With greater than $4.6 trillion in capital tied up in private markets (June 30, 2025),[1] Fund managers are under increasing pressure to deploy capital while maintaining due diligence discipline. Buyouts and growth capital particularly are fiercely competitive as about $2 trillion price of dry powder chases a limited pool of suitable targets.
Although most private equity (PE) performance is as a result of the mechanical benefits of leverage,[2] Experienced fund managers know that it pays to be selective when making investment decisions.
Slow and regular wins the race
Leveraged buyouts (LBOs) with one of the best prospects for fulfillment have one common characteristic: recurring revenue and predictable money flows.
Indebted corporations are exposed to years of compound interest and ultimately the repayment of the loans they took out. You subsequently have to generate regular money flows. The company shouldn’t have significant investment or working capital needs. However, one of the best approach to ensure such regularity of liquidity is to pursue a business model by which profits and money flows will not be subject to large fluctuations.
For example, Software as a Service (SaaS) is healthier than providing software or hardware alone. A SaaS provider offers long-term solutions and not only a one-time product sale. Likewise, a smartphone manufacturer like Apple shouldn’t be only a hardware and software designer. The company provides application platforms that attract app developers and increase end-user engagement. Once smartphone users download multiple apps to their phone, their apps reside within the cloud and will be transferred from one phone to the subsequent.
The incontrovertible fact that app developers are independent, normally self-employed, contractors also reduces the danger profile of this revenue model from the angle of the app platform. Apps follow a blockbuster profile, meaning only a few of them are winners. If Apple needed to develop all of the apps itself, the incontrovertible fact that lots of them generate limited demand would result in an uncertain revenue flow, while developers’ salaries could be fixed. In summary, corporations with a hard and fast revenue profile and variable (or outsourced) costs are good LBO targets.
The value not lies in a one-time product sale, but in recurring platform access. This shift toward solutions slightly than products reflects the business model that General Electric established within the Nineteen Eighties under the leadership of Jack Welch. GE went beyond fridges and aircraft engines to change into a provider of options, accessories, maintenance and even financing services. By proposing an entire, integrated solution, money flows change into more predictable as customers’ switching costs increase.
Subscription and fee-based revenue models, corresponding to those advocated by fund managers, are higher than blockbuster projects like video games and movies because they provide high visibility.
Likewise, corporations with an installed base offer greater predictability. A incessantly cited example is Gillette’s razor blade model, which ensures customer loyalty. Social networks like Facebook and serps like Google also profit from economies of scale through network effects, a contemporary extension of the installed base principle.
Another strength of predictable, positive money flows is that they attract lenders because credit agreements typically provide limited upside but significant downside risk.
Imperfect market structure
The best LBO candidates must have a dominant market position with high barriers to entry. Monopolization promotes profit maximization.[3] You shouldn’t be exposed to the danger of disruption from recent technologies or recent entrants or substitutes. Let’s take a look at some practical implications:
Fragmentation of the client and supplier base: One approach to protect money flows is to trade with many suppliers and customers. Conversely, it’s dangerous to be depending on one or simply a handful of key service providers or customers. For example, within the wake of the worldwide financial crisis (GFC), TPG-sponsored broadcaster Univision was heavily depending on a significant content provider, Televisa, which negatively impacted its contract renegotiation performance. Companies with such a concentrated sourcing or sales profile pose an excessive amount of risk to undergo an LBO.
Cyclic vs. cycle-independent: Cyclical corporations are also not a reliable source of leveraged assets. Sectors corresponding to retail, particularly fashion retail, in addition to transaction-based industries corresponding to investment banking, air travel, commodity trading and advertising-dependent segments are best avoided.
There’s a dangerously smug phrase within the investing world: “recession-proof.” No company is actually protected from the negative effects of an economic downturn, especially whether it is overleveraged.
Still, subscription-based models, food and beverage manufacturing – a key cornerstone of many PE firms – and corporations that operate under long-term contracts, corresponding to airport and toll road operators, are more resilient.
Pop culture vs. tech cultureFor years, outside of corporate turnarounds attributable to downturns, LBO fund managers focused almost exclusively on value plays, namely sectors and corporations with long product cycles and regular, if unremarkable, growth in revenue and money flow. These corporations rarely experienced major performance changes.
The technological revolution that began within the business-to-business sectors of the economy and progressively penetrated the patron world during the last 30 years has modified the structure of many industries. Companies that were expected to adapt to popular culture, whose trends are measured in multi-year and even decade-long product life cycles, now face a far more dynamic boom-and-bust and fashion-driven market.
The digitization of entire sectors of the economy, from information to retail and from entertainment to leisure, shortened product updates for the shortest-lived video games to a 12 months, sometimes even a number of quarters. The consequences of technological disruption for corporations searching for to service their debt predictably will be traumatic.[4]
PE fund managers must refrain from investing in sectors which can be or are prone to be exposed to technological changes. A reliable LBO goal shouldn’t require major strategic changes or major rationalizations.
Optimal business fundamentals
In addition to market dominance and predictability of money flow to cover debt obligations, mature, profitable and self-contained corporations are probably the most desirable LBO targets.
Two other criteria price mentioning relate to assets and folks.
Plant efficiency: For asset-rich corporations, a very powerful query a fund manager needs to reply is methods to get more out of the assets. High asset intensity, i.e. the ratio of assets to income, can have a negative impact on returns.
PE fund managers, who traditionally seek corporations with unencumbered assets as collateral, are actually looking to cut back a portfolio company’s asset burden. An asset-intensive business requires regular upgrades or investments to switch aging equipment.
In its acquisition of Hilton, Blackstone demonstrated that management contracts can provide traditional property managers corresponding to hotel groups with a approach to maximize return on equity without the burden of capital expenditures on money flows which can be higher used to pay down debt or pay dividends. Partly to make itself less cyclical, Hilton has shifted its model from an asset-rich to a fee-based model, making the group less vulnerable to the volatility of asset valuations.
The danger of an asset-light strategy is that if the corporate runs into difficulties, it’s going to not give you the option to resort to selling parts of its property or equipment to generate urgent liquidity.
When the accounting fraud got here to light in 2001, Enron couldn’t handle it. Management had spent years transforming the corporate from an asset-based gas pipeline operator into an asset-light trading platform. With liabilities 3 times its book value, Enron had no alternative but to file for Chapter 11.
Even in the event that they will not be as creative in accounting, highly leveraged corporations may find it difficult to weather a downturn or market disruption in the event that they follow an asset-light model.
People company: Traditionally, a sector like promoting hasn’t been an excellent source of LBOs since it relies on creative people, a fickle bunch. With ads now automated, promoting platforms like Facebook and Google are incredible targets. That is, if their founders ever thought that financial engineering was price their time. They are currently focused on growth through product and repair innovation. But that might change.
Record label EMI Music showed during its failed takeover between 2007 and 2011 that its recording division, which relied on artists and repertory staff, was too volatile for a leveraged transaction. The publisher’s catalog was more reliable and an excellent goal for securitization, as KKR demonstrated in 2009 with its investment in BMG Rights, a publishing three way partnership with the German media group Bertelsmann. For less stressful acquisitions, it is best to avoid people businesses.
Today’s LBO environment
Due to intense competition, the profile of LBOs has modified dramatically because the trade’s emergence within the Nineteen Seventies. At that point, a lot of the targets were non-core business areas (carve-outs) of corporations, corporations in difficulty and in urgent need of financing, family businesses with succession problems or unwanted divisions of a bigger takeover.
Today, such goals only make up a really small proportion of business volume. Due to market saturation, around half of all annual deals are secondary buyouts, i.e. sponsor-to-sponsor deals.[5] Public markets represent one other fertile source of deals. In a typical 12 months, delistings or take-privates account for 10 to twenty% of deal flow.
Of course, all fund managers strive for LBO targets with as lots of the above characteristics as possible, however it is difficult to stay disciplined in a bloated market. Record dry powder has led to record deal valuations: 4 of the last five years have seen entry multiples at all-time highs.[6] In the present PE landscape, being on the sell side is preferable.
Parts of this text were adapted from by Sebastien Canderle.
[1] https://pitchbook.com/news/articles/global-private-market-funds-dry-powder-dashboard-2026
[6] https://pitchbook.com/news/reports/2025-annual-us-pe-breakdown
