How is the balance sheet adjusted in an LBO? What happens to existing shareholders' equity?

• A. It is increased to reflect new equity
• B. It remains the same
• C. It is converted into debt
• D. It is wiped out and replaced by investor equity

Answer: (D)

In an LBO, the purchase is financed largely with debt, with a smaller amount of equity from the sponsor. When the deal closes, the target’s existing shareholders are paid out and their equity is removed from the books. The balance sheet is then restructured so the old equity is wiped out and replaced by the sponsor’s equity, while new debt is added to liabilities to fund the purchase. This reflects the new capital structure: high leverage and ownership by the investor group, not the previous owners.

So the existing shareholders’ equity isn’t kept or converted into debt; it’s eliminated and replaced by investor equity.