Leveraged Buyout Model
A leveraged buyout (LBO) model is a financial model used by private equity firms to evaluate acquiring a company using a combination of equity and a large amount of borrowed capital, with the acquired company's assets and cash flows serving as collateral and the primary source of debt repayment. The LBO model determines the maximum purchase price a financial buyer can pay while still achieving its target return on invested equity.
In an LBO, a private equity firm such as KKR, Blackstone, or Apollo Global Management acquires a company using typically 50% to 70% debt and 30% to 50% equity. The model works backward from a target internal rate of return — usually 20% or higher on the equity investment — and solves for the maximum entry multiple the sponsor can afford to pay given the target company's projected cash flows, anticipated leverage, and expected exit multiple at the end of a holding period of roughly four to seven years.
The LBO model is structured around the target company's free cash flow, which is the primary mechanism for repaying acquisition debt over the holding period. Companies with stable, predictable cash flows — consumer staples brands, software companies with recurring subscription revenue, and healthcare services businesses — are attractive LBO candidates because their cash generation provides reliable debt service coverage. Companies with cyclical revenues or large capital expenditure requirements are less suitable because they cannot predictably service acquisition debt across an economic cycle.
The model outputs a projected equity return (IRR and multiple on invested capital) under a range of operating scenarios. Sensitivity tables show how the returns change as operating assumptions, exit multiples, and leverage ratios vary. Investment committees use these sensitivities to assess downside risk alongside the base case.
LBO analysis is also used by public company investors as a floor valuation. If a company's market capitalization is low enough that a private equity buyer could acquire it, take it private, and generate strong equity returns based on the company's own cash flows, that LBO floor provides a valuation anchor. This discipline was evident when companies like Dell Technologies and Hilton Worldwide were taken private before subsequently returning to public markets.