LBO Returns Attribution

the amount you get in hand is all that matters, so your exit value rules

but the returns are:

1. Business dependant, which leads you to nr. 2 below.

2. Thesis dependant. The investment thesis preceeds your returns attribution. If you expect to use the biz as an M&A platform, then you'll be focused on multiples/EBITDA, not as much FCF. If it's already stagnated, then probably FCF.

Got asked this in a PE interview. Interviewer picked FCF (debt pay down) - any thoughts on why?

The one that aligns with the story I’ve been telling my LPs about what my strength and differentiation is as a firm. 

When comparing the impact of $1 EBITDA growth, $1 multiple expansion, and $1 debt paydown, the clear winner is multiple expansion due to its outsized leverage on Equity Val. In this scenario, a $1 increase in the multiple applied to EBITDA results in a significantly greater impact. For example, with a $100 EBITDA base and an initial 10x multiple, a $1 increase in the multiple (from 10x to 11x) boosts EV and Equity Val by $100. In contrast, $1 EBITDA growth contributes to EV only in proportion to the multiple (e.g., at 10x, $1 in EBITDA increases EV and Equity Val by $10), and $1 debt paydown increases Equity Val on a simple 1:1 basis without affecting EV. While multiple expansion delivers the most dramatic increase in Equity Val, it is often less controllable, relying on favorable market dynamics or strategic repositioning. EBITDA growth, although less impactful per unit, is more durable and reflects core operational improvement or synergistic M&A activity. Debt paydown, while essential for de-risking the investment and optimizing returns prior to exit, is the least compelling driver of equity value creation in this framework

The interviewer said something about how when comparing EBITDA growth vs Multiple Expansion, the answer should be EBITDA growth for similar reasons as Price vs Volume increase?

A single turn of expansion has outsized impact. You don’t even have to do anything.

Very hard to drive EBITDA growth and debt pay down is capped by the amount of debt you have.

Best case scenario is buying at a bottom-cycle multiple and selling at a top - even if the business stays the same / slightly declines, you’ll make out like a king.

Multiple expansion can happen in an instant. Same can't be the said for the other two...

Let me suggest why you might pick the cash generation as you mention the interviewer did.

Let‘s first agree on the premisis: there is $1 in value creation across all alternatives, i.e. for a $100 EBITDA and 10x EV/EBITDA business we are comparing:

1) $1 additional Cash generation

2) $0.1 additional EBITDA (with no increase in cash generation)

3) 0.01x increase in multiple

Each of these contributes $1 in value.

Firstly, consider time value of money. The cash generation is today and you can pay yourself a dividend, while the $1 increase from EBITDA or multiple expansion only comes through at time of exit, which may not be today.

Secondly, the cash generation feels more permanent than an increase in multiple (or even the EBITDA) which may change again if you choose to not sell at that point in time.

Consider also that PE firms try to market themselves as good custodians of businesses to investors, potential targets, etc. As above poster said: it depends what you are marketing as your strategy. Usually they like to emphasise that their value creation comes from EBITDA increases and cash generation. That’s because it is more under their control vs multiple expansion which is not equally attributable to them / the business. (Of course this is a bs argument because PE firms select firms that will grow anyway and we do not have the counterfactual, but they do say this a lot).