What makes a good LBO candidate?

Startup Funding

The most important characteristic of a good LBO candidate is stable cash flows, since the PE owner will have to service the debt and stay within covenants in order for the investment to be successful. This means recurring revenue is very valuable, meaning that the revenue is “sticky” and it’s hard for customers to switch to other providers. Having stable margins is crucial as well.

Good LBO candidates should also not have too many other cash outflows, and have relatively light capex. PE firms usually avoid manufacturing companies for this reason, since they require a lot of capex to build new factories and buy new equipment.

Ideally, the company should also be strongly positioned as a leader in its industry or niche, and have high growth potential and multiple growth avenues to grow revenue and EBITDA. If there are opportunities to improve the company, this would also be also attractive.

Having a large tangible asset base is useful as well for providing collateral and potentially securing more debt on better terms.

Finally, other important positives include a very experienced management team and a favorable acquisition price. For example, a favourable price may be driven by mispricing in the public markets due to the short-term focus of public stocks.