LBO Debt Model

Based on the most helpful WSO content, here's what you need to know:

Your observation is correct—if you fix the debt at 0.5× Revenue 2024 and maintain a 40% debt share in the total sources, the equity contributions from both sponsors (30% each) will also remain constant as a percentage of the total sources. However, this approach can create a disconnect between the entry multiple and the capital structure, which might not align with typical LBO modeling practices.

Here are a few key points to consider:

1. Debt Sizing and Entry Multiple:
   In most LBO models, debt is typically sized based on leverage ratios (e.g., 4.5×–6.5× EBITDA) rather than a fixed percentage of revenue. This ensures that the debt level is aligned with the company's cash flow generation capacity, which is critical for servicing the debt. By tying debt to revenue, you might inadvertently create a structure that doesn't reflect the company's ability to handle leverage.

2. Flexibility in Equity Contributions:
   If you fix the debt at 40% of total sources, the equity contributions from the sponsors will indeed remain constant as a percentage. However, in practice, the equity contributions should be flexible and adjust based on the entry multiple and the total purchase price. This ensures that the capital structure remains reasonable and reflects market norms.

3. Alternative Approach:
   Instead of fixing the debt at 0.5× Revenue 2024, consider using a leverage ratio based on EBITDA (e.g., 4.5× EBITDA). Then, calculate the total purchase price using the entry multiple and adjust the equity contributions to fill the gap between the debt and the total purchase price. This approach allows for a more dynamic and realistic capital structure.

4. Market Norms:
   As highlighted in WSO threads, most LBOs in a pre-COVID market are structured with 35–40% equity and 60–65% debt. Leverage typically ranges from 4.5×–6.5× EBITDA, depending on the industry and the company's risk profile. If you're working with a revenue-based debt assumption, ensure that it translates into a reasonable leverage ratio.

Practical Steps:

• Reassess the debt sizing methodology to ensure it aligns with EBITDA-based leverage norms.
• Calculate the total purchase price using the entry multiple and adjust the equity contributions dynamically.
• Validate your assumptions by comparing them to public comparable companies or recent LBO transactions in the same industry.

By adopting a more flexible and market-aligned approach, you'll create a model that better reflects real-world LBO dynamics. Let me know if you'd like further clarification or help with specific calculations!

Sources: Private Credit Resources and Prep, Creating own LBO assumptions, How Private Equity Owned Companies Fund Add-Ons, Sources and Uses statement - private LBO model, LBO Returns - Increasing Leverage Doesn't Increase Returns?