Sources and Uses in an LBO: The 5-Minute Explainer

What sources and uses actually is

Sources and uses answers the most basic question about any leveraged buyout: where does the money come from, and where does it go? Every dollar that funds the deal appears on the sources side; every dollar the deal consumes appears on the uses side. The two sides must balance exactly — it is a closed system, the accounting identity of the transaction.

Think of it as the deal's receipt. Before a single year of operations is projected, before any returns are computed, sources and uses pins down the one number everything else depends on: the sponsor's equity check — the actual cash the PE fund invests on day one. Get this table right and your whole model stands on solid ground. Get it wrong and every return number downstream is fiction.

The formula

The structure never changes, whatever the deal:

Uses = equity purchase price + repayment of existing debt + transaction fees
Sources = new debt + sponsor equity + cash on balance sheet (+ rollover equity, if any)
Sources = Uses (always)

And the bridge that connects enterprise value to what you actually pay for the equity:

Equity purchase price = Enterprise value − existing debt + cash

That bridge is the single most-tested line in the paper LBO. Enterprise value is what the business is worth; the equity purchase price is what the shares cost. The difference is the capital structure you're inheriting — debt you have to repay, cash you get to keep.

Worked example with real numbers

Same company we use across our paper LBO guides: TargetCo does $50M of EBITDA, bought at an 8.0x multiple. It carries $60M of existing debt and $20M of cash. Transaction fees are 2% of EV. New debt is 3.5x EBITDA.

Step 1 — entry EV: 8 × $50M = $400M.

Step 2 — the bridge: equity purchase price = $400M − $60M + $20M = $360M.

Step 3 — uses:

Step 4 — sources: new debt = 3.5 × $50M = $175M. Cash on the balance sheet contributes $20M. The sponsor's equity check is the plug: $428M − $175M − $20M = $233M.

$428M = $428M ✓. The table balances, and the sponsor's equity check — $233M — is now circled. That number is the denominator for every return calculation in the model. Our 30-minute paper LBO framework picks up exactly here, building the five-year model on top of this foundation.

Each line, explained

Purchase of equity ($360M). What the buyer pays the sellers for the shares. Note it's not the $400M EV — the sellers' equity is worth EV minus the debt the buyer will repay plus the cash the buyer keeps. Candidates who write "$400M purchase price" have already failed the exercise.

Repayment of existing debt ($60M). In a buyout, the target's old debt is almost always refinanced at close — the new lenders want a clean capital structure with their own terms and covenants. So the old debt is a use: cash out the door on day one. (The exception is assumed debt, which the prompt would state explicitly.)

Transaction fees ($8M). Bankers, lawyers, lenders, accountants — the deal's toll collectors. Real cash, paid at close, earning no return. The standard paper-LBO assumption is 2% of EV. Forgetting fees is one of the classic paper LBO mistakes because the prompt mentions them once and candidates never carry them into the model.

New debt ($175M). The leverage that makes it an LBO. Sized as a multiple of EBITDA (here 3.5x) because lenders underwrite to cash flow. More debt means a smaller equity check, which means higher returns on that check — the entire economic engine of the deal.

Cash on balance sheet ($20M). Money already inside the deal perimeter. It reduces the funding the buyer must raise, so it's a source. The intuition: you're buying a company that comes with $20M in its pocket — that $20M helps pay for itself.

Sponsor equity ($233M). The fund's actual cash investment — always the plug, computed last. If your sources and uses doesn't balance, the error is never in this line; it's in one of the lines above. Never "plug" the equity check to force a balance without finding the real gap.

Why interviewers test this first

Sources and uses sits at the top of every paper LBO because it's the highest-leverage five minutes of the exercise. It produces the equity check, and the equity check is the denominator of MOIC and the anchor of IRR — get it wrong and nothing downstream can be right. Interviewers also use it as a filter: a candidate who can't build sources and uses in five minutes won't survive the modeling test, so there's no point watching them try.

It's also a judgment test disguised as arithmetic. The prompt hands you EV inputs, debt, cash, and fees scattered across a paragraph — assembling them into a balanced table requires deciding what each number is, not just adding them up. That classification skill (is this a source or a use? does this reduce the purchase price or add to funding needs?) is what separates candidates who understand deals from candidates who memorized formulas.

Three traps that break the balance

Trap 1 — funding the EV instead of the equity. Writing $400M as the purchase price instead of $360M. The $40M overstatement flows straight into an overstated equity check and understated returns. Fix: always write the EV-to-equity bridge before touching sources and uses.

Trap 2 — cash on the wrong side. Putting the $20M of cash in uses ("we're buying the cash too") or omitting it entirely. Cash is a source — it funds the deal. Fix: ask of every line, "does this consume funding or provide it?"

Trap 3 — the silent plug. Sources come to $420M, uses to $428M, and the candidate bumps sponsor equity to $241M without a word. The table "balances" but the $8M of forgotten fees is still missing — and the interviewer watched you paper over it. Fix: a gap is a missing line item, never a rounding error. Find it.

Run the self-check every time: bridge written, fees included, cash as a source, both sides equal to the dollar. Ninety seconds, and the foundation of your model is bulletproof.

Frequently asked questions

What are sources and uses in an LBO?

Sources and uses is the accounting identity of a leveraged buyout: it shows where every dollar funding the deal comes from (sources) and where every dollar goes (uses). The two sides must balance exactly. Uses are typically the equity purchase price, repayment of existing debt, and transaction fees. Sources are typically new debt, the sponsor's equity check, and cash on the target's balance sheet.

Do sources and uses have to balance?

Yes, always — sources must equal uses to the dollar. It is a closed system: every dollar that enters the transaction must be accounted for on both sides. In a paper LBO, an unbalanced sources-and-uses is the single most common structural error, and it means the equity check is wrong, which corrupts every return calculation downstream.

Is cash on the balance sheet a source or a use?

It is a source. Cash sitting on the target's balance sheet at close reduces the funding the buyer must raise — it is money already inside the deal perimeter. The common error is treating the full enterprise value as the amount to fund; the correct funding need is the equity purchase price (EV minus existing debt plus cash) plus refinanced debt plus fees, with the target's own cash counted as a source against it.

Where do transaction fees go in sources and uses?

Transaction fees are a use of cash — real money paid to bankers, lawyers, and lenders on day one that earns no return. They are typically modeled as a percentage of enterprise value (2% is the standard paper-LBO assumption). Forgetting fees is one of the most common paper LBO mistakes because the prompt mentions them once and candidates never carry them into the model.