Definition
In an LBO, a financial sponsor (typically a private equity firm) acquires a company using a significant amount of borrowed money (60-80% of purchase price). The target company's assets and cash flows serve as collateral and repayment source. Returns are generated through leverage, operational improvements, and multiple expansion at exit.
functions Formula
Equity IRR = (Exit Equity / Entry Equity)^(1/years) − 1
lightbulb Example
PE firm buys company for $500M with $150M equity and $350M debt. Over 5 years, debt is repaid to $200M and exit value is $700M. Exit equity = $500M. IRR = ($500M/$150M)^(1/5) − 1 = 27.2%.
verified_user Key Points
- Debt typically represents 60-80% of purchase price
- Target must have stable, predictable cash flows
- Returns enhanced by leverage, operational improvements, and multiple expansion
- Sponsor targets 20%+ IRR over 3-7 year hold