Secondary Buyout

Step 1: Entry Equity Cheque

Entry Equity = (Entry EBITDA × Entry Multiple) - Net Debt at Entry

Where: Entry EBITDA = last-twelve-months EBITDA at signing, Entry Multiple = the EV/EBITDA multiple paid for the business, Net Debt at Entry = the acquisition debt raised, quoted here as turns of entry EBITDA.

Sponsor 1 — using entry EBITDA of $60.0m, an entry multiple of 9.0x and leverage of 5.0x:

Enterprise Value = $60.0m × 9.0 = $540.0m

Net Debt = $60.0m × 5.0 = $300.0m

Entry Equity = $540.0m - $300.0m = $240.0m

Sponsor 2 — using entry EBITDA of $95.0m, an entry multiple of 11.0x and leverage of 5.5x:

Enterprise Value = $95.0m × 11.0 = $1,045.0m

Net Debt = $95.0m × 5.5 = $522.5m

Entry Equity = $1,045.0m - $522.5m = $522.5m

The entry equity cheque is the capital the fund actually draws from its limited partners, and it is the denominator of every return metric that follows. Sponsor 2 writes a cheque more than twice the size of Sponsor 1's for the same business — the asset has grown, the multiple has risen, and half a turn of extra leverage does not come close to closing the gap. That is the defining constraint of any secondary buyout: the second sponsor starts from a larger and more expensive base, so it needs a genuinely new source of value to earn its return.

Step 2: Exit Equity Value

Exit Equity = (Exit EBITDA × Exit Multiple) - Net Debt at Exit

Sponsor 1 — using exit EBITDA of $95.0m, an exit multiple of 11.0x and net debt of $180.0m:

Exit Enterprise Value = $95.0m × 11.0 = $1,045.0m

Exit Equity = $1,045.0m - $180.0m = $865.0m

Sponsor 2 — using exit EBITDA of $140.0m, an exit multiple of 11.0x and net debt of $340.0m:

Exit Enterprise Value = $140.0m × 11.0 = $1,540.0m

Exit Equity = $1,540.0m - $340.0m = $1,200.0m

Note the internal consistency that makes this a secondary buyout rather than two unrelated deals: Sponsor 1's exit enterprise value of $1,045.0m is exactly Sponsor 2's entry enterprise value. One sponsor's exit is the other's entry, on the same day, at the same price. Exit equity value is what the seller receives after the outstanding debt is repaid out of the sale proceeds, and it is the number that determines whether the fund returns capital to its investors or not.

Step 3: Returns — MoM and IRR

MoM = Exit Equity / Entry Equity

IRR = MoM^(1 / Holding Period in Years) - 1

Where: MoM = money multiple (also called MOIC or cash-on-cash return), IRR = internal rate of return, the annualised compound return on the equity cheque.

Sponsor 1 — using exit equity of $865.0m, entry equity of $240.0m and a 5-year hold:

MoM = $865.0m / $240.0m = 3.60x

IRR = 3.60x^(1/5) - 1 = 1.292 - 1 = 29.2%

Sponsor 2 — using exit equity of $1,200.0m, entry equity of $522.5m and a 5-year hold:

MoM = $1,200.0m / $522.5m = 2.30x

IRR = 2.30x^(1/5) - 1 = 1.181 - 1 = 18.1%

MoM tells you how much money came back; IRR tells you how fast. The two must always be read together, because IRR alone rewards speed and can be flattered by an early partial exit, while MoM alone ignores the time value of money entirely. The headline result here is the one the interviewer is testing for: on identical five-year mechanics, the second sponsor earns 18.1% against the first sponsor's 29.2%. Nothing has gone wrong — the second sponsor simply paid 11.0x for a business the first sponsor bought at 9.0x, and the cheapest form of value creation in this deal, buying low, has already been consumed.

Step 4: Value Creation Bridge

EBITDA Growth Contribution = (Exit EBITDA - Entry EBITDA) × Entry Multiple

Multiple Expansion Contribution = (Exit Multiple - Entry Multiple) × Exit EBITDA

Debt Paydown Contribution = Net Debt at Entry - Net Debt at Exit

Sponsor 1 — using EBITDA of $60.0m growing to $95.0m, a multiple moving from 9.0x to 11.0x, and net debt falling from $300.0m to $180.0m:

EBITDA Growth = ($95.0m - $60.0m) × 9.0 = $35.0m × 9.0 = $315.0m

Multiple Expansion = (11.0 - 9.0) × $95.0m = 2.0 × $95.0m = $190.0m

Debt Paydown = $300.0m - $180.0m = $120.0m

Total = $315.0m + $190.0m + $120.0m = $625.0m, which reconciles to the equity gain of $865.0m - $240.0m = $625.0m.

Sponsor 2 — using EBITDA of $95.0m growing to $140.0m, a flat 11.0x multiple, and net debt falling from $522.5m to $340.0m:

EBITDA Growth = ($140.0m - $95.0m) × 11.0 = $45.0m × 11.0 = $495.0m

Multiple Expansion = (11.0 - 11.0) × $140.0m = $0.0m

Debt Paydown = $522.5m - $340.0m = $182.5m

Total = $495.0m + $0.0m + $182.5m = $677.5m, which reconciles to the equity gain of $1,200.0m - $522.5m = $677.5m.

The value creation bridge decomposes equity value creation into the three levers a sponsor can actually pull: growing the earnings base, selling at a higher multiple than was paid, and using free cash flow to retire debt. It is the single most revealing exhibit in a private equity investment committee memo, because it shows how much of the return came from operating skill and how much came from the market. Sponsor 1 generated almost a third of its gain from multiple expansion — a lever that, by construction, is not available to Sponsor 2, whose bridge must be carried by EBITDA growth alone. That is why an interviewer asking about a secondary buyout is really asking whether you understand which levers are still unused.

Step 5: Exit Multiple Required for a 20% Target IRR

Required Exit Equity = Entry Equity × (1 + Target IRR)^Holding Period

Required Exit Multiple = (Required Exit Equity + Net Debt at Exit) / Exit EBITDA

Using Sponsor 2's entry equity of $522.5m, a target IRR of 20% (0.20), a 5-year hold, exit net debt of $340.0m and exit EBITDA of $140.0m:

Required Exit Equity = $522.5m × 1.20^5 = $522.5m × 2.488 = $1,300.1m

Required Exit Enterprise Value = $1,300.1m + $340.0m = $1,640.1m

Required Exit Multiple = $1,640.1m / $140.0m = 11.7x

Against a base case that assumes a flat 11.0x exit, Sponsor 2 needs roughly 0.7 turns of multiple expansion — or, equivalently, materially more EBITDA than the $140.0m base case — to clear a 20% hurdle. Reverse-engineering the required exit multiple is how deal teams pressure-test an entry price without rebuilding the model: it converts an abstract return target into a single, checkable statement about the future that the investment committee can accept or reject. Here the honest conclusion is that the base case delivers a solid but sub-target 18.1%, and the deal only reaches 20% if the second sponsor either finds additional earnings through add-on acquisitions or sells into a stronger market than it bought in.

Final Results

• Sponsor 1 entry equity: $240.0m — exit equity: $865.0m
• Sponsor 1 returns: 3.60x MoM / 29.2% IRR
• Sponsor 2 entry equity: $522.5m — exit equity: $1,200.0m
• Sponsor 2 returns: 2.30x MoM / 18.1% IRR
• Share of value from multiple expansion: 30.4% for Sponsor 1, 0.0% for Sponsor 2
• Exit multiple Sponsor 2 needs for a 20% IRR: 11.7x

These outputs feed straight into the investment committee decision on price: the required exit multiple of 11.7x becomes the headline sensitivity in the bid letter, and the bridge showing zero contribution from multiple expansion is what forces the deal team to underwrite a concrete operating plan rather than a market view. In practice the same framework is then re-run under a downside case with a lower exit multiple, to establish how much of the equity cheque is genuinely at risk.

Would you like to explore how the answer changes if the first sponsor rolls part of its proceeds into the new deal, or if the second sponsor funds two add-on acquisitions in year two?