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

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.