How do you decide how much leverage to use in an LBO?

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IBPrep · Accepted Answer

Start with the target's risk profile: (1) Historical EBITDA volatility, cyclical or volatile businesses → less leverage (3-4x EBITDA); stable, recurring revenue → more leverage (6-7x); (2) FCF conversion, if a lot of EBITDA leaks to CapEx, less debt can be serviced; (3) Interest coverage, aim for a 2-3x minimum cushion; (4) Market appetite, lenders set the ceiling (regulators flag leveraged loans >6x as 'criticized'); (5) Industry norms, software LBOs often 7-8x, manufacturing 4-5x; (6) Equity cushion required by lenders. Then sensitize against downside scenarios to ensure debt is serviceable in a recession.

How do you decide how much leverage to use in an LBO?

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