A PE firm puts up $200 million of equity to buy a $700 million company, borrowing the other $500 million. Five years later, it sells for $1.35 billion. Cash flow has paid down $80 million of debt, so $420 million is still owed and the equity is worth $930 million. That is a 4.65x multiple on invested capital (MOIC). For comparison, the company's terminal enterprise value is only about 1.9x its $700 million purchase price. That 1.9x compares only the starting and ending enterprise values.
A buyout means acquiring a controlling stake in a mature, cash-flow-generating business. The target is typically an established company with predictable revenue, the opposite of a venture capital startup. The PE sponsor uses that stable cash flow to service acquisition debt. An leveraged buyout (LBO) classification kicks in when the post-deal debt-to-equity ratio is much higher than before, historically as high as 9:1 and more commonly capped near 6:1 after the Great Financial Crisis.
Three features together mark a transaction as an LBO:
Common mistakes
- Confusing MBO with MBI. An MBO is led by the existing management team. An MBI brings in an external team to replace incumbents. A BIMBO blends both. If the scenario says "an outside team acquires and takes over," that is an MBI.
- Calling a secondary buyout a "second round of funding." A secondary buyout is specifically one PE firm selling a portfolio company to another PE firm. It is not a second round of equity financing, not a follow-on investment, and not a public market transaction.
- Naming PIPEs "strategic vs financial." The curriculum taxonomy is traditional (fixed purchase price or fixed conversion terms) vs structured (floating conversion terms). "Strategic" and "financial" do not describe PIPE types in this curriculum.
Bottom line
- Buyouts acquire control of mature companies that keep running as standalone businesses, through five transaction types: MBO, MBI, BIMBO, SBO, P2P.
- Three economic and agency issues frame the strategy: market segmentation, MBO fiduciary conflicts, and MBI golden-parachute incentives.
- Eight LBO categories run from Traditional and Operational Efficiency through Carve-outs, Spin-offs, Buy-and-build, Turnaround, Growth Buyout, and Buyout-to-buyout.
- Buyout funds earn several fees (management 1.25-3%, carry 20-30%, transaction, breakup, divestiture, directors'), while the 8% preferred return is an LP hurdle that governs when carry begins.
Exam shortcut
When you see an LBO calculation, draw the capital stack first: enterprise value at top, subtract net debt to get equity. Enterprise value minus net debt equals equity value (just debt when there is no excess cash). With one initial equity contribution and no interim distributions, equity at exit divided by equity at entry equals MOIC; more generally, MOIC is total equity proceeds divided by total equity invested.
The full lesson (about 7,580 words, 51 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- intro
- firms and funds
- institutional programs
- subscription lines
- lp gp lifecycle
- publicly traded gps
- exit ipos
- exit spacs
- vc overview
- vc stages
- vc risk returns
- vc return research
- vc valuations
- vc financing
- vc securities
- vc dynamics
- growth equity intro
- growth equity valuation
- growth equity deals
- buyouts overview
- buyout strategies
- buyout characteristics
- lbos
- pipes
- liquid alts
- long-hold buyout funds
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