Every acquisition pitchbook rests on models. They look like spreadsheets, but they decide whether multi-millions (and sometimes billions) move across the table. For bankers, PE associates, and anyone working on live transactions, models are the foundation of any deal.
There are many types of M&A models. However, generally speaking, there are three that are often associated to M&A deals: the Merger Model, the LBO Model, and the DCF Model.
This guide takes a closer look at each, highlighting their mechanics, strengths, and common pitfalls.
Before diving into each framework, it is worth framing the role models play.
Valuation driver: A model determines what a buyer can pay and still generate acceptable returns.
Negotiation tool: Assumptions on synergies, leverage, and discount rates directly influence deal terms.
Risk filter: Stress tests reveal how sensitive a deal is to market swings, execution risks, or financing costs.
A single misstep – overstating synergies, underestimating leverage strain, or being too optimistic on cash flows – can sink a deal that looked compelling on paper. That is why mastering these models is essential for anyone serious about investment banking or private equity.
The merger model is the banker’s first test of an acquisition: will it create or destroy value for the buyer’s shareholders? The primary lens is earnings per share (EPS). If the combined company’s EPS rises, the deal is considered accretive. If it falls, it is dilutive.
Synergies – Projected cost savings or revenue boosts from combining operations.
Accretion/Dilution – How the buyer’s EPS changes post-acquisition.
Pro Forma Balance Sheet – The combined entity’s assets, liabilities, and equity.
Bankers often pitch a deal as accretive to win management support. But EPS accretion alone does not guarantee value creation. The real question is whether the combined business generates enough free cash flow to justify the premium paid and the financing used.
Overestimated synergies: Many deals promise them; few deliver at scale.
Ignoring integration risk: Even simple back-office integrations can drag on performance.
Narrow focus on EPS: A deal can look accretive while eroding shareholder value if cash flows weaken or debt balloons.
Consider a large-cap consumer goods company buying a rival for $20 billion. The base case model shows 10% EPS accretion in year one, supported by $1 billion in cost synergies from procurement and distribution overlaps. On paper, the pitch is compelling.
But what happens if synergies take two years longer than expected? The accretion drops from 10% to only 2%, and free cash flow coverage of acquisition debt weakens. Push it further – if only 70% of projected synergies are realized, EPS impact could swing negative and credit agencies might downgrade the acquirer.
That has real consequences for cost of capital, investor confidence, and even management tenure. This is why experienced teams run sensitivities not only on the size of synergies but also on timing and integration costs.
The leveraged buyout (LBO) model is private equity’s model of choice. It answers the question: Can we buy this company with mostly borrowed money and still generate attractive returns?
Sources & Uses – How the deal is funded (equity vs. layers of debt).
Debt Schedules – Interest, principal repayments, and refinancing assumptions.
Exit Scenarios – Projected returns when the company is sold, usually 3–7 years later.
In a buyout, debt does the heavy lifting. While equity sponsors can contribute a minimum of 10%, they typically contribute 30–40% of the purchase price, financing the rest with senior loans, mezzanine debt, or high-yield bonds. The LBO model tests whether the company’s cash flow can support this structure while still delivering a target internal rate of return (IRR).
Multiple expansion vs. operational gains: IRR is often more sensitive to entry and exit multiples than to EBITDA growth.
Debt repayment timing: Front-loaded vs. back-loaded schedules change risk dramatically.
Covenant headroom: Tight covenants can create hidden risk even if the model looks solid.
Take a mid-market industrial company generating $200 million in EBITDA. A PE fund bids at 9x EBITDA, or $1.8 billion. To finance the purchase, the fund puts in $700 million equity and raises $1.1 billion in debt across a senior term loan, mezzanine tranche, and revolving facility.
The base case projects EBITDA growing 6% annually. With steady deleveraging, debt-to-EBITDA falls from 5.5x at entry to 3.5x by year five. At a 9x exit multiple, the IRR comes out at 21% and the money multiple is 2.6x.
Now stress it: if exit multiples compress to 7x, the IRR drops to 12% and the multiple falls below 2.0x. Add in a recession scenario where EBITDA contracts 10% in year two, and debt covenants could trigger, forcing a distressed refinancing. A solid LBO model should capture these risks in sensitivity tables and scenarios, not just the upside case that makes the deal look attractive.
The discounted cash flow (DCF) model asks the most fundamental valuation question: What is this company worth today, based on its ability to generate future cash flows?
While M&A bankers often lean more heavily on comps and precedent transactions, the DCF provides a reality check. Private equity and corporate buyers care deeply about the cash flow profile since it underpins debt capacity and long-term value.
Free Cash Flow Forecasts – Operating performance, capex, and working capital.
Discount Rate (WACC) – Reflecting the cost of both debt and equity capital.
Terminal Value – Typically based on perpetuity growth or exit multiples.
The DCF forces transparency. Unlike multiples, which hide assumptions inside comparables, the DCF lays bare management’s forecasts and the investor’s view of risk.
Terminal value dominance: Often 60–70% of total valuation comes from this single assumption.
Discount rate sensitivity: Change WACC by 1%, and valuation can swing by billions.
Forecast optimism: Management projections are rarely conservative.
Consider a high-growth SaaS company with $150 million in current revenue and strong retention. A DCF projects free cash flow growing from $20 million to $200 million in ten years, discounted at a 10% WACC. The base case suggests an equity value of $2.5 billion.
But shift the terminal growth rate from 3% to 2%, and the valuation falls to $2.1 billion. Lower WACC assumptions by just 0.5% and value jumps back above $2.7 billion. Add a scenario where churn worsens and revenue growth slows by five percentage points, and the projected value could collapse to under $1.8 billion. This kind of sensitivity is why buyers never rely on a single DCF output – they use it as a framework to test how fragile the implied valuation really is.
Each model serves a different purpose in the deal process:
Merger Model – EPS impact and synergy-driven value.
LBO Model – Returns under leveraged financing.
DCF Model – Intrinsic value from future cash flows.
In practice, bankers triangulate all three. A strategic acquirer might prioritize EPS accretion, while a PE buyer lives and dies by the LBO. Meanwhile, both sides use a DCF as a check against paying too much.
These models are staples of technical interviews. You may be asked to walk through how to build an LBO, explain why accretion/dilution matters, or describe the impact of a higher discount rate in a DCF. Interviewers are not just testing if you can memorize steps – they want to see if you understand how assumptions drive outcomes.
On real transactions, models are in constant motion. Forecasts are updated weekly, financing terms shift after lender meetings, and assumptions are debated line by line. The role of the analyst is not building a perfect model but knowing which sensitivities matter most and being able to turn them quickly when a managing director asks.
Juniors who can pressure-test assumptions and explain results clearly earn trust on deal teams. An associate who can say, “If synergies come in 20% lower, we move from accretive to dilutive, but cash flow still covers debt service” shows judgment. That judgment is what senior bankers and PE partners rely on in front of clients and investment committees.
Deeply understanding these three models is extremely relevant for anyone interested in M&A. While there are more and more tools that can help build models, it is still important to be able to make them from scratch. I say this not only to build technical skills, but also to help boost analytical skills.
Ultimately, what distinguishes professionals is their ability to interpret what the models reveal about risk, negotiating leverage, and transaction feasibility. Those who can move most effectively from technical execution to actionable insight are the ones who progress.
The merger model, LBO model, and DCF model are the frameworks that drive M&A decisions. They answer different questions, but together they determine valuation, financing, and risk.
For professionals aiming to break into investment banking or private equity, fluency in these models is essential. For those already in the industry, sharpening your ability to stress-test and interpret them builds credibility with senior dealmakers.
If you want hands-on practice, I’ve pulled together templates for each model, as well as investment banking bonus materials.
