3 Drivers of LBO Returns: EBITDA, Leverage, and Multiples
Deep dive into the three main return drivers in LBOs. Learn how EBITDA growth, debt paydown, and multiple expansion create value in PE deals.
Understanding the three drivers of LBO returns is fundamental to PE interviews and investing. Every PE professional thinks about value creation through these three lenses.
The Three Drivers
Note
LBO returns come from three sources:
- EBITDA Growth – Growing the business operationally
- Debt Paydown (Deleveraging) – Using cash flow to reduce debt
- Multiple Expansion – Selling at a higher multiple than you bought
Each driver contributes independently to returns, and the best deals fire on all three cylinders.
Driver 1: EBITDA Growth
EBITDA growth is the most important and controllable driver. It increases exit value directly and generates cash for debt paydown.
How to Grow EBITDA
Revenue Growth Levers
| Term | Definition | Note |
|---|---|---|
| Organic Growth | Growing existing business | New customers, pricing |
| New Products | Expanding offerings | R&D, innovation |
| Geographic Expansion | New markets | Domestic or international |
| Add-on Acquisitions | Buy-and-build strategy | Very common in PE |
Margin Improvement Levers
| Term | Definition | Note |
|---|---|---|
| Cost Cutting | Reduce operating expenses | SG&A, overhead |
| Procurement Savings | Better supplier terms | Scale benefits |
| Operational Efficiency | Lean operations | Automation, process |
| Pricing Power | Raise prices | If market position supports |
A PE investor asks you: 'If you could only improve one LBO return driver, which would you choose and why?' What's the BEST answer?
Example
EBITDA Growth Impact:
- Entry: $100M EBITDA at 10x = $1B EV
- Exit: $150M EBITDA at 10x = $1.5B EV
- Value created from EBITDA growth alone: $500M
Driver 2: Debt Paydown (Deleveraging)
When you use cash flow to pay down debt, the equity value increases even if Enterprise Value stays flat.
Equity Value = Enterprise Value - Net DebtAs debt decreases, equity value increases dollar-for-dollar.
Example
Deleveraging Impact:
- Entry: EV = $1B, Debt = $600M, Equity = $400M
- Exit: EV = $1B (unchanged), Debt = $300M (paid down), Equity = $700M
- MOIC from deleveraging alone: $700M / $400M = 1.75x
The company didn't grow at all, but equity value increased 75%.
Deleveraging math is tested constantly in PE interviews. Know how to calculate the equity impact of debt paydown.
Driver 3: Multiple Expansion
Selling at a higher EV/EBITDA multiple than you bought at creates additional value.
Example
Multiple Expansion Impact:
- Entry: $100M EBITDA × 10x = $1B EV
- Exit: $100M EBITDA × 12x = $1.2B EV (EBITDA unchanged)
- Value created from multiple expansion: $200M
Multiple Expansion Drivers
| Term | Definition | Note |
|---|---|---|
| Improved Growth Profile | Higher expected growth rate | Most impactful |
| Better Margins | Higher quality earnings | Shows improvement |
| Increased Scale | Larger = lower risk | From M&A or organic |
| Market Conditions | Rising tide lifts all boats | Not controllable |
| Strategic Premium | Buyer willing to pay more | Synergy expectations |
Warning
Important: Multiple expansion is the least reliable driver. It depends on market conditions and buyer sentiment, which PE firms can't control.
Good PE firms never underwrite to multiple expansion—they assume flat or declining multiples in base cases.
A PE fund buys a company at 10x EBITDA. Over 5 years, EBITDA grows 50% and debt is paid down by $400M. If multiples contract to 8x at exit, is this still a good deal? (Entry: $100M EBITDA, $600M debt, $400M equity)
Combined Example: All Three Drivers
Full LBO Return Attribution
Entry (Year 0):
- EBITDA: $100M
- Entry Multiple: 10x
- Enterprise Value: $1,000M
- Debt: $600M (60% leverage)
- Equity: $400M
Exit (Year 5):
- EBITDA: $150M (50% growth)
- Exit Multiple: 11x (10% expansion)
- Enterprise Value: $1,650M
- Debt: $300M (paid down $300M)
- Equity: $1,350M
Returns: MOIC: $1,350M / $400M = 3.4x | IRR: ~28%
In a typical successful LBO, what percentage of returns typically comes from operational improvements (EBITDA growth) vs. financial engineering (leverage and multiples)?
Key Takeaways
Key Takeaway
- Three drivers: EBITDA growth, deleveraging, multiple expansion
- EBITDA growth is king – controllable, compounds, affects other drivers
- Deleveraging is reliable – requires strong cash flow business
- Multiple expansion is a bonus – never underwrite to it
- Best deals fire on all three – but can work with just two
Continue Learning
- LBO Explained Simply — Full LBO mechanics walkthrough
- What Makes a Good LBO Candidate? — Screening criteria for PE deals
- Top 20 PE Interview Questions — Complete PE interview prep
- PE vs Investment Banking — Career comparison