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 |
Why EBITDA Growth is Key
EBITDA growth is special because it compounds:
- Higher EBITDA → Higher exit value (via multiple)
- Higher EBITDA → More cash flow → Faster debt paydown
- Higher EBITDA → Higher quality business → Potential for multiple expansion
It attacks multiple return levers simultaneously.
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%.
What Enables Deleveraging?
- Strong free cash flow – More cash available for debt paydown
- Low CapEx requirements – Less reinvestment needed
- Working capital efficiency – Cash not tied up in operations
- No mandatory dividends – Cash stays in the business
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
What Drives Multiple Expansion?
Multiple Expansion Drivers
| Term | Definition | Note |
|---|---|---|
| Improved Growth Profile | Higher expected growth rate | Most impactful |
| Better Margins | Higher quality earnings | Shows operational 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.
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%
Return Attribution:
- EBITDA Growth: ~55% of returns
- Deleveraging: ~30% of returns
- Multiple Expansion: ~15% of returns
Which Driver Matters Most?
Driver Comparison
| Term | Definition | Note |
|---|---|---|
| EBITDA Growth | Most important | Controllable, compounds |
| Debt Paydown | Very important | Requires cash flow |
| Multiple Expansion | Bonus, not base case | Market dependent |
The best PE investments generate returns primarily from EBITDA growth and deleveraging. Multiple expansion is gravy.
Interview Questions
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