How do you determine how much debt a company can take on in an LBO?

Answer

Key constraints: (1) Debt/EBITDA ratio — typically 5-7x total leverage for healthy businesses, lower for risky industries; (2) Interest coverage — EBITDA / Interest must stay above ~2-3x (covenants are tighter); (3) FCF / Debt — the company must generate enough cash to service the debt; (4) Market appetite — what lenders are actually willing to provide; (5) Equity cushion — sponsors typically want 30-40% equity to keep the investment risk-reward profile balanced.