With more than $4.6 trillion of capital committed in the private markets (June 30, 2025),[1] fund managers face increasing pressure to deploy capital while maintaining due diligence discipline. Buyouts and growth capital in particular are highly competitive, with approximately $2 trillion in dry powder chasing a limited pool of eligible targets.
Although the majority of private equity (PE) performance is realized through 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 chances of success share a common feature: recurring revenue 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 generate regular cash flows. The company should not have a substantial need for capital investment or working capital, although the best way to ensure such regularity in liquidity is to embrace a business model in which profits and cash flows are not subject to much variation.
For example, software as a service (SaaS) is better than the delivery of software or hardware itself. A SaaS provider offers solutions over time, not just a one-time product sale. Likewise, a smartphone maker like Apple is not just a hardware and software designer. The company offers application platforms that attract app developers and make the offering more attractive to the end user. Once smartphone users download multiple apps on their phone, their apps are in the cloud and can be transferred from one phone to another.
The fact that app developers are independent, often self-employed contractors, also reduces the risk profile of this revenue model from the app platform’s perspective. Apps follow a blockbuster profile, which means very few apps are winners. If Apple had to develop all its apps in-house, the fact that many of them generate limited demand would create an uncertain revenue stream, while developer salaries would be fixed. In summary, companies with a fixed revenue profile and variable (or outsourced) costs make great LBO targets.
The value is no longer in a one-time product sale, but in recurring platform access. This shift to solutions rather than products reflects the business model that General Electric introduced in the 1980s under the leadership of Jack Welch. In addition to refrigerators 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 as switching costs for customers increase.
Subscription- and fee-based revenue models, such as those of fund managers, are better than blockbuster projects like video games and movies because they offer strong visibility.
Likewise, companies with an installed base offer greater predictability. An often-cited example is Gillette’s razor-and-blade model, which keeps the customer sticky. 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 strength of predictable, positive cash flows is that they attract lenders because loan agreements typically offer limited upside participation, yet significant downside exposure.
Imperfect market structure
The best LBO candidates must have a dominant market position with high barriers to entry. Monopolization promotes profit maximization.[3] They should not be faced with the risk of disruption from new technologies, new entrants or substitutes. Let’s look at some practical implications:
Fragmentation of customer and supplier base: One way to protect cash flows is to trade with many suppliers and customers. Conversely, it is risky to depend on one or just a handful of key service providers or customers. For example, in the aftermath of the Global Financial Crisis (GFC), TPG-sponsored broadcaster Univision was heavily dependent on one key content provider, Televisa, which negatively impacted performance during contract renegotiations. Companies with such a concentrated purchasing or sales profile pose too great a risk to undergo an LBO.
Cyclic vs. cycle-agnostic: Cyclical companies are also not reliable sources of leveraged assets. Sectors such as retail, especially fashion retail, as well as transaction-based sectors such as investment banking, air travel, commodity trading and advertising-dependent segments are best avoided.
There’s a dangerously complacent expression in the investment world: “recession-proof.” No company is truly safe from the negative effects of an economic downturn, especially if it is over-indebted.
Nevertheless, subscription-based models, food and beverage manufacturing – a key part of many PE firms – and companies that operate under long-term contracts, such as airport and toll road operators, are more resilient.
Popular culture versus technology culture: For years, outside of recession-induced business turnarounds, LBO fund managers have 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 companies rarely experienced major shifts in performance.
The technological revolution that started in the business-to-business sectors of the economy and gradually infiltrated the consumer world over the past thirty 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, fad-driven marketplace.
The digitalization of entire parts of the economy, from information to retail and from entertainment to leisure, shortened product upgrades to a year, sometimes a few quarters for the most short-lived video games. The consequences of technological disruption for companies trying to make debt service payments predictable could be traumatic.[4]
PE fund managers should avoid investing in sectors that are exposed or likely to be exposed to technological changes. A reliable LBO target would not require major strategic changes or large-scale rationalizations.
Optimal business foundations
In addition to market dominance and cash flow predictability to cover debt, the most sought-after LBO targets are mature, viable, standalone businesses.
Two other criteria worth mentioning relate to assets and people.
Asset efficiency: For asset-rich companies, the most important question a fund manager must answer is how to get more out of their assets. High asset intensity, that is, the ratio of assets to income, can negatively impact profits.
PE fund managers, who traditionally look for companies with unencumbered assets to use as collateral, are now eager to lighten the asset burden of a portfolio company. An asset-intensive business requires regular upgrades or investments to replace outdated equipment.
In acquiring Hilton, Blackstone demonstrated that management contracts can provide conventional property managers such as hotel groups with a way to maximize return on equity without the burden of capital expenditures on cash flows that could be better used to pay down debt or pay dividends. Partly 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 company hits a roadblock, it cannot resort to selling parts of its assets or equipment to generate urgent liquidity.
When the accounting fraud was exposed in 2001, Enron couldn’t handle it. Management had spent years transforming the company from an asset-based gas pipeline operator to an asset-light trading platform. With liabilities three times its book value, Enron had no choice but to file for Chapter 11.
Even if they aren’t as creative on an accounting front, highly leveraged companies may find it difficult to deal with a downturn or market disruption if they adopt a low-asset model.
People companies: Traditionally, an industry like advertising was not a good source of LBOs because it relied on creative people, a fickle group. Now that advertising is automated, advertising platforms like Facebook and Google are fantastic targets; at least if their founders ever thought financial engineering was worth it. They are currently focusing on growth through product and service innovation. But that could change.
Record label EMI Music showed during its failed takeover in 2007 to 2011 that its recording unit, dependent on artists and repertoire personnel, was too volatile for a leveraged transaction. The publisher’s catalog was more reliable and a good target for securitization, as KKR demonstrated with its 2009 investment in BMG Rights, a joint venture with German media group Bertelsmann. For less stressful buyouts, it’s best to avoid people companies.
The current LBO environment
Due to intense competition, the profile of LBOs has changed dramatically since the boom of the trade in the 1970s. At the time, most targets were non-core divisions (spinoffs) of conglomerates, companies in trouble and in dire need of financing, family businesses with succession issues, or unwanted spinoffs from a larger acquisition.
Today, these types of objectives represent a very small portion of deal volume. Due to market saturation, approximately half of all annual deals are secondary buyouts, i.e. sponsor-to-sponsor deals.[5] Public markets are another fertile source of deals. In a normal year, delistings or take-privates are responsible for 10% to 20% of the deal flow.
Of course, all fund managers strive for LBO objectives with as many of the above characteristics as possible, but it is difficult to remain disciplined in an inflated market. Record dry powder has led to record valuations for deals, with entry multiples at record highs in four of the last five years.[6] In the current PE landscape, it is preferable to be on the sell side.
Parts of this article are adapted from The good, the bad and the ugly of private equity by Sébastien Canderle.
[1] https://pitchbook.com/news/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/news/reports/2025-annual-us-pe-breakdown
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