How to Build an LBO Model in Excel

A leveraged buyout model tests whether buying a company with mostly borrowed money produces an attractive return. You build a sources and uses table to fund the purchase, layer in debt tranches that amortize and get swept down with free cash flow, then measure returns with IRR and MOIC. The driver of returns is debt paydown and EBITDA growth between entry and exit.

What an LBO model is and how it works

An LBO model values a company from the perspective of a financial sponsor who funds most of the purchase with debt and a smaller slice of equity. Because the equity check is small relative to the enterprise value, paying down debt with the company's cash flow transfers value to the equity holder over the hold period.

The mechanics run in three stages. At entry, a sources and uses table shows how the deal is funded. Over the hold, the company's free cash flow pays down debt through mandatory amortization and a cash sweep. At exit, the company is sold at an assumed multiple, debt is repaid, and the remaining equity value drives the return.

Build sources and uses step by step

Sources and uses must balance: total funding equals total cost. This compact example funds a purchase with two debt tranches and a sponsor equity check.

1. Compute entry enterprise value: =entry_multiple * entry_EBITDA.
2. List uses: purchase of equity, refinanced debt, and transaction fees.
3. List sources: each debt tranche sized off EBITDA, with sponsor equity as the plug.
4. Solve equity: =total_uses - total_debt_sources.
5. Carry opening debt balances into the debt schedule.
6. Project free cash flow and sweep it against the tranches each year.

Sponsor equity is the plug that makes sources equal uses; here a 610 purchase is funded with 550 of debt and 60 of equity.

Debt tranches, the cash sweep, and returns

Each tranche runs through a debt schedule with a beginning balance, mandatory amortization, an optional cash sweep, and interest. Free cash flow after mandatory items feeds the sweep, which pays down the most senior tranche first. As with any sweep, interest on a balance that depends on the sweep creates circularity, so enable iterative calculation.

Returns are measured two ways. MOIC is exit equity divided by entry equity. IRR is the annualized rate that equates the entry equity outflow with the exit equity inflow over the hold period.

• Entry equity: =enterprise_value - net_debt + fees, funded by the sponsor.
• Exit enterprise value: =exit_multiple * exit_EBITDA.
• Exit equity: =exit_enterprise_value - net_debt_at_exit.
• MOIC: =exit_equity / entry_equity.
• IRR: =(exit_equity / entry_equity) ^ (1 / years) - 1 for a single in and out, or =IRR(cash_flows) with interim distributions.

Pitfalls and what reviewers check

The first thing a reviewer checks is whether sources equal uses. If they do not, the equity plug is wrong and every return downstream is meaningless. Build a check cell that reads zero.

The second is the cash sweep and its circularity. Pair it with a switch so you can break the loop, confirm the sweep never pays more than a tranche's balance, and verify seniority, the senior tranche sweeps before the subordinated tranche.

Reviewers also pressure test the exit multiple assumption. A return driven mostly by multiple expansion, exiting at a higher multiple than entry, is weaker than one driven by EBITDA growth and debt paydown. Show the return bridge so the source of value is explicit.