How would you structure a cash sweep and debt-paydown waterfall in an LBO, and what are the key considerations?
An advanced Private Equity question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
A cash sweep forces a defined percentage of excess free cash flow to prepay debt, accelerating deleveraging (a core LBO return driver). Structure: define excess cash flow (FCF after mandatory amortization, interest, capex, and a minimum cash balance), set the sweep percentage (often stepping down as leverage falls — e.g. 75% above a leverage threshold, 50% below, 0% once de-levered), and apply it down the waterfall in order of priority — mandatory amortization first, then the sweep prepays the most senior/expensive tranche first (typically the term loan), respecting the intercreditor. Key considerations: leave enough liquidity for operations and growth/add-on capex (over-sweeping starves the business), watch prepayment penalties/make-wholes and whether prepaying fixed vs floating is optimal, model the interaction with covenants and the minimum cash, and balance deleveraging against retaining cash for value-creating investment or a later dividend recap. The optimal structure maximizes IRR by deleveraging fast without constraining growth or tripping liquidity.
WHAT INTERVIEWERS LISTEN FOR
- ✓Sweep prepays debt from excess FCF (after amortization, interest, capex, min cash)
- ✓Sweep % often steps down as leverage falls; prepay senior/expensive tranche first per intercreditor
- ✓Preserve operating + growth/add-on liquidity (don't over-sweep)
- ✓Watch prepayment penalties, covenant interaction; balance deleveraging vs reinvestment
COMMON MISTAKES
- ✗No definition of excess cash flow or minimum cash
- ✗Over-sweeping that starves growth/add-ons
- ✗Ignoring prepayment order/penalties and covenant interaction
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