Sponsor returns come from three places: the EBITDA you bought going up, the exit multiple you sell at, and the debt you paid down along the way. This page decomposes any LBO into those three buckets so you can see whether the deal works on operations, on a re-rating bet, or on financial engineering โ and how fragile each path is.
How exit equity gets built out of entry equity, step by step. Yellow flag if multiple expansion is >30% of total return โ that's a re-rating bet, not an operating story.
Rows = EBITDA CAGR. Columns = exit-vs-entry multiple change (turns). Center cell is your current case. Green cells > 25% IRR; red cells negative or below 10%.
The decomposition. Sponsor exit equity equals entry equity plus three pieces of value creation. EBITDA growth is the change in EBITDA (entry to exit) multiplied by the entry multiple โ what the operating story is worth at the price you bought. Multiple expansion is exit EBITDA times the change in multiple (exit minus entry) โ what re-rating contributes. Debt paydown plus retained cash is the difference between debt at close and debt at exit, plus any cash that piled up during the hold (after capex, NWC, taxes, interest, and mandatory amort). Add the three pieces, you should land within rounding of (exit equity โ sponsor equity).
Why the breakdown matters. Two LBOs can both produce 25% IRR but do it for completely different reasons. A deal driven 70% by EBITDA growth is operationally robust โ if the operating thesis works, you get paid even if the multiple compresses. A deal driven 50% by multiple expansion is a re-rating bet โ if exit comps come down, the math collapses. PE firms get tagged on this in their LP letters: which funds delivered returns through ops, and which through the cycle. The waterfall above tells you up front which one you're underwriting.
The 30% rule. Industry rule of thumb: if multiple expansion is >30% of total value creation, you're betting on a re-rate. Below ~15%, you're underwriting an operational thesis; above 30%, you're underwriting market-timing.
Dividend recap. An optional input โ models a leverage refresh in year 3 that pulls cash out and rebuilds debt back toward the original level. Recaps boost MOIC because cash returns get pulled forward, but they don't change the underlying operating story. They show up here as a separate component in the bridge.
What it isn't. The decomposition is a backward-looking math identity, not a forecast. The point is to make the implicit drivers explicit โ so you and your IC know what bet you're actually making. See the disclaimer for more.
The 17-tab LBO/M&A template includes a full year-by-year debt schedule, returns attribution, and reverse-LBO — with two worked Micron scorecards (through-cycle + AI-cycle) so you can see how the same deal looks with different assumptions on the cycle.
โ Open the template"Sponsor returns demystified" walks through what each driver of LBO returns actually means, the typical mistakes, and how to read a fund manager's numbers when they pitch you.
โ Read the postNothing on this page is investment advice. See the full disclaimer.