LBO

The acquisition of a company using a significant amount of debt (typically 60-80% of the purchase price) to finance the purchase price, with the acquired company's assets and cash flows serving as collateral. LBOs are the primary transaction structure in private equity. The equity IRR is amplified by financial leverage — a key reason PE firms use this structure. Standard LBO modeling involves building a 5-year projection with exit at an EBITDA multiple.

LBO returns are driven by three factors: (1) Multiple expansion — buying at 7x EBITDA and selling at 10x EBITDA; (2) EBITDA growth — growing the business operationally (revenue growth, margin improvement, add-on acquisitions); (3) Debt paydown — as the company generates cash, debt is repaid, increasing equity value. In a typical 5-year LBO with 5x leverage, even modest EBITDA growth produces 20-25% equity IRR — the target benchmark for top-tier PE funds.

LBO debt structure typically includes: Senior Secured (Term Loan A/B, Revolving Credit Facility) at SOFR/EURIBOR + 300-500 bps; Second Lien (higher yield, structurally subordinated); Subordinated notes or mezzanine (PIK — payment in kind interest that accrues rather than paying cash); and equity (20-40% of total capitalization). The debt-to-EBITDA ratio at entry, interest coverage, and free cash flow conversion are the key credit metrics lenders analyze.

For compliance and KYB professionals encountering PE-owned companies, the LBO structure has specific implications: the acquired company (Newco/BidCo) may sit beneath a complex chain of Luxembourg or Netherlands holding companies (HoldCo, MidCo) designed for tax efficiency. The ultimate beneficial owner is typically the PE fund, but the fund is controlled by its GP. Understanding the full ownership chain — from the operating company up through BidCo, HoldCo, and to the GP — is essential for AML compliance and sanctions screening in financial services.

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