1) Deleveraging – As more loan principal is paid down with the help of the cash flows produced by the acquired company, the value of the equity held by the private equity firm increases over time.
2) EBITDA Growth Increasing EBITDA can be done through introducing new growth strategies to boost revenue, cost-cutting initiatives to improve the company’s margin profile, and accretive add-on acquisitions.
3. Multiple Expansion A financial sponsor ideally wants to buy a business at a low entry multiple (“going in cheap”) and subsequently sell it at a higher multiple. Higher economic conditions, better investor sentiment in the relevant industry, and favourable transaction dynamics can all enhance the exit multiple (e.g., competitive sale process led by strategic buyers). Most LBO models, however, use the cautious assumption that the company would be sold at the same EV/EBITDA multiple at which it was bought. The rationale is because the future transaction climate is uncertain, making it riskier to rely on several expansions to satisfy the return threshold.
