What is a cash sweep in an LBO?

Define it as using spare cash to repay debt early. In the model, pay mandatory amortization first, keep minimum cash, then sweep to prepayable loans by seniority. In the loan agreement, an excess cash flow sweep forces part of it.

The numbers, step by step

The term loan from the answer: $400 million with 1% a year of amortization and $50 million of free cash flow in the year.

Mandatory amortization$400 million × 1%

$4 million

Cash left to sweep$50 million − $4 million

$46 million

Term loan paid down with a full sweep$4 million + $46 million

$50 million

Required under a 50% excess cash flow sweep$46 million × 50%

$23 million

What the interviewer listens for

• Do you define the sweep as prepaying debt with spare cash?
• Do you pay mandatory amortization first and keep minimum cash?
• Do you sweep in order of seniority and usually skip the bonds?
• Do you know the excess cash flow sweep in the loan agreement?

Common mistakes

• Sweeping cash before the mandatory amortization is paid.
• Leaving the company nothing to operate on by sweeping every dollar.Keep a minimum cash balance.
• Assuming bonds get swept like term loans.They usually can't be repaid early without a premium.

Likely follow-ups

• Why would a lender want an excess cash flow sweep?It brings leverage down faster when the business does well, which lowers the lender's risk.
• Why does the sweep create a circular reference?Interest depends on the average debt balance, which depends on how much cash is swept, which depends on net income after interest. I'd break it with a switch or by charging interest on the opening balance.
• When would a sponsor rather not sweep cash?When it has better uses, like add-on acquisitions or growth capex that earn more than the after-tax cost of the debt.

More finance technicals

• Walk me through a basic LBO.
• What makes a company a good LBO candidate?
• Why private equity?
• What is the difference between IRR and MOIC?
• Where do the returns in an LBO come from?

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