At first glance, it may seem counterintuitive—shouldn't a higher required Internal Rate of Return (IRR) result in a lower valuation?
In theory, yes. However, the LBO (Leveraged Buyout) valuation method reflects a different investor mindset and set of assumptions.
Understanding LBO Valuation Dynamics
The LBO approach estimates what a financial buyer—such as a private equity investor—could pay for a company while still achieving their required return (IRR). The valuation result is influenced by four main factors:
1. Free Cash Flow Growth
Projected operational cash flows over the holding period drive value creation and debt repayment capacity.
2. Leverage (Debt Financing)
LBOs are typically structured with a high level of debt, which magnifies equity returns and increases buying power.
3. Exit Multiple
The assumed multiple at exit (e.g., EBITDA multiple) plays a key role in estimating the future sale price.
4. Target IRR
This is the minimum return a financial buyer expects. While a higher IRR typically lowers the valuation, favourable assumptions for the other factors (especially leverage and exit value) can offset that downward pressure, sometimes resulting in higher valuation outputs.
Where to Adjust LBO Assumptions in Valutico
You can fully customize the LBO valuation by going to the Financial Projections or Valuation tab and selecting “Change Parameters” (top-right corner of the screen).
The Target IRR setting is located at the bottom of the Parameters panel.
You can also adjust the leverage level, exit multiple, and cash flow assumptions from this section.
