With more than $4.6 trillion of capital committed across private markets (30 June 2025),[1] fund managers face growing pressure to deploy capital while maintaining discipline in due diligence. Buyouts and growth capital, in particular, are highly competitive, with approximately $2 trillion of dry powder chasing a limited pool of suitable targets.
Although the largest proportion of private equity (PE) performance is delivered thanks to the mechanical benefits of leverage,[2] experienced fund managers know that it pays to be selective when making investment decisions.
Slow and Steady Wins the Race
Leveraged buyouts (LBOs) with the best odds of success share a common trait: recurring revenues and predictable cash flows.
Indebted companies are exposed to years of compounding interest and, ultimately, the repayment of the loans they borrow. They therefore need to produce regular streams of cash flows. The business should face no substantial capex or working capital requirements, though the best way to secure such regularity in liquidity is by embracing a business model where profits and cash flows are not subject to much variability.
As one example, software as a service (SaaS) is better than the delivery of software or hardware on its own. A SaaS provider offers solutions over time, not just a one-off product sale. Likewise, a smartphone maker like Apple is not just a hardware and software designer. The company provides application platforms that attract app developers that make its offer stickier with the end user. Once smartphone users have downloaded multiple apps on their phones, their apps sit in the cloud and are transferable from one phone to the next.
The fact that app developers are independent, usually self-employed contractors, also reduces the risk profile of this revenue model from the app platform’s standpoint. Apps follow a blockbuster profile, meaning that very few of them are winners. If Apple had to develop all apps in-house, the fact that many of them generate limited demand would create an uncertain flow of revenue while the salaries of developers would be fixed. In summary, businesses with a sticky revenue profile and variable (or outsourced) costs are great LBO targets.
The value is no longer in a one-off product sale but in recurring platform access. This shift toward solutions rather than products reflects the business model General Electric introduced in the 1980s under Jack Welch’s leadership. Moving beyond fridges and aircraft engines, GE became a supplier of options, accessories, maintenance, and even financing services. Proposing a complete, integrated solution makes cash flows more predictable because customer switching costs rise.
Subscription- and fee-based revenue models, like the ones espoused by fund managers, are better than blockbuster projects like video games and movies because they provide strong visibility.
Similarly, businesses with an installed base offer greater predictability. A commonly cited example is Gillette’s razor-and-blade model, which ensures customer stickiness. Social networks like Facebook and search engines like Google also benefit from economies of scale through network effects, a modern extension of the installed base principle.
Another strong point of predictable, positive cash flows is that they attract lenders, as loan agreements typically offer limited upside participation yet sizeable downside exposure.
Imperfect Market Structure
The best LBO candidates should hold a dominant market position with high barriers to entry. Monopolization favors profit maximization.[3] They should not face the risk of disruption from new technologies nor from new entrants or substitutes. Let’s review a few practical implications:
Fragmentation of customer and supplier base: One way to protect cash flows is to trade with many suppliers and clients. Inversely, being dependent on one or only a handful of key service providers or clients is risky. In the wake of the global financial crisis (GFC), for instance, TPG-sponsored broadcaster Univision was heavily dependent on one key content provider, namely Televisa, which negatively affected its performance during contract renegotiations. Companies with that sort of concentrated sourcing or sales profile represent too much of a risk to undergo an LBO.
Cyclical vs. cycle agnostic: Cyclical companies are not reliable sources of leverageable assets, either. Sectors like retail, especially fashion retail, as well as transaction-based industries like investment banking, air travel, commodities trading, and advertising-dependent segments are best avoided.
There is a dangerously complacent phrase in the investing world: “recession proof.” No company is truly safe from the negative effects of an economic downturn, especially if it is overleveraged.
Nonetheless, subscription-based models, food & beverage manufacturing — a key staple of many PE firms — and businesses that operate on long-term contracts like airport and toll-road operators are more resilient.
Popular culture vs. tech culture: For years, outside of downturn-driven corporate turnarounds, LBO fund managers focused almost exclusively on value plays, namely sectors and companies with long product cycles and steady, if unremarkable, growth in sales and cash flows. These businesses rarely experienced large shifts in performance.
The tech revolution that started in the business-to-business sectors of the economy and gradually infiltrated the consumer world over the past 30 years has changed the structure of many industries. Companies that were expected to adapt to popular culture, with trends measured in multi-year or even decades-long product life cycles, today face a much more dynamic boom-and-bust, fad-oriented market.
The digitalization of whole swathes of the economy, from information to retail and from entertainment to leisure, shortened product upgrades to one year, sometimes a few quarters for the most ephemeral video games. The consequences of technological disruption on companies trying to deliver predictability to service debt can be traumatic.[4]
PE fund managers must refrain from investing in sectors exposed or likely to get exposed to technological changes. A reliable LBO target should require no major strategic changes or wide-scale rationalization.
Optimal Business Fundamentals
Beside market dominance and cash-flow predictability to cover debt commitments, the most sought-after LBO targets are mature, viable, stand-alone businesses.
Two other criteria worth mentioning relate to assets and people.
Asset efficiency: For asset-rich businesses, the key question a fund manager must answer is how to get more out of the assets. High asset intensity, that is the ratio of assets to revenues, can be a drag on earnings.
PE fund managers, traditionally seeking businesses with unencumbered assets to use as security, are nowadays eager to lighten the asset load of a portfolio company. An asset-intensive business requires regular upgrades or investments to replace obsolete equipment.
In its buyout of Hilton, Blackstone demonstrated that management contracts can give conventional property managers like hotel groups a way to maximize return on equity without the burden of capital expenditure on cash flows better used to redeem debt or distribute dividends. In part to make itself less cycle-dependent, Hilton transformed its model from asset-rich to fee-based, making the group less sensitive to volatility in asset valuations.
The danger of an asset-light strategy is that, when the business hits a roadblock, it cannot resort to selling off parts of its property or equipment to generate liquidity urgently.
When its accounting fraud came to light in 2001, Enron could not cope. Management had spent years morphing the business from an asset-based gas pipeline operator to an asset-poor trading platform. With liabilities three times the size of its book value, Enron had no alternative but to file for Chapter 11.
Even if they do not get that creative on the accounting front, highly leveraged businesses can find it difficult to face a downturn or market disruption if they follow an asset-light model.
People businesses: Traditionally, a sector like advertising was not a good source of LBOs as it relied on creative people, a fickle lot. Now that ads are automated, advertising platforms like Facebook and Google are fantastic targets; that is if their founders ever considered financial engineering worth their time. At present, they focus on growth via product and service innovation. But that could change.
Record label EMI Music showed, during its failed buyout in 2007 to 2011, that its recording unit, dependent on artists and repertoire staff, was too volatile for a leveraged transaction. The publishing catalogue was more dependable and a good target for securitization, as KKR demonstrated with its 2009 investment in BMG Rights, a publishing joint venture with German media group Bertelsmann. For less stressful buyouts, it is best to avoid people businesses.
Today’s LBO Environment
Due to intense competition, the profile of LBOs has changed dramatically since the emergence of the trade in the 1970s. Back then, most targets were non-core divisions (carve-outs) of conglomerates, companies in difficulty and urgent need of funding, family businesses with succession issues, or unwanted divisions of a larger acquisition.
Nowadays, these kinds of targets represent a very small proportion of deal volume. Due to market saturation, about half of all annual deals are secondary buyouts, that is sponsor-to-sponsor deals.[5] Public markets represent another fruitful source of deals. In a typical year, delistings, or take-privates, account for 10% to 20% of deal flow.
Of course, all fund managers seek LBO targets with as many of the aforementioned characteristics, but it is difficult to remain disciplined in a bloated market. Record dry powder has led to record deal valuations: four of the last five years have seen entry multiples at all-time highs.[6] In the current PE landscape, it is preferable to be on the sell side.
Parts of this article were adapted from The Good, the Bad and the Ugly of Private-Equity by Sebastien Canderle.
