In the highly competitive world of Private Equity (PE), the interview process is designed to rigorously test your financial knowledge, problem-solving ability, and investment judgment. One of the most challenging and pivotal components of the interview process is the Paper LBO (Leveraged Buyout) exercise. This task is not just about understanding the mechanics of an LBO, but also demonstrating how you think like a Private Equity investor.

This article will explain what a Paper LBO is, why it’s essential for PE interviews, and provide tips on how to excel in this part of the process, ensuring you stand out as a top candidate.

What Is a Paper LBO?

A Paper LBO is a technical exercise where candidates are asked to build an LBO model from scratch, often with limited information, and typically without the help of Excel or financial software. This exercise is usually performed using pen and paper, hence the name.

The purpose of a Paper LBO is to evaluate your ability to:

• Think critically under time pressure
• Understand key financial metrics
• Demonstrate familiarity with the LBO structure and its drivers of value

You are provided with basic financial inputs (such as purchase price, EBITDA, debt structure, and exit assumptions) and asked to calculate key figures like Internal Rate of Return (IRR), cash-on-cash return, and sometimes debt repayment schedules.

Why Is a Paper LBO Crucial for Private Equity Interviews?

Tests Your Core Technical Skills

Private Equity firms expect candidates to have a strong grasp of financial modeling and valuation techniques. An LBO is one of the most common structures used in Private Equity deals, making it essential for you to understand how it works.

The Paper LBO tests your ability to:

• Build financial models quickly and accurately: You’ll need to calculate key metrics without making errors, all while under time pressure.
• Simplify complex concepts: You’re expected to break down the intricate workings of leverage, cash flow, and returns into manageable parts, using only basic inputs.
• Understand the drivers of value: PE firms want to see that you can identify and focus on the core drivers of a deal’s success — primarily leverage, operational improvements, and exit multiples.

Assesses Your Time Management and Prioritization

In a Private Equity setting, analysts and associates are expected to juggle multiple deals and time-sensitive projects. The Paper LBO exercise mimics this high-pressure environment by limiting the time available to complete the task, typically around 30 to 60 minutes.

You need to:

• Prioritize key elements: Focus on the most important assumptions and outputs, such as debt levels, EBITDA growth, and exit multiples. Diving too deep into minor details can hurt your overall performance.
• Manage your time efficiently: A polished but incomplete model won’t impress interviewers. Make sure you allocate enough time to build a complete model and present it.

Reveals How You Think Like an Investor

A successful candidate in Private Equity isn’t just someone who can build an LBO model — it’s someone who can think like an investor. PE firms want to see that you understand the strategic rationale behind a deal, not just the numbers.

In a Paper LBO exercise, interviewers are looking for you to:

• Explain your assumptions: Why did you choose certain growth rates or leverage levels? Can you justify your choices based on market dynamics or sector-specific knowledge?
• Assess risks and returns: How would you mitigate risk in the deal? Is the return realistic based on the assumptions you’ve made? Your ability to evaluate a deal’s potential in a thoughtful way will set you apart from other candidates.

4. Tests Your Communication Skills

Even if you build a perfect LBO model, you won’t land the job if you can’t explain your results clearly. The Paper LBO exercise often ends with a discussion where you’ll present your model and answer follow-up questions. This is your chance to demonstrate how well you understand your work and how effectively you can communicate your thought process.

You’ll need to:

• Walk the interviewer through your logic: Clearly articulate why you made certain assumptions and how they affect the overall outcome of the deal.
• Defend your conclusions: Be prepared to answer probing questions about your model’s assumptions, risks, and outputs.

Effective communication is critical because PE professionals need to explain complex financial concepts to a range of stakeholders, including management teams, investment committees, and portfolio companies.

How to Prepare for a Paper LBO

Understand the Basics of an LBO

Before diving into practice, make sure you fully understand the Leveraged Buyout structure. In an LBO, a company is acquired using a significant amount of borrowed money (debt) to finance the purchase. The assets of the company are often used as collateral, and the goal is to enhance returns for equity investors through operational improvements, deleveraging, and exit at a higher multiple.

Key elements of an LBO include:

• Purchase Price: The price paid to acquire the company.
• Equity Contribution: The portion of the purchase price financed through investor equity.
• Debt: The amount of leverage (debt) used to finance the deal.
• EBITDA Growth: The operational improvements or cost efficiencies to grow earnings.
• Exit Multiple: The valuation multiple at which the business will be sold.

Practice Under Time Pressure

The most important part of preparation is timed practice. Set yourself 30 to 60 minutes and work through multiple Paper LBOs. This will help you:

• Get comfortable with the process: Repeated practice ensures you can build the model quickly and accurately.
• Recognize common pitfalls: Through practice, you’ll learn which parts of the model are most prone to error or confusion.
• Improve time management: Learn how to balance speed with accuracy, and focus on completing the most critical elements first.

Simplify Your Approach

While it might be tempting to over-engineer your Paper LBO model, especially if you’re highly proficient with Excel, it’s crucial to keep it simple. A clear, concise model will not only be easier to explain but also show interviewers that you can distill complex ideas into practical, actionable insights.

Know How to Justify Assumptions

In a Paper LBO, you won’t have access to extensive data. You’ll often be given a few core inputs, and it will be up to you to fill in the gaps using reasonable assumptions. Be ready to:

• Explain your assumptions: Why did you assume 5% EBITDA growth? What’s your reasoning behind using a certain debt-to-equity ratio?
• Stay conservative: When in doubt, opt for conservative assumptions. PE interviewers want to see that you understand risk management and aren’t making overly optimistic projections.

Be Prepared for Follow-Up Questions

Once your Paper LBO is complete, expect the interviewer to ask follow-up questions. This could involve sensitivity analysis (what happens if growth slows or leverage increases), or questions about how you would mitigate certain risks in the deal.

To prepare:

• Understand potential risks: Know how to identify and manage the key risks in an LBO deal, such as economic downturns, industry shifts, or high debt loads.
• Analyze sensitivities: Be prepared to discuss how changes in key assumptions (e.g., EBITDA growth, interest rates, or exit multiples) would impact the overall returns.

The Paper LBO is a critical part of any Private Equity interview, but it’s just one piece of the puzzle. By mastering the mechanics of an LBO, understanding the strategic context of the deal, and honing your communication skills, you’ll be well-prepared to impress your interviewers and secure a role in Private Equity.

With practice and preparation, you can confidently approach the Paper LBO, demonstrating not just technical expertise but also the ability to think and act like an investor.