The Paper LBO: A Practical Tutorial Guide


In this guide, we will explore the practice of the paper LBO, a common test used by private equity firms to assess potential candidates. Unlike traditional LBO modeling tests, the paper LBO test requires candidates to analyze a hypothetical company and calculate key metrics using only pen and paper. Let’s dive into the details.

Understanding the Paper LBO

During a private equity interview, candidates are typically presented with a “prompt” – a brief description providing an overview of a hypothetical company and relevant financial data. Armed with only a pen and paper, candidates have 5-10 minutes to derive the implied internal rate of return (IRR) and other essential metrics based solely on the information given in the prompt. It’s important to note that calculators are not provided during these interviews, so candidates must be comfortable performing mental calculations under timed pressure.

The paper LBO test is often used in the early stages of the private equity interview process, serving as a quick assessment of a candidate’s abilities. As candidates progress to subsequent rounds, they may be asked to complete more comprehensive LBO modeling tests or take-home case studies.

How to Approach the Paper LBO

To successfully complete a paper LBO test, it’s crucial to follow a structured approach. Here are the steps you should take:

Step 1: Input Transaction and Operating Assumptions

Begin by analyzing the operational assumptions provided in the prompt. Calculate the total amount required to purchase the target company based on these assumptions.

Step 2: Build Sources and Uses of Funds Table

Next, construct a Sources and Uses table that reflects the transaction structure assumptions. Determine the cost of acquiring the company, the required debt and equity financing, and ensure both sides of the table balance. Keep in mind that in a real LBO model, additional factors such as transaction and financing fees would be included in the Uses of Funds section.

Step 3: Project Financials

Now, it’s time to forecast the financials of the target company. Utilize the operational assumptions provided earlier to project revenue, EBITDA, and net income.

Step 4: Calculate Free Cash Flow (FCF)

Having completed the financial forecast, you can now calculate the free cash flows (FCFs) generated by the target company over the holding period. This step is crucial in determining the amount of debt that can be paid down during the investment period.

Step 5: Evaluate LBO Returns

In the final step, assess the returns of the investment using metrics such as the multiple on invested capital (MOIC) and the internal rate of return (IRR). In our hypothetical scenario, we exit the investment at the same multiple as the entry multiple, assuming no multiple expansion.

Example Prompt Analysis

Let’s take a look at an example prompt to better understand the paper LBO process:

JoeCo, a coffee company, has generated $100mm in last twelve months (LTM) revenue and this figure is expected to increase by a growth rate of 10% annually into the foreseeable future.

JoeCo’s LTM EBITDA was $50mm and its EBITDA margin should remain unchanged in the years ahead.

Based upon management guidance, JoeCo’s depreciation and amortization (D&A) and its capital expenditures (Capex) is expected to be 5.0% as a percentage of revenue, with no change in net working capital (NWC) and the effective tax rate fixed at 25%.

If a PE firm acquired JoeCo for 10.0x EBITDA and exited at the same multiple five years later, what is the implied internal rate of return (IRR) and multiple on invested capital (MOIC)?

For the financing of the LBO, assume the initial leverage ratio used to fund the purchase was 6.0x EBITDA and that the debt carries an interest rate of 8.0% with no required principal amortization until maturity, at which debt is fully paid down upon exit.

By following the step-by-step process outlined earlier, you can arrive at the implied IRR and MOIC for this specific scenario.


The paper LBO test serves as a valuable tool for private equity firms to assess the analytical skills of potential candidates. By mastering the art of pen and paper calculations and familiarizing yourself with the structured approach outlined in this guide, you will be well-prepared to tackle this test during your interviews.

Remember, practice makes perfect. So grab a pen and paper, and start honing your skills with the paper LBO approach!

Quill and Fox