Introduction
The paper LBO is one of the most common technical exercises in investment banking and private equity interviews. The interviewer provides a set of simplified assumptions (purchase price, EBITDA, leverage, growth rate, exit multiple, hold period) and asks the candidate to calculate the sponsor's returns using only mental math and a pen and paper. The exercise tests three things simultaneously: technical understanding of LBO mechanics, comfort with mental math under pressure, and the ability to communicate clearly while performing calculations. For a more detailed walkthrough with worked examples, see our blog post on paper LBOs.
- Paper LBO
A simplified LBO analysis performed without a computer, using mental math and a pen and paper (or whiteboard), typically in 5-10 minutes during an interview. The paper LBO strips the full LBO model down to its essential components: entry price, leverage, EBITDA growth, exit value, debt paydown, and returns calculation. It tests the candidate's ability to think through the deal structure logically and communicate the analysis in real time, rather than their ability to build complex Excel models.
The Five-Step Framework
Calculate the Purchase Price and Equity Check
Multiply the EBITDA by the entry multiple to get the enterprise value. Subtract debt (leverage x EBITDA) to get the equity check. Example: $100M EBITDA x 10x entry = $1B EV. At 5x leverage, debt = $500M, equity = $500M.
Project EBITDA at Exit
Grow the entry EBITDA by the annual growth rate over the holding period. For 5% annual growth over 5 years: $100M x 1.05^5 is approximately $128M (use the approximation: 5 years x 5% = 25% total growth, so $125M; compounding adds a bit, so $127-128M).
Calculate Exit Enterprise Value
Multiply exit EBITDA by the exit multiple. At 10x exit: $128M x 10x = $1,280M.
Calculate Exit Equity Value
Subtract remaining debt from exit EV. If the company repaid $150M of debt (through amortization and cash sweeps), remaining debt = $350M. Exit equity = $1,280M - $350M = $930M.
Calculate Returns
MOIC = exit equity / entry equity = $930M / $500M = 1.86x. For IRR, use mental math shortcuts (see below).
Mental Math Shortcuts for IRR
Calculating exact IRR requires a financial calculator or Excel. In an interview, use these approximations:
- Rule of 72
A mental math shortcut for estimating how long it takes an investment to double at a given rate of return (or, equivalently, what rate of return is needed to double in a given time). The formula is: Years to double is approximately equal to 72 / annual return (%). At 20% annual return, an investment doubles in approximately 3.6 years (72 / 20). If an investment doubles in 5 years, the implied annual return is approximately 14.4% (72 / 5). The Rule of 72 is the single most useful mental math tool in paper LBOs because it allows quick conversion between MOIC and IRR without a calculator.
Application: To estimate IRR from any MOIC, first convert to a doubling framework. A 3.0x MOIC is 1.5 doublings (since 2^1.5 is approximately 2.83). Over 5 years, one doubling takes 5 / 1.5 = 3.33 years, implying an IRR of approximately 72 / 3.33 = 21.6%. This is close to the exact answer of ~24.6%, which is accurate enough for interview purposes.
Common benchmarks to memorize:
| MOIC | 3-Year IRR | 4-Year IRR | 5-Year IRR |
|---|---|---|---|
| 1.5x | ~14% | ~11% | ~8% |
| 2.0x | ~26% | ~19% | ~15% |
| 2.5x | ~36% | ~26% | ~20% |
| 3.0x | ~44% | ~32% | ~25% |
Having these benchmarks memorized allows you to quickly approximate the IRR for any MOIC / holding period combination. In the example above (1.86x over 5 years), the IRR is between the 1.5x row (8%) and the 2.0x row (15%), approximately 13%.
Common Interview Prompts and Variations
Standard Prompt: "A company has $100 million in EBITDA. You acquire it at 10x with 5x leverage. EBITDA grows at 5% per year. You exit at 10x after 5 years. Assume $30 million per year in debt paydown. What are the returns?"
Variations to Prepare For:
- Different growth rates: 0%, 5%, 10%, or declining EBITDA
- Multiple expansion or compression: Exit at 11x (expansion) or 8x (compression)
- Variable debt paydown: "Assume the company generates $50M in annual free cash flow after interest"
- Dividend recapitalization: "After Year 3, the sponsor takes out a $100M dividend recap"
- Add-on acquisition: "In Year 2, the company acquires a bolt-on for $100M at 6x EBITDA"
Each variation tests whether the candidate can adapt the framework to new assumptions without losing the structure.
How to Handle the Harder Variations
Dividend recapitalization: The sponsor receives cash during the holding period (not just at exit). Add the dividend to the total cash received in the MOIC numerator. For example, if the sponsor invests $400 million, receives a $100 million dividend recap in Year 3, and exits for $700 million in Year 5, the MOIC is ($100M + $700M) / $400M = 2.0x. The IRR is higher than a 2.0x without the dividend because cash is received earlier (the dividend in Year 3 is "worth more" to the IRR calculation than the same amount received in Year 5).
Add-on acquisition: The sponsor invests additional equity to fund the bolt-on. Add the follow-on investment to the equity denominator. If the initial equity check is $400 million and the sponsor contributes $50 million for a Year 2 bolt-on, the total invested capital is $450 million. The bolt-on's EBITDA contribution is added to the exit EBITDA for the exit value calculation. The key insight: bolt-on acquisitions at lower multiples than the platform multiple (e.g., buying at 6x and integrating into a 10x platform) create immediate multiple arbitrage that boosts returns.
Multiple compression: If the exit multiple is lower than the entry, EBITDA growth must compensate. At 10x entry and 8x exit, EBITDA must grow enough that the lower exit multiple still produces an acceptable equity value. This variation tests whether the candidate can quickly identify how much growth is needed to overcome the multiple headwind.
Free Interview PDF Guide