Why is 'debt repayment' a 'free lunch' component of the equity return?
De-leveraging raises the equity value without the enterprise value changing at all. With stable EBITDA and a stable multiple it is mechanical — hence "free lunch".
Year 0 EV $400m ($50m EBITDA × 8x), Equity $150, Debt $250. Year 5 EV unchanged at $400m, debt reduced to $100 via the cash sweep → Equity $300m. Equity doubles without the business having gotten any better.
the sponsor has to have taken on leverage in the first place. EBITDA has to stay stable. Cash flow has to be enough to service the paydown.
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| Driver | Sponsor control | Market risk |
|---|---|---|
| EBITDA growth | high | medium |
| De-leveraging | high | low |
| Multiple expansion | low | high |
De-leveraging is the most reliable IRR driver because with stable EBITDA it is almost guaranteed. That is why leverage is the sponsor's number-one IRR strategy.
if EBITDA falls, leverage acts as an IRR bomb. Equity value gets swallowed first — with a 20% EBITDA drop and 5x leverage, equity can be halved before debt is even affected.
the sponsor underestimates the cash needed for capex and working capital — paydown is delayed and the free-lunch effect fails to materialize.
Question: "Why is it called a free lunch?"
Answer: "Because the equity build arises without the sponsor having to create operating value — pure debt reduction with stable EBITDA. But it's only 'free' if EBITDA holds. In a decline the effect reverses — leverage then acts as an IRR bomb"