Common E/D ratios in an LBO

Common E/D ratios in an LBO

• A. 60% equity / 40% debt
• B. 20% equity / 80% debt
• C. 40% equity / 60% debt
• D. 50% equity / 50% debt

Answer: (C)

In a leveraged buyout, funding the purchase with as much debt as possible while keeping equity as the minority stake is the defining approach. The debt portion is used to magnify returns on the equity invested, provided the target’s cash flows can comfortably cover interest and principal payments and meet lender covenants. This balance—debt being the larger piece of the financing and equity the smaller—hits a practical middle ground: it aims to maximize upside for the sponsor without taking on unsustainable default risk. Too much equity would dampen returns, while too little debt could strain financing terms and reduce the leverage advantage. So, the common structure shown—debt as the larger portion and equity as the smaller portion—best reflects typical LBO financing practice.

In a leveraged buyout, funding the purchase with as much debt as possible while keeping equity as the minority stake is the defining approach. The debt portion is used to magnify returns on the equity invested, provided the target’s cash flows can comfortably cover interest and principal payments and meet lender covenants. This balance—debt being the larger piece of the financing and equity the smaller—hits a practical middle ground: it aims to maximize upside for the sponsor without taking on unsustainable default risk. Too much equity would dampen returns, while too little debt could strain financing terms and reduce the leverage advantage. So, the common structure shown—debt as the larger portion and equity as the smaller portion—best reflects typical LBO financing practice.