Leverage defined: the debt used to fund a buyout, measured in turns of EBITDA (Net Debt / EBITDA). How it amplifies equity returns and risk, with the case study math.
By Andrew Gallagher · Private equity investor; former middle-market PE Senior Associate
Exhibit
Leverage is the amount of debt used to fund an acquisition, usually expressed in
turns of EBITDA (Net Debt
/ EBITDA). It is the defining feature of a buyout: the debt lets a sponsor acquire a business far
larger than its equity check alone would allow, and it magnifies the return on that equity in both
directions.
Why it matters
Debt amplifies equity returns. The more of the purchase funded with debt, the smaller the equity
check and the higher the return on that equity if the deal performs. It also raises risk, because
interest and amortization are fixed claims that must be paid in good years and bad. Leverage is
only safe to the extent free cash flow can service it
through a downturn.
Worked example
Turns and the equity check
Buying the $150M case study with $80M of gross debt is 3.2x leverage (80 / 25), 3.0x net of $5M
cash, and funds just over half of enterprise value
with debt, leaving an $80M sponsor equity check. Each turn of leverage is roughly $25M of extra
debt capacity, and a smaller equity check, at the cost of a heavier fixed burden.
The common mistake
Sizing leverage off headline EBITDA without stress-testing free cash flow. Debt is only as safe as
the cash that services it, so a disciplined model checks coverage through a downturn rather than
maximizing turns. See the full build in
How to Build an LBO Model and the pitfalls in
5 Common LBO Modeling Traps.
Frequently asked
What does turns of leverage mean?
Leverage is usually quoted in turns of EBITDA, meaning Net Debt divided by EBITDA. $75M of net debt on $25M of EBITDA is 3.0x, or 3.0 turns; gross debt of $80M is 3.2x.
How much leverage is used in an LBO?
It varies by sector and cash-flow quality, but middle-market buyouts are often funded with roughly half to two-thirds debt. The case study funds the $150M deal with about $80M of debt (3.2x gross, 3.0x net) and $80M of equity.
Why does leverage increase risk?
Interest and amortization are fixed claims that must be paid in good years and bad. The more of the purchase funded with debt, the smaller the equity check and the higher the return if the deal performs, but the less room there is if free cash flow falls.
