Debt Schedule & Cash Sweep

The debt schedule is where the operating model and the capital structure converge. It takes the free cash flow generated each year and determines how much debt gets repaid, how much interest is owed, and what the remaining debt balance is at year-end. The debt schedule is mechanically the most intricate part of an LBO model because it involves multiple debt tranches, each with different repayment rules, and because interest expense depends on the debt balance, which depends on repayment, which depends on free cash flow after interest. This circularity is a defining feature of LBO modeling.

Understanding the debt schedule is critical because debt paydown is one of the three core return drivers in an LBO. Every dollar of principal repaid during the hold period increases equity value dollar-for-dollar at exit. A company that enters an LBO with $500M of debt and exits with $200M of debt has transferred $300M of value to the equity holders through the forced discipline of debt repayment.

Beyond mandatory amortization, most leveraged credit agreements include an excess cash flow sweep provision. A cash sweep requires the company to use a percentage of its excess cash flow (typically 50-75%) to prepay debt above and beyond the mandatory amortization amount.

How it works:
1. Start with EBITDA for the year
2. Subtract cash interest expense
3. Subtract cash taxes
4. Subtract capital expenditures
5. Subtract (or add) changes in working capital
6. Subtract mandatory amortization already paid
7. The result is excess cash flow
8. Multiply by the sweep percentage (e.g., 50%)
9. That amount is applied as additional debt prepayment

Cash sweeps accelerate debt paydown in good years when the company generates strong free cash flow. Many credit agreements include step-downs: the sweep percentage decreases as leverage falls. For example, the sweep might be 75% when leverage exceeds 4.0x, 50% when leverage is 3.0-4.0x, and 25% when leverage is below 3.0x. This rewards the company for deleveraging by allowing it to retain more cash for operations or growth.

The company also retains the option to make voluntary prepayments beyond the sweep amount. PE sponsors sometimes choose to prepay aggressively if the cost of debt is high relative to reinvestment opportunities, or to position the company for a dividend recapitalization.

The revolving credit facility (revolver) is a distinct debt instrument that functions like a corporate credit card. Unlike term loans, which are drawn in full at closing and repaid over time, the revolver provides a committed line of credit that the company can draw on and repay as needed.

Key characteristics of revolvers in LBO models:

Commitment amount: Typically sized at 1-2x EBITDA. The company can borrow up to this limit at any time. A $50M EBITDA company might have a $75M revolver commitment.

Draws and paydowns: The company draws on the revolver when it needs short-term liquidity (seasonal working capital needs, unexpected expenses) and repays when cash flow recovers. In the LBO model, the revolver is typically modeled as a plug that absorbs any cash shortfall in a given year. If free cash flow after debt service is negative, the revolver is drawn to cover the gap.

Cost: The company pays interest (SOFR + 200-400 bps) only on the drawn balance, plus a small commitment fee (0.25-0.50%) on the undrawn portion.

Priority: Revolver draws are typically pari passu (equal priority) with the Term Loan in the capital structure. In the debt repayment waterfall, revolver balances are usually repaid before optional term loan prepayments because the revolver is intended to be a temporary source of liquidity, not permanent financing.

The debt schedule connects the operating model to the returns analysis. Higher free cash flow means faster debt paydown, which means more equity value at exit. This is why PE sponsors focus intensely on FCF conversion: it is the mechanism through which operational performance translates into debt reduction and ultimately into fund returns.

One modeling nuance worth noting: interest expense depends on the debt balance, but the debt balance depends on repayment, which depends on free cash flow after interest. This creates a circular reference in the model. Most modelers handle this by either iterating the spreadsheet (enabling iterative calculations) or by using the beginning-of-period debt balance to calculate interest (a slight simplification that avoids circularity). In the next lesson, we will use the debt schedule outputs to calculate returns and build sensitivity tables that show how different assumptions affect the equity outcome.