A candidate's margins, leverage, and growth
PG — Operating Margin, Debt/Equity, Revenue Growth. Open PG on the Ledge to see current values.
The criteria and their red flags
| Criteria | Why It Matters | Red Flag |
|---|---|---|
| Stable, predictable cash flows | Must service debt through cycles | Cyclical revenue, project-based |
| Low capex requirements | More FCF available for debt paydown | Heavy annual capex obligations |
| Strong market position | Pricing power protects margins under leverage | Commoditized, price-taking |
| Operational improvement potential | Margin expansion drives returns | Already best-in-class margins |
| Tangible assets | Collateral for secured debt | Asset-light, IP-dependent |
| Experienced management | Can execute under pressure of debt | Founder-dependent, thin team |
Why cash-flow stability ranks first
Cash flow stability is the #1 criterion. A cyclical business with 50% EBITDA drops during downturns cannot service 5–6x leverage. Recession-resistant businesses (healthcare, defense, consumer staples, business services) are the classic LBO targets.
Screen a real company as an LBO target
Look at a company in Fundamentals. Would it survive an LBO? Check: How stable are cash flows? How much capex is required? Is there margin improvement opportunity?
Software versus construction as targets
A software company with 90% recurring revenue, 30% EBITDA margins, and minimal capex vs. a construction company with project-based revenue and 10% margins. Which is a better LBO candidate?
Why boring businesses make the best targets
The traits of an ideal LBO target
What business traits make the BEST LBO target?
Check your understanding
Sit with the ideas.
Two companies are being evaluated as LBO targets. Company P: $80M EBITDA, 30% EBITDA margin, 3% capex/revenue, 5% annual revenue growth, recurring revenue model. Company Q: $120M EBITDA, 25% EBITDA margin, 12% capex/revenue, 15% annual revenue growth, project-based contracts. Which is the better LBO candidate and why?
Why: