Paper LBO: A Step-By-Step Guide with Interview Examples

Preparing for private equity or growth equity interviews is quite an undertaking. Whether it’s your first interview or your tenth, there’s a lot you need to prepare. 

Preparing for that first one is especially tricky, though, because you’re facing your first paper LBO exercise. 

The paper LBO requires knowledge of the ins-and-outs of a leveraged buyout model, as well as strong analytical skills, knowledge of the deal, and a quick mind for mental math. 

Once you know how to do it, be sure to practice – you don’t want to have the additional challenge of feeling pressured while you think. 

In this article, we’ll cover what a Paper LBO model is, how to prepare, and example prompts so you can go into it feeling extremely confident.

What is a paper LBO?

At its most basic level, a paper LBO highly is a simplified LBO model that uses certain simplifying assumptions that allow you to either calculate using pen and paper (or verbally).  It allows you to estimate returns for a deal quickly without a full model.  

The paper LBO is not actually used much “on the job” but it is often asked for during private equity interviews (and even growth equity interviews). 

In an interview situation, the interviewer will commonly ask the candidate to pencil out a paper LBO for a company or deal they’ve worked on in their previous job.  In other cases, the interviewer might present a new company and supply the candidate with assumptions and financial metrics to use.

Because the paper LBO simplifies the math, usually you can complete a paper LBO using paper & pen, or verbally in an interview.  Sometimes interviewers will lead you along with questions, as you complete the Paper LBO live on the fly.  

Usually the paper LBO exercise will last 5-20 minutes during an interview.

Paper LBO in Interviews

Paper LBO calculations are mostly for private equity interviews, although they can show up in growth equity interviews as well.  

The Paper LBO assesses many key skills for private equity and growth equity jobs and internships:  

First, it’s an excellent way to quickly assess your knowledge of the mechanics of LBO modeling. 

It’s also a great way for an interviewer to assess your communication and quantitative skills. Can you make quick calculations on the fly?  Can you sift through financial metrics in your head and calculate orally with confidence? 

Additionally, the Paper LBO allows the interviewer to dig into a deal on your resume by asking you to sketch out a Paper LBO for the deal.  This allows in-depth follow up questions.

Finally, because usually the Paper LBO is requested for a company/deal you’ve worked on, it tests your level of preparation for the interviews, because in order to complete it successfully you need to remember or memorize key financial metrics for the company and deal.

Paper LBO vs full LBO model

The paper LBO you might encounter in an interview is a highly simplified version of a full leveraged buyout model. 

Here are a couple key ways that paper LBO models differ from full LBO models:

• Instead of building a full 3-statement model, simply focus on projecting Revenue, EBITDA, and free cash flow every year (memorize these for the entire projection period for all your deals!)
• Since you are memorizing financial numbers for Revenue, EBITDA, and FCF, it’s OK to use figures that are rounded to the nearest $5 million 
• Often, you’ll assume growth in metrics over the projection period is linear, allowing you to memorize the year 0 and year 5 metric values (and assume linear growth between them)
• No need to build out balance sheet or debt schedule; you’ll capture their impact by simply projecting FCF

Sometimes interviewers will throw in a complicating factor or two, but the calculations are all designed to be completed without a computer in less than ~20 minutes.  

Step-by-step process for Paper LBO

In many ways, completing a paper LBO is the same as completing any other financial model. 

For any model, you can remember the ASBICIR process.  This stands for the following steps:

• Assumptions – gather all your operating and entry assumptions (incl. pro forma valuation and debt figures); start with the purchase price and debt/equity financing split. 
• Sources and uses – using the assumptions, fill out your sources and uses, which shows where the cash flows to and from in the acquisition transaction.  Ultimately, this will get you to your “Sponsor Equity” which is the investment amount upon which you should base your IRR
• (Pro forma) Balance sheet – With your Sources & Uses done, you can now complete your pro forma balance sheet, and start laying the foundations for projecting it forward until the exit year.  This includes setting up your debt schedule, if your modeling an LBO
• Income statement – next, you can start projecting forward your income statement, all the way down to net income; notably, do not yet integrate interest expense; leave this blank for now
• Cash flow – with your income statement and balance sheet up, you can project forward your cash flows.  This and the prior two steps will be iterative as you set up schedules and make calculations that are interdependent on multiple statements (e.g. D&A)
• Interest – finally, once your 3-statements are connected and projected forward, always the last step is to calculate interest expense and connect it to the income statement; turn on model iterations
• Returns – the last step is to make an assumption about your exit, and to calculate your returns by comparing the entry investment amount to the exit investment amount

For the paper LBO, the only differences are:

• No need for Balance Sheet and Interest Expense steps; these are both excluded; given this, you’re left with the Paper LBO short version: ASICR
• Instead of building a full 5-year projection, instead build up the model for Year 0 and Year 5 (from memory).  To estimate the intervening years, you can either assume linear growth or you can use the “average” method
• To estimate the debt balance at exit (year 5), take the average of Year 0 FCF and Year 5 FCF.  This will give you average FCF across all 5 projection years.  Then take this number and multiply it by 5.  This is an estimate of the total amount debt will decrease during the hold period
• Round numbers to the nearest $5 million

Paper LBO format

Sometimes your interviewer will give you calculation aids like a calculator or basic Excel functionality (which you shouldn’t count on).

However, most of the time your interviewer will want to hear you talk through your thought process. After all, they are hiring human talent, not a calculating robot. (AI isn’t coming for private equity – yet.) 

Follow the ASICR flow above as you calculate and speak. 

Plan anywhere between 5 and 20 minutes for total exercise time, both calculating and speaking. 

As you practice, record yourself going through the entire thing, both to time yourself and to assess your confidence and speaking ability.

Key Assumptions Checklist for Paper LBOs

Before starting a Paper LBO exercise, it’s essential to confirm the key assumptions that will guide your calculations. Use this checklist to ensure you have all the necessary details, helping you avoid mistakes and present a solid analysis during interviews.

1. Revenue and Growth

• Starting Revenue: What is the initial revenue figure provided?
• Growth Rate: Is the revenue growing each year? If so, by how much or what percentage?

2. EBITDA and Margins

• Initial EBITDA Margin: What is the EBITDA margin for the starting year?
• Margin Stability: Are the EBITDA margins constant, or do they change over the projection period?

3. CapEx and Depreciation

• CapEx: What are the annual capital expenditures? Do they match depreciation?
• Depreciation: Is depreciation flat, or does it vary each year?

4. Working Capital

• Changes in Working Capital: Are there annual investments or changes in working capital? How do they impact cash flow?

5. Debt and Interest

• Debt Level: What is the initial amount of debt, usually expressed as a multiple of EBITDA?
• Interest Rate: What is the interest rate on the debt?

6. Taxes

• Tax Rate: What tax rate should be used to calculate net income?

7. Exit Assumptions

• Exit Multiple: What multiple of EBITDA is used to determine the exit value?
• Exit Timing: When is the exit assumed to occur (e.g., at the end of Year 5)?

8. Free Cash Flow

• Key Components: Are all elements like EBITDA, CapEx, working capital changes, and taxes accounted for in FCF calculations?

9. Equity Contribution

• Equity vs. Debt: How much of the purchase price is funded by equity versus debt?

10. Special Assumptions

• Unique Factors: Are there any special conditions, such as non-recurring costs or specific investment requirements?

Using this checklist will help ensure that you cover all critical assumptions before starting your Paper LBO, making your analysis more reliable and easier to explain during interviews.

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Paper LBO Example

This is a sample paper LBO prompt you might be given in an interview situation. 

The assumptions here are pretty standard, but if there are any different ones in your interview, you will know about them. The final result of your paper LBO calculations will be the IRR and MoM for the deal. 

Here’s the sample prompt:

Imagine our firm is considering an LBO of Company X, and you’re on our investment team.  Right now, create a paper LBO live with your interviewer to estimate the IRR and Multiple-on-Money return for the deal. Use the following assumptions:

All dollar amounts are in millions. 

• Year 0 revenue: $100 
• Revenue growth: $10 every year
• Year 0 EBITDA margin: 40% in Year 0
• EBITDA margins: remain constant every year
• Entry timing: at end of Year 0
• Entry multiple: 10x LTM EBITDA
• Pro forma debt: 6.0x LTM EBITDA with blended average interest rate of 5% 
• Year 0 D&A: $5, flat across projection
• CapEx = D&A throughout projection
• Working capital: Cash investment of $10 every year
• Tax rate: 40%
• Entry timing: at end of Year 5
• Assume entry-exit multiple parity

When you pencil out this Paper LBO, what IRR do you get?  I get ~21% or 2.6x MoM.

Below are the key steps with outputs.

Step 1/2: Assumptions + Sources & Uses

Steps 3/4: Income & Cash flow Statements

Step 5: Returns

Special tricks for solving

• Follow the flow. The interviewer wants to see that you know how to think like an investor, and wants to see a clear, logical train of thought from beginning to end. Logical shortcuts are fine, as long as the interviewer can follow what you are doing. 

• IRR is tough to calculate, but the multiple on money, or cash-on-cash return, is easy to calculate. You will need the beginning and ending equity values for the company. Then, you can use this to help you find IRR.

• Since IRR involves time value of money, it’s tricky to find without Excel or a calculator. A good rule of thumb is the Rule of 72. The Rule of 72 states that the time it takes to double your money is 72 divided by the MoM rate of return.
  
  There are also IRR tables you can memorize for common IRR values over a 5-year horizon, but the Rule of 72 has the advantage of being more flexible and easier to remember.

Common Variations and Pitfalls in Paper LBO Interviews

While Paper LBO exercises generally follow a standard format, interviewers often introduce variations or unexpected elements to test your adaptability and depth of understanding. Here’s a look at some common variations you might encounter and the pitfalls to watch out for, along with strategies to handle them effectively:

1. Variations in Assumptions:

• Variation: Interviewers may tweak key assumptions, such as revenue growth rates, EBITDA margins, or the debt-to-equity ratio, to see how you adjust your calculations on the fly.
• Pitfall: Failing to adjust interconnected metrics when a single assumption changes, leading to inaccuracies in your projections.
• Strategy: Always cross-check how a change in one assumption (e.g., lower EBITDA margin) impacts other elements like free cash flow or debt reduction. Be prepared to explain your rationale for adjustments clearly.

2. Limited or Incomplete Information:

• Variation: You may be provided with incomplete data or asked to make assumptions where information is missing, reflecting real-world scenarios where not all data is readily available.
• Pitfall: Making overly optimistic or unrealistic assumptions that could skew the results and reduce credibility in your analysis.
• Strategy: When data is missing, use conservative estimates and justify your assumptions. For example, if given no specific revenue growth rate, default to a modest industry average or historical trend.

3. Introduction of Complicating Factors:

• Variation: Interviewers might add complexities such as fluctuating working capital needs, irregular CapEx schedules, or non-linear growth assumptions.
• Pitfall: Struggling to accommodate these factors within a simplified Paper LBO framework can lead to errors or incomplete analyses.
• Strategy: Break down complex factors into manageable parts. For example, if working capital fluctuates, focus on average requirements rather than year-by-year precision. Clearly articulate any simplifications you make.

4. Changes in Exit Conditions:

• Variation: Interviewers may alter exit conditions, such as changing the exit multiple, introducing a partial exit scenario, or applying different exit timing assumptions.
• Pitfall: Incorrectly applying the exit assumptions can significantly alter the IRR and MoM calculations, which are critical to demonstrating the deal’s attractiveness.
• Strategy: Practice recalibrating your exit value calculations quickly under different scenarios. Clearly outline how each change impacts the overall returns and be ready to discuss the implications of your revised calculations.

5. Verbal-Only Walkthroughs:

• Variation: Some interviewers may ask you to conduct the entire exercise verbally without writing down calculations, testing your ability to articulate your thought process and perform mental math.
• Pitfall: Losing track of steps or becoming flustered under pressure can lead to mistakes and diminish your performance.
• Strategy: Regularly practice verbalizing your Paper LBO calculations. Develop a clear, logical script in your head, focusing on the key steps and checking your work as you go along.

Common Pitfalls to Avoid:

• Overcomplicating the Exercise: Remember, the goal of a Paper LBO is to simplify the analysis. Avoid diving too deep into granular details that aren’t necessary for the exercise.
• Rushing Calculations: While speed is important, accuracy is critical. Take a moment to double-check key figures, especially when estimating debt reduction or exit equity value.
• Failing to Communicate Clearly: Even if your math is perfect, poor communication can undermine your performance. Practice explaining your thought process clearly and concisely, ensuring the interviewer can follow along with your reasoning.

Troubleshooting Common Calculation Errors in Paper LBOs

Performing a Paper LBO under interview conditions can be challenging, and errors in calculations are not uncommon. Here’s a troubleshooting guide to help you identify, correct, and avoid common mistakes during the exercise. This guide will equip you with strategies to ensure accuracy and maintain confidence under pressure.

1. Double-Check Key Figures and Assumptions:

• Common Error: Incorrect starting figures or misremembered assumptions, such as using the wrong EBITDA margin or debt ratio, can throw off your entire calculation.
• Troubleshooting Tip: Always take a moment to verify the key inputs before proceeding with calculations. Repeat the main assumptions back to the interviewer if possible, and jot down any critical figures. This will help ensure you’re working with accurate data from the start.

2. Validate Your Revenue and EBITDA Projections:

• Common Error: Miscalculating growth rates or inconsistently applying margins, leading to inaccurate projections.
• Troubleshooting Tip: Break down the projections year-by-year, even if only mentally, to ensure growth is applied consistently. For linear growth assumptions, quickly verify that the start and end figures align with the projected annual increases. Consistency is key to avoiding compounding errors over the projection period.

3. Simplify Complex Calculations with Approximations:

• Common Error: Overcomplicating the math or trying to perform exact calculations when approximations would suffice, leading to time wastage and errors.
• Troubleshooting Tip: Use rounding and approximations to simplify complex calculations. For instance, round to the nearest $5 million or use the average method for calculating free cash flows. This not only saves time but also reduces the risk of errors creeping in through overly precise calculations.

4. Cross-Check Cash Flow Calculations:

• Common Error: Missing critical adjustments, such as working capital changes or CapEx, which can lead to incorrect free cash flow estimates.
• Troubleshooting Tip: Use a checklist approach: after calculating EBITDA, ensure you’ve subtracted D&A, CapEx, and working capital changes before arriving at free cash flow. Mentally review each step to ensure nothing has been overlooked.

5. Verify Exit Calculations and Debt Reduction:

• Common Error: Incorrectly estimating the debt balance at exit or misapplying exit multiples, resulting in flawed MoM and IRR calculations.
• Troubleshooting Tip: Re-calculate the debt reduction using average free cash flows if time allows, and ensure the exit multiple is applied consistently with the initial assumptions. A quick sense-check: compare your projected exit equity value against the entry value to see if it logically aligns with your expected return.

6. Use Mental Math Checks to Confirm Results:

• Common Error: Missteps in mental math can skew results, especially under pressure.
• Troubleshooting Tip: Utilize mental math techniques like the Rule of 72 for IRR estimation or back-of-the-envelope calculations to cross-check major results. For example, if you calculate that equity value should triple, the corresponding IRR should roughly align with doubling time in 4 years (~18%) versus tripling (~32%).

7. Manage Calculation Flow to Avoid Overlooking Steps:

• Common Error: Missing a critical calculation step, such as adjusting for taxes or correctly allocating interest expenses.
• Troubleshooting Tip: Follow a structured approach like ASICR (Assumptions, Sources, Income, Cash Flow, Returns) and mentally tick off each step as you complete it. This ensures that no critical component is missed during the exercise.

8. Recognize When to Move On:

• Common Error: Getting stuck on a difficult calculation and losing valuable time, leading to incomplete answers.
• Troubleshooting Tip: If you find yourself bogged down in a particularly complex step, summarize your approach to the interviewer and move on. It’s more important to demonstrate a complete understanding of the process than to get every number exactly right under time pressure.

Paper LBO prep plan

Private equity headhunters and interviewers alike are looking for one thing: expertise. 

Since the paper LBO calculation is one of the most technical things you will cover in your interview, it is worth your while to practice.  Timing yourself is also key. 

Memorize key deal financials

For each of the major deals you list on your resume, memorize the following financial metrics:

• Revenue- Year 0 (entry) and Year 5 (exit)
• EBITDA – Year 0 and Year 5 
• FCF (calculated from EBITDA) – Year 0 and Year 5 
• Entry valuation multiple
• Entry debt
• Exit valuation multiple
• Exit debt
• IRR & MoM of deal

If the deal wasn’t an LBO or acquisition, you should still memorize these figures because you might be asked to pencil out an LBO for it anyway.

Memorize the Rule of 72 and Rule of 115

These will help you go from multiple on money to IRR calculations for a 5 year period.

Practice with pen and paper

If you are working from pen-and-paper case studies, see if you can get your time down to 5-10 minutes for a straightforward case study, or 10-15 for a more complex example (e.g. read more about private equity case studies). 

Practice with your deals

You can also use deals on your private equity resume to generate paper LBO calculations. Go through each deal you completed and create a paper LBO scenario. 

Basically, you need to reduce the full model from the actual deal to a simplified paper calculation. Ensure that the relevant ending metrics, such as the internal rate of return and the cash-on-cash return, are the same between the original and simplified versions (within rounding error). 

Since it has more meaning to you than a case study, you should be able to memorize each paper LBO scenario for previous deals. Not only will this help you become more efficient with your paper LBO calculations, but it will also make you a more confident interviewee. 

Quick Reference Guide for Paper LBOs

Use this quick reference guide to streamline your preparation and boost your confidence during Paper LBO exercises. This cheat sheet condenses essential formulas, key metrics, and useful rules of thumb that are crucial for tackling Paper LBOs in interviews.

Key Formulas and Calculations

• Enterprise Value (EV): EV = EBITDA × Entry/Exit Multiple
• Equity Value at Exit: Equity Value = Exit Enterprise Value – Remaining Debt
• Free Cash Flow (FCF): FCF = EBITDA – CapEx – Change in Working Capital – Taxes
• Debt Reduction Estimate: Total Debt Reduction = Average FCF × Projection Period

Rules of Thumb

• Rule of 72: Use this to estimate the time it takes for an investment to double in value:
  Time to Double = 72 ÷ Annual IRR. Example: For a 20% IRR, it takes approximately 3.6 years to double the investment (72 ÷ 20).
• Rule of 115: To estimate the time for tripling an investment, use: Time to Triple = 115 / Annual IRR. Example: A 25% IRR suggests tripling in roughly 4.6 years (115 ÷ 25).

Essential Steps for a Paper LBO

1. Gather Assumptions: Start with revenue, EBITDA margin, CapEx, working capital, and debt/equity split.
2. Calculate Initial Equity Investment: Subtract debt from the purchase price to determine equity needed.
3. Project Key Metrics: Estimate revenue, EBITDA, and FCF over the projection period using simplified growth assumptions (e.g., linear growth).
4. Estimate Debt Paydown: Use projected FCF to calculate debt reduction over the hold period.
5. Calculate Exit Equity Value: Apply the exit multiple to Year 5 EBITDA, then subtract the remaining debt.
6. Determine Returns: Calculate IRR and Multiple on Money (MoM) to assess deal attractiveness.

Common Interview Tips

• Simplify where possible: Use rounded numbers to speed up calculations and reduce complexity.
• Communicate clearly: Always articulate your thought process, even when unsure of exact figures.
• Prioritize key drivers: Focus on metrics that significantly impact the outcome, such as EBITDA and debt levels.

Quick Mental Math Tricks

• Percent Calculations: Use approximate percentages (e.g., 10% of $100 million is roughly $10 million) to speed through parts of your analysis.
• Multiples Estimation: Quickly estimate multiples by breaking down large calculations (e.g., 8x EBITDA can be thought of as 10x less 20%).

Frequently Asked Questions

How long should a paper LBO take?

A simple case study with pen and paper provided and no complicating factors can be completed in five minutes. 

A more complex calculation where Excel is allowed should not take more than five minutes either. 

If the LBO study has complicating factors like multiple investors or a one-time cash outflow within the case study timeline, it can take longer, but no more than about 20 minutes including discussion time. 

Are paper LBOs actually on paper?

Yes!  Sometimes.

They can be on paper. Some firms may choose to do a simplified Excel version for more complex LBO examples. 

Other firms may have paper or may simply do a fully verbal interview with a simpler example.

What should I do if I’m given unexpected data or assumptions during the interview?

When faced with unexpected data or assumptions, stay calm and quickly identify how these changes impact your overall model. Acknowledge the new information, adjust your calculations accordingly, and clearly communicate your thought process.

If the new data contradicts prior assumptions, explain how you will reconcile the differences. Demonstrating flexibility and a logical approach is more important than reaching the exact answer under pressure.

How should I handle incomplete or missing information in a Paper LBO exercise?

In real-world situations, data is often incomplete, and interviewers use this to test your problem-solving skills. When information is missing, make reasonable and conservative assumptions based on industry norms or historical data.

Clearly state your assumptions to the interviewer and explain why you chose them. This shows that you can navigate ambiguity and make sound decisions without all the details.

What if I’m asked to perform the Paper LBO verbally without writing anything down?

If required to perform the exercise verbally, focus on articulating each step clearly and logically. Break down your thought process into distinct sections—assumptions, projections, calculations, and conclusions—and speak through each part systematically.

Practice verbal LBOs beforehand to build confidence and refine your ability to keep calculations organized in your head.

How do I manage my time effectively during a Paper LBO interview?

Time management is crucial in a Paper LBO exercise. Start by quickly outlining the main steps you’ll take, focusing on key assumptions and calculations. Prioritize the most impactful elements—like estimating EBITDA, projecting cash flow, and calculating exit values—before diving into less critical details.

If you’re running short on time, summarize your remaining steps verbally to demonstrate your complete understanding of the process.

What are the most common mistakes to avoid in Paper LBO exercises?

Common mistakes include overcomplicating the calculations, failing to communicate your steps clearly, and neglecting to double-check key figures. Avoid getting bogged down in unnecessary details that don’t significantly impact the overall outcome.

Always keep the big picture in mind: you’re demonstrating your ability to estimate potential returns and think like an investor, not just crunching numbers.

How can I best prepare for a Paper LBO if I don’t have a finance background?

Even without a formal finance background, you can excel in Paper LBOs by mastering the basics of financial modeling and practicing regularly. Focus on understanding the key components of a leveraged buyout—purchase price, debt financing, cash flow projections, and exit valuation.

Use online resources, simplified models, and practice scenarios to build your confidence. Familiarity with mental math and common industry metrics will also help you perform under interview conditions.

What should I do if my calculations seem off during the interview?

If you realize your calculations may be off, don’t panic. Quickly identify where the error might have occurred, and if possible, correct it on the spot. If time doesn’t permit, acknowledge the potential discrepancy to the interviewer, explain how you would typically verify and correct it, and continue with your rationale.

This shows that you’re attentive to detail and proactive in managing errors, both valuable traits in finance roles.

How should I explain the rationale behind my assumptions and decisions?

Clearly explaining your assumptions and decisions is as important as the calculations themselves. Use a structured approach: state the assumption, justify it with logical reasoning or data (if available), and briefly discuss its impact on your overall model.

Be concise but thorough, demonstrating that each assumption is carefully considered and contributes to a coherent financial analysis.