Not investment advice. Educational reading. See Disclaimer.
L.8 · ADVANCED · 4 MIN
Cash Sweep Mechanics: How FCF Routes to Debt Paydown
In an LBO, the debt tranches do not pay themselves down automatically — most of the paydown is governed by a CASH SWEEP provision in the credit agreement. The sweep routes a contractual percentage of excess free cash flow (FCF above mandatory amortization and defined reserves) to prepay senior debt, conditional on the company's leverage ratio. The sweep is one of the highest-leverage features in an LBO model: a 75% sweep at high leverage can lift equity IRR by 200-400 bps over a typical 5-year hold versus a no-sweep base case, simply by accelerating debt-paydown timing. Understanding sweep mechanics — the leverage-tier schedule, which tranches are prepayable, what counts as 'excess' FCF, and how the sweep interacts with the sponsor's cash-distribution rights — is one of the deepest reads in advanced LBO modeling.
Aggressive deleveraging; sponsor has no discretion over excess FCF
4.0x - 5.0x net leverage
50-75% sweep
Active deleveraging mode; sponsor has limited discretion
3.0x - 4.0x net leverage
25-50% sweep
Transition tier; sponsor gains some capital-allocation optionality
Below 3.0x net leverage
0% sweep
Sponsor regains full discretion over excess FCF (dividend recap, bolt-on M&A, build cash)
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The sweep applies only to PREPAYABLE debt. Term Loan B is almost always prepayable at par with no penalty (the 'covenant-lite' standard). Senior Notes typically carry a 2-3 year non-call period and a make-whole or call-premium schedule beyond that; during the non-call period the sweep cannot route to them. Mezzanine and subordinated debt is usually NOT prepayable at all during the early years. In practice, sweep dollars route to Term Loan B first, then to Senior Notes once the non-call period expires, then to mezzanine — but in most LBO models the bond and mezz tranches are paid down only at exit via refinancing or proceeds. The TLB is the load-bearing prepayment tranche for sweep purposes.
Open the calculator above. With baseline inputs ($110M FCF, $20M mandatory amort, $15M reserves, 75% sweep), the annual sweep paydown is $56.25M. Now drag sweep to 50%: paydown drops to $37.5M, and $18.75M routes to sponsor-discretion cash. Over a 5-year hold, the difference between 75% and 50% sweep is approximately $95M of cumulative paydown — equivalent to roughly 5-7% of typical LBO equity, materially shifting the equity IRR. Now drag FCF down to $70M (a 35% EBITDA decline scenario): excess shrinks to $35M, sweep at 75% routes $26.25M to paydown, and the sponsor has only $8.75M of discretionary FCF — which is why high-sweep agreements are dangerous in downside scenarios (they consume all of FCF for paydown, leaving none for working capital or bolt-on opportunities).
§ 05
A sponsor is comparing two LBO term sheets on the same target. Term Sheet A: $400M Term Loan B at 7%, 75% / 50% / 0% sweep schedule. Term Sheet B: $400M Term Loan B at 7.5% (50 bps higher), 25% / 0% / 0% sweep schedule. Both are otherwise identical. Over a 5-year hold with $90M annual excess FCF and entry leverage of 5.0x falling to 3.5x at exit, which term sheet maximizes equity IRR, and what is the trade-off the sponsor is making?
§ 06
The covenant-lite trend (2014-2022) has materially loosened the sweep schedules typical in private-credit and broadly-syndicated TLB agreements. Pre-2014 standard was 75% / 50% / 0% with reserves tightly defined; the covenant-lite standard moved toward 50% / 25% / 0% with broader reserve definitions and more sponsor-discretion baskets. The economic effect was to transfer roughly 100-200 bps of IRR optionality from lenders to sponsors at the cost of higher interest spreads (15-30 bps) on the senior tranches. Post-2022 rate-rise environment partially reversed the trend (sweep schedules tightening modestly as lenders regained pricing power), but the structural lean toward sponsor-friendly sweep remains. A sophisticated LBO model varies the sweep schedule across base / downside / bull cases — recognizing that a low-sweep agreement looks great in a bull case (sponsor deploys discretionary FCF productively) but can become a liability in a downside case (cash builds with no productive use while leverage stays elevated, eventually forcing a covenant amendment that costs the sponsor more than the original sweep would have).
§ 07
Two years into a 5-year LBO, the company's leverage has fallen from 5.5x to 3.2x, putting it just above the 3.0x threshold where the sweep drops to 0%. EBITDA growth is on plan. The sponsor has identified a bolt-on acquisition opportunity at 6.5x EBITDA (accretive at current multiples) requiring $50M of cash. The credit agreement allows bolt-on M&A as a permitted use of excess FCF below 4.0x leverage. What is the most disciplined sponsor move?
Five questions · AI feedback
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Sit with the ideas.
An LBO target generates $90M of FCF in Year 1 after mandatory amortization ($20M). The credit agreement has a 75% excess-cash-flow sweep triggered when net leverage exceeds 4.0x, falling to 50% at 3.0-4.0x and 0% below 3.0x. Year-end net leverage is 4.5x. The capital stack is $400M Term Loan B at 7%, $200M Senior Notes at 9% (non-callable for two years), and $200M sponsor equity. How does the sweep route the $90M of post-amortization FCF, what is the IRR impact over a 5-year hold, and what would change if the agreement had no sweep?
