With greater than $4.6 trillion of capital dedicated throughout non-public markets (30 June 2025),[1] fund managers face rising stress to deploy capital whereas sustaining self-discipline in due diligence. Buyouts and progress capital, specifically, are extremely aggressive, with roughly $2 trillion of dry powder chasing a restricted pool of appropriate targets.
Though the biggest proportion of personal fairness (PE) efficiency is delivered due to the mechanical advantages of leverage,[2] skilled fund managers know that it pays to be selective when making funding selections.
Sluggish and Regular Wins the Race
Leveraged buyouts (LBOs) with the perfect odds of success share a typical trait: recurring revenues and predictable money flows.
Indebted corporations are uncovered to years of compounding curiosity and, in the end, the reimbursement of the loans they borrow. They due to this fact want to provide common streams of money flows. The enterprise ought to face no substantial capex or working capital necessities, although one of the simplest ways to safe such regularity in liquidity is by embracing a enterprise mannequin the place earnings and money flows usually are not topic to a lot variability.
As one instance, software program as a service (SaaS) is healthier than the supply of software program or {hardware} by itself. A SaaS supplier affords options over time, not only a one-off product sale. Likewise, a smartphone maker like Apple is not only a {hardware} and software program designer. The corporate offers utility platforms that entice app builders that make its provide stickier with the top person. As soon as smartphone customers have downloaded a number of apps on their telephones, their apps sit within the cloud and are transferable from one telephone to the subsequent.
The truth that app builders are unbiased, often self-employed contractors, additionally reduces the danger profile of this income mannequin from the app platform’s standpoint. Apps observe a blockbuster profile, which means that only a few of them are winners. If Apple needed to develop all apps in-house, the truth that a lot of them generate restricted demand would create an unsure stream of income whereas the salaries of builders can be fastened. In abstract, companies with a sticky income profile and variable (or outsourced) prices are nice LBO targets.
The worth is not in a one-off product sale however in recurring platform entry. This shift towards options quite than merchandise displays the enterprise mannequin Common Electrical launched within the Nineteen Eighties beneath Jack Welch’s management. Transferring past fridges and plane engines, GE grew to become a provider of choices, equipment, upkeep, and even financing companies. Proposing a whole, built-in answer makes money flows extra predictable as a result of buyer switching prices rise.
Subscription- and fee-based income fashions, like those espoused by fund managers, are higher than blockbuster tasks like video video games and flicks as a result of they supply robust visibility.
Equally, companies with an put in base provide better predictability. A generally cited instance is Gillette’s razor-and-blade mannequin, which ensures buyer stickiness. Social networks like Fb and serps like Google additionally profit from economies of scale via community results, a contemporary extension of the put in base precept.
One other robust level of predictable, constructive money flows is that they entice lenders, as mortgage agreements sometimes provide restricted upside participation but sizeable draw back publicity.
Imperfect Market Construction
The very best LBO candidates ought to maintain a dominant market place with excessive limitations to entry. Monopolization favors revenue maximization.[3] They need to not face the danger of disruption from new applied sciences nor from new entrants or substitutes. Let’s evaluate a couple of sensible implications:
Fragmentation of buyer and provider base: One strategy to defend money flows is to commerce with many suppliers and purchasers. Inversely, being depending on one or solely a handful of key service suppliers or purchasers is dangerous. Within the wake of the worldwide monetary disaster (GFC), for example, TPG-sponsored broadcaster Univision was closely depending on one key content material supplier, specifically Televisa, which negatively affected its efficiency throughout contract renegotiations. Firms with that kind of concentrated sourcing or gross sales profile characterize an excessive amount of of a danger to endure an LBO.
Cyclical vs. cycle agnostic: Cyclical corporations usually are not dependable sources of leverageable belongings, both. Sectors like retail, particularly vogue retail, in addition to transaction-based industries like funding banking, air journey, commodities buying and selling, and advertising-dependent segments are greatest prevented.
There’s a dangerously complacent phrase within the investing world: “recession proof.” No firm is actually protected from the unfavorable results of an financial downturn, particularly whether it is overleveraged.
Nonetheless, subscription-based fashions, meals & beverage manufacturing — a key staple of many PE corporations — and companies that function on long-term contracts like airport and toll-road operators are extra resilient.
Fashionable tradition vs. tech tradition: For years, exterior of downturn-driven company turnarounds, LBO fund managers targeted nearly completely on worth performs, specifically sectors and corporations with lengthy product cycles and regular, if unremarkable, progress in gross sales and money flows. These companies hardly ever skilled massive shifts in efficiency.
The tech revolution that began within the business-to-business sectors of the economic system and progressively infiltrated the buyer world over the previous 30 years has modified the construction of many industries. Firms that had been anticipated to adapt to in style tradition, with traits measured in multi-year and even decades-long product life cycles, right now face a way more dynamic boom-and-bust, fad-oriented market.
The digitalization of entire swathes of the economic system, from info to retail and from leisure to leisure, shortened product upgrades to 1 12 months, generally a couple of quarters for essentially the most ephemeral video video games. The results of technological disruption on corporations making an attempt to ship predictability to service debt could be traumatic.[4]
PE fund managers should chorus from investing in sectors uncovered or more likely to get uncovered to technological adjustments. A dependable LBO goal ought to require no main strategic adjustments or wide-scale rationalization.
Optimum Enterprise Fundamentals
Beside market dominance and cash-flow predictability to cowl debt commitments, essentially the most sought-after LBO targets are mature, viable, stand-alone companies.
Two different standards value mentioning relate to belongings and folks.
Asset effectivity: For asset-rich companies, the important thing query a fund supervisor should reply is methods to get extra out of the belongings. Excessive asset depth, that’s the ratio of belongings to revenues, could be a drag on earnings.
PE fund managers, historically in search of companies with unencumbered belongings to make use of as safety, are these days desirous to lighten the asset load of a portfolio firm. An asset-intensive enterprise requires common upgrades or investments to interchange out of date tools.
In its buyout of Hilton, Blackstone demonstrated that administration contracts can provide standard property managers like resort teams a strategy to maximize return on fairness with out the burden of capital expenditure on money flows higher used to redeem debt or distribute dividends. Partially to make itself much less cycle-dependent, Hilton reworked its mannequin from asset-rich to fee-based, making the group much less delicate to volatility in asset valuations.
The hazard of an asset-light technique is that, when the enterprise hits a roadblock, it can not resort to promoting off elements of its property or tools to generate liquidity urgently.
When its accounting fraud got here to gentle in 2001, Enron couldn’t cope. Administration had spent years morphing the enterprise from an asset-based fuel pipeline operator to an asset-poor buying and selling platform. With liabilities 3 times the scale of its ebook worth, Enron had no different however to file for Chapter 11.
Even when they don’t get that artistic on the accounting entrance, extremely leveraged companies can discover it troublesome to face a downturn or market disruption in the event that they observe an asset-light mannequin.
Folks companies: Historically, a sector like promoting was not an excellent supply of LBOs because it relied on artistic folks, a fickle lot. Now that advertisements are automated, promoting platforms like Fb and Google are improbable targets; that’s if their founders ever thought of monetary engineering value their time. At current, they concentrate on progress by way of product and repair innovation. However that might change.
Report label EMI Music confirmed, throughout its failed buyout in 2007 to 2011, that its recording unit, depending on artists and repertoire workers, was too risky for a leveraged transaction. The publishing catalogue was extra reliable and an excellent goal for securitization, as KKR demonstrated with its 2009 funding in BMG Rights, a publishing three way partnership with German media group Bertelsmann. For much less tense buyouts, it’s best to keep away from folks companies.
As we speak’s LBO Setting
As a consequence of intense competitors, the profile of LBOs has modified dramatically for the reason that emergence of the commerce within the Nineteen Seventies. Again then, most targets had been non-core divisions (carve-outs) of conglomerates, corporations in issue and pressing want of funding, household companies with succession points, or undesirable divisions of a bigger acquisition.
These days, these sorts of targets characterize a really small proportion of deal quantity. As a consequence of market saturation, about half of all annual offers are secondary buyouts, that’s sponsor-to-sponsor offers.[5] Public markets characterize one other fruitful supply of offers. In a typical 12 months, delistings, or take-privates, account for 10% to twenty% of deal stream.
After all, all fund managers search LBO targets with as lots of the aforementioned traits, however it’s troublesome to stay disciplined in a bloated market. Report dry powder has led to report deal valuations: 4 of the final 5 years have seen entry multiples at all-time highs.[6] Within the present PE panorama, it’s preferable to be on the promote aspect.
Components of this text had been tailored from The Good, the Unhealthy and the Ugly of Non-public-Fairness by Sebastien Canderle.
[1] https://pitchbook.com/information/articles/global-private-market-funds-dry-powder-dashboard-2026
[2] https://blogs.cfainstitute.org/investor/2022/10/21/tricks-of-the-private-equity-trade-part-2-leverage/
[3] https://blogs.cfainstitute.org/investor/2023/08/14/debunking-the-myth-of-perfect-competition/
[4] https://blogs.cfainstitute.org/investor/2023/05/16/distress-investing-a-tale-of-two-case-studies/
[5] https://blogs.cfainstitute.org/investor/2022/02/09/private-equity-market-saturation-spawns-runaway-dealmaking/
[6] https://pitchbook.com/information/reviews/2025-annual-us-pe-breakdown
