What Makes A Good Leveraged Buyout?

Many investors are familiar with leveraged buyouts (or LBO’s), but what most don’t actually know is what makes a leveraged buyout good. Ultimately an LBO needs to result in an attractive purchase of a business with huge upside that results in big profits on the backend.

So what actually contributes to a Leveraged Buyout being good?

There are many factors that PE Firms evaluate when choosing a company to invest in (or buyout). These factors dictate the projected amount of capital needed to complete the acquisition and the outlook on what that company will produce later on. These factors must showcase the ability of the company to reach a much higher profitability from when they are acquired to when they reach an exit (approximately 5 years out).

Let’s look at these factors a little more intensively.

5 Things Private Equity Firms Look For When Choosing An Investment Asset

We’re boiling this down to 5 specific things firms look for when choosing an asset or company they will acquire.

Stable & predictable cash flow

The company or asset being acquired has to be able to show steady / stable cash flow on its books. Using the free cash flow available, models are run to determine future profitability based on growth and efficiencies brought on by experienced management teams.

Minimal Capital Expenditure requirements (CAPEX)

When buying a company or asset naturally a firm takes on debt to acquire that asset. So one of the main goals of the firm is debt repayment. This happens both over time and at the time of the sale of the asset. Repayment of debt is calculated into the models that utilize cash flow to ensure growth and profitability are feasible. This means that minimizing capital expenditures is critical as it reduces the outlay of cash making it easier to repay the debt.

Two types of expenditures are considered. Capex assigned to maintaining the business vs Capex assigned to growing the business. Both are necessary but both play a different part in generating a successful outcome from an LBO.

Market Position and Competitive Advantages 

Buying a company that maintains a competitive position in the marketplace for it’s industry is a strong sign that it has the potential for sustainable growth.

For a business to be competitive they must meet certain criteria:

• Be unique, authoritative and a potential leader in a sector, segment or industry
• Have a strong promise that they provide the customer what they consider a high value
• Have built detailed short term and long term business plans
• Conducted SWOT Analyses that cover both competitors and potential partners
• Maintain risk management & mitigation plans

Many firms will update these plans, processes and research once acquired so ensuring they exist makes this process much easier for the firm allowing them to focus on the growth of profitability of the acquisition.

Favorable Industry Trends

Not only does the firm look at the business or asset alone, there is also a focus on whether or not the business is taking advantage of current trends within their industry. This could include economic shifts, technological innovation or cultural changes. If a company's mission / vision are in alignment with the trends in their given industry it’s much easier to capitalize on them and grow.

So whether it’s new technology such as A.I. (artificial intelligence) or automation to consumer behavior or regulations, being able to act on these trends is critical in the evaluation process.

Strong Management Team

The success of a business can be achieved by having a strong and stable management team.

Companies that possess leadership with the skills and experience along with a solid organizational structure can easily implement change and capitalize on trends, efficiencies and growth plans.

Some of the key experiences needed are risk mitigation, navigating volatile markets, previous hyper growth and strong discipline. This foundation of leadership can be retained to achieve the goals set forth by the firm.

While this isn’t an exhaustive list of everything a firm evaluates when looking for good LBO candidates it is at its core the primary components & characteristics. If you are looking to invest or know of a company looking for capital we would love to have a conversation.