By Edoardo Tosti (Boston University) and Carlo Leopardi.
Picture by Sean Pollock (Unsplash)
Walkthrough
When seeking Leverage Buyout (LBO) opportunities, private equity firms look for target companies that meet specific criteria to ensure a high Internal Rate of Return (IRR) and Multiple on Invested Capital (MOIC) within their investment period. Here are a few characteristics of a good LBO candidate:
1) Strong and Predictable Free Cash Flow – as during the investment period the acquired company has to regularly pay off the leverage used to finance the LBO, this is the fundamental characteristic of any LBO candidate
2) Right Capital Structure – As LBOs significantly leverage target companies, private equity firms seek targets with low levels of indebtedness to ensure they don’t default on outstanding debt payments
3) Strong Management Team – The presence of a strong management team supports the private equity firm’s value creation, driving growth while managing debt levels during the holding period
4) Room for Growth & Multiple Expansion – Private equity firms will target companies with room for revenue growth and margins expansions. Additionally, target companies with the potential to expand in new business segments trading at higher multiples will yield higher returns
5) Exit Opportunities – as the aim of a LBO is to earn high returns, private equity firms will target companies with potential high multiple exit markets through strategic or financial sponsor M&A or Initial Public Offerings (IPOs)