Sources include: revolving credit facility (usually undrawn at close), term loan A and/or term loan B from banks, high-yield bonds or subordinated notes, mezzanine financing, and sponsor equity to balance the two sides.
For a detailed breakdown, see our guide on sources and uses of funds in M&A.
"How do you calculate the IRR?"
Explain that the IRR is the discount rate that makes the net present value of all cash flows equal to zero. In an LBO context, the cash flows are the initial equity investment (negative, at time zero) and the exit equity proceeds (positive, at time of exit), plus any interim cash flows like dividend recapitalizations. You don't need to derive the formula in an interview, but you should know that IRR accounts for the time value of money (a 2.0x return in 3 years is a better IRR than 2.0x in 5 years) and that PE firms typically target 20-25% IRR for control buyouts.
"What are typical leverage levels?"
Leverage is expressed as Total Debt / EBITDA and varies by market conditions, industry, and company quality:
In current markets, typical leverage is 4-6x EBITDA for most LBOs, with senior debt at 3-4x and subordinated debt at 1-2x. Very stable businesses (healthcare services, software) might support 6-7x, while cyclical businesses (manufacturing, energy) might only support 3-4x. Historical peaks reached 7-8x before the 2008 financial crisis, and lenders have generally maintained more disciplined levels since then.
For detailed coverage of how lenders evaluate borrowing capacity, see our guide on debt capacity analysis in LBOs. For a quick modeling exercise you might encounter in interviews, review our guide on how to do a paper LBO in five minutes.
"What's the difference between IRR and MOIC?"
MOIC (Multiple of Invested Capital) measures the absolute return regardless of time: if you invest $100M and receive $250M at exit, the MOIC is 2.5x. IRR (Internal Rate of Return) measures the annualized return and accounts for when cash flows occur. A 2.5x MOIC over 3 years represents a much higher IRR than the same 2.5x over 7 years. PE firms report both metrics because MOIC shows absolute value creation while IRR shows efficiency of capital deployment over time.
Get the complete guide: Download our comprehensive 160-page PDF covering LBO mechanics, valuation frameworks, and all technical concepts, access the IB Interview Guide for detailed preparation.
Common Mistakes to Avoid
Mistake 1: Confusing Enterprise Value and Equity Value
Many candidates say "the PE firm buys the company for $1 billion" without clarifying whether this is enterprise value or equity value. In an LBO, you purchase the equity of the company and assume or refinance its existing debt. The purchase enterprise value equals the equity check plus the debt in the new capital structure. Always be precise about which value you're discussing.
Mistake 2: Forgetting Transaction Fees
Sources and uses must balance. Many candidates describe the purchase price and debt/equity split but forget that transaction fees (advisory, financing, legal) typically add 3-5% to the total uses, requiring additional equity or debt to fund.
Mistake 3: Describing Only One Return Lever
Some candidates mention only debt paydown or only EBITDA growth. A complete answer references all three levers (deleveraging, EBITDA growth, multiple expansion) and explains which are most controllable versus dependent on market conditions.
Mistake 4: Not Understanding Why Debt Is Cheaper Than Equity
If an interviewer asks "why use debt at all?", you should explain that debt is cheaper than equity for two reasons: debt holders have priority in bankruptcy (lower risk means lower required return) and interest payments are tax-deductible (creating a tax shield that effectively reduces the cost of debt). These two factors make the blended cost of capital lower with leverage than without it, amplifying equity returns when the business performs well.
Mistake 5: Ignoring the Downside
Sophisticated interviewers appreciate candidates who acknowledge that leverage is a double-edged sword. Mentioning that LBOs fail when companies can't generate enough free cash flow to service debt, leading to covenant violations, restructuring, or bankruptcy, shows mature understanding of risk. Reference that PE firms stress-test their models with downside scenarios to ensure the company can survive even if performance disappoints.
For a comprehensive deep dive into the full LBO modeling process beyond the interview walkthrough, see our guide on LBO modeling explained and our article on EBITDA and why it matters for the foundational metric underlying all LBO analysis.
Key Takeaways
The "walk me through an LBO" question tests your ability to explain a complex financial transaction clearly and completely. Mastering it requires understanding not just the steps, but the logic behind each one.
Essential principles to remember:
- An LBO uses significant debt (60-70%) and PE equity (30-40%) to acquire a company, with the company's cash flows servicing the debt over a 3-5 year hold period
- Three value creation levers drive returns: debt paydown (most predictable), EBITDA growth (most impactful), and multiple expansion (least controllable)
- Sources and uses must balance with uses including purchase price, debt refinancing, and transaction fees, and sources including various debt tranches and sponsor equity
- Free cash flow is the critical operating metric calculated as EBITDA minus interest, taxes, capex, and working capital changes
- PE firms target 20-25% IRR and 2.0-3.0x MOIC with leverage typically at 4-6x EBITDA
- Good LBO candidates have stable cash flows, strong market positions, low capex needs, and clear paths to EBITDA growth
For interview execution:
- Prepare both 30-second and 2-minute versions and deliver whichever the situation calls for
- Structure your answer in three clear phases: transaction setup (sources and uses), operating period (cash flow and debt paydown), and exit (returns calculation)
- Be ready for follow-up questions on any concept you mention including leverage mechanics, good LBO characteristics, sources and uses details, and IRR versus MOIC
- Demonstrate business judgment by connecting mechanics to real-world considerations like what types of companies PE firms target
- Acknowledge that leverage amplifies both gains and losses to show sophisticated understanding of risk
Conclusion
The LBO walkthrough is where technical knowledge meets communication skill. Every investment banking candidate studies LBO mechanics, but the ones who get offers are those who can explain the entire transaction lifecycle in a clear, structured, and compelling way while handling follow-up questions with confidence and depth.
The key to mastering this question is practice. Write out your 30-second and 2-minute versions, say them out loud repeatedly, and have friends or mentors challenge you with follow-up questions. The more you practice articulating each step and defending each concept, the more natural your delivery becomes. In the actual interview, you want your walkthrough to feel effortless and conversational, not rehearsed and mechanical.
Remember that the LBO question connects to virtually every other technical topic in investment banking: valuation (how you price the company), accounting (how cash flows are calculated), capital markets (how debt is raised and structured), and M&A (how the transaction is executed). A strong LBO answer signals to interviewers that you understand how all the pieces of investment banking fit together, which is ultimately what they're looking for in candidates they'll trust with live deal work.
Invest the time to truly understand each step rather than memorizing a script. When you can explain why each element matters (not just what it is), you'll handle any variation of this question and any follow-up with the confidence that earns offers at the most competitive banks.
Download on App Store
Download Free PDF