The investment banking interview question we’re going to go over today is “Walk me through an LBO model”. This question comes up less frequently than “Walk me through a DCF” but it’s still very common. We’re going to show you exactly how you should answer it.
“The purpose of the LBO model is to estimate the returns a private equity firm can earn from investing in the company.
The first step in a LBO model is to determine the entry valuation. We need to know how much the PE firm will pay to buy the company. Second, we need to build the Sources and Uses section, so that we know how the PE will finance the transaction, like how much leverage they’ll be using. Third, we should project out the company’s future Levered Free Cash Flow over its holding period, usually 5-7 years.
Once that’s done, we can perform the last step, building the returns analysis to calculate the MOIC and the IRR.”
And that’s how you can answer the interview question “Walk me through an LBO model”. Here’s an important takeaway. You don’t have to walk us through a full blown three statement LBO. For whatever reason, lots of candidates like to dive into three statement LBOs. They’d walk us through all these Balance Sheet adjustments and fancy integrations. In fact, most of the LBOs that you’ll build won’t be three statements. Three statements are built mainly to impress clients. They don’t have much functional use.