How do you pick purchase multiples and exit multiples in an LBO model?
Answer
You would use the Comparable Companies or Precedent Transactions methods. Of course, you’ll have a sensitivity table to go with this.
A nice way to add some alpha here is to state that you sometimes make the exit multiple one “turn” (1x) less than the entry multiple. The reason bankers do this is to make sure they’re being super conservative and are essentially handicapping the returns via moderate multiple compression. Although, you want to caveat this by also saying that before doing this, you set it to the same as the entry multiple and examine both.
Why this matters to bankers
Purchase (or entry) multiples and exit multiples are key drivers of an LBO. Since the purchase price today drives the future returns of an LBO and the exit multiple drives the exit price, they’re crucial to get right to create an accurate LBO.