In the world of mergers and acquisitions, there are many ways to structure the sale of a business. One of the most sophisticated and powerful —but also one of the riskiest— is the leveraged buyout, or LBO. In this guide, we explain what it is, how it's structured, which companies are ideal candidates, and the risks you need to understand before considering a deal of this kind.
What exactly is an LBO?
An LBO (leveraged buyout) is a deal to acquire a company in which the buyer uses a small amount of its own capital and a very large share of external financing (debt) to close the purchase.
To do this, the buyer —usually a private equity firm— sets up a special purpose vehicle (an ad hoc holding company, known as an SPV) that takes on debt to acquire the target company. The acquired company's assets and future cash flows are used as collateral for that debt.
It's not unusual for financial leverage to reach 60% to 80% of the total purchase price. In some deals, debt can finance close to 90%.
📊 Practical example: how a €10M LBO is structured
Imagine a deal to buy an industrial SME valued at €10 million with 70% leverage:
- Fund's own capital (equity): €3,000,000 (30%)
- Bank and mezzanine debt: €7,000,000 (70%)
- Total purchase price: €10,000,000
If, after five years, the fund sells the company for €15M after paying down €3M of debt, the equity value goes from €3M to €11M. That's a 3.7x return on the initial capital. That's the magic —and also the risk— of the LBO.
Why use an LBO?
The main advantage of an LBO is that it allows the buyer to control a company with a relatively small capital investment, maximizing the return on the equity contributed.
This financial leverage means that even midsize companies can be acquired by funds with limited resources, as long as the target company has stable cash flows large enough to carry the debt burden.
In addition, for sellers, an LBO can offer an attractive exit route: in many cases it means an all-cash purchase —or close to it— and simplifies the process compared with more complex alternatives such as a deferred earn-out.
What kinds of companies are ideal candidates for an LBO?
Not every company is suited to an LBO. The characteristics funds look for most are:
- Stable, recurring cash flows that can cover debt service.
- Sufficient assets —or a solid structure— to offer as collateral.
- A proven business, with relatively predictable revenue and margins.
- Room to improve operational efficiency or restructure after the acquisition, which makes it possible to increase value and pay down the debt.
For these reasons, many private equity firms opt for an LBO when they're looking for mature companies with a good financial track record, moderate but steady growth, and potential for optimization. If you want to learn how these funds think, we recommend reading our analysis of private equity strategies for buying companies.
How is an LBO deal structured?
A typical LBO follows these steps:
- Setting up a holding entity (SPV) that takes on the debt.
- Financing the purchase through a combination of debt (banks, bonds, mezzanine, subordinated debt, etc.) and the buyer's own contribution.
- Debt service: once the purchase closes, the acquired company's cash flows go toward paying interest and principal.
- Increasing the asset's value through operational improvement, growth, restructuring, or cost optimization.
- Divestment (exit): after 4–7 years, the buyer sells the company to a strategic buyer, to another fund (secondary buyout) or, less often, through an IPO.
LBO risks: when leverage becomes a problem
The LBO is not a risk-free technique. The main risks are:
- Unstable cash flows: if the company doesn't generate the expected cash, it can be hard to keep up with debt service.
- Excessive debt (overleveraging): a leverage ratio that's too high can put the entire deal at risk with any drop in revenue.
- Dependence on post-acquisition management: if the planned operational improvements don't materialize, neither does the expected value.
- Limited time horizon: private equity firms look for a clear exit within 4 to 7 years, which can push toward short-term decisions.
⚠️ Warning sign: When debt service consumes more than 50%–60% of annual EBITDA, the deal enters the risk zone. In these cases, even a moderate drop in revenue can trigger liquidity problems or a breach of bank covenants.
Who should understand how an LBO works?
In a market where company prices are high, the LBO is emerging as an alternative that lowers the financial barrier to entry without giving up acquisition opportunities. Understanding how it works is useful for three profiles:
- Business owners who want to sell: an LBO can be an efficient way for the buyer to finance the deal, which can make it easier to close.
- Financial investors and funds: it makes it possible to evaluate acquisition opportunities that would be out of reach with limited cash of their own.
- Executives and strategic buyers: with a good business plan, an LBO with moderate leverage can be a powerful tool for acquiring SMEs.
🎙️ Want to dig deeper into how debt is used in real acquisitions? In the episode “Debt as a lever for growth (and for acquiring companies)” of our Rainmaker podcast, we talk with Gerardo Redondo, Investment Director at Inveready, about how to structure leveraged deals in Spanish SMEs:
Conclusion: a powerful tool that demands discipline
The leveraged buyout is one of the most important strategies in M&A and private equity. It makes it possible to pursue acquisitions with minimal equity, using the target company's financial structure to fund the deal. If the company is well chosen and managed prudently, it can be a very attractive route for both buying and selling.
However, success depends on key variables: sustainable cash flows, operational and financial capacity, disciplined debt management, and a clear exit plan. For sellers, understanding the LBO can make the difference between a quick sale and a deal that fails before it even starts.
💡 Are you thinking about selling your business or looking for investment opportunities?
At Deale, we connect business owners who want to sell with financial investors and strategic buyers —many of them funds that structure deals as LBOs. Get in touch with our team to explore your case.
Sell your business · See businesses for sale
Frequently asked questions about the LBO
What's the difference between an LBO and an MBO?
An LBO is any leveraged acquisition, usually led by a private equity firm. An MBO (management buyout) is a specific type of leveraged deal in which the company's own managers buy it. Many MBOs are in turn structured as LBOs, combining equity from the management team with bank debt. If you want to go deeper, we have a dedicated guide on what an MBO is and how it works for SMEs.
What level of leverage is reasonable in an LBO?
In today's Spanish market, typical levels range from 50% to 70% of the purchase price financed with debt. Above 80%, the deal is considered very aggressive and is only viable for companies with highly predictable cash flows, such as infrastructure or businesses with recurring subscription revenue.
Can an SME be the target of an LBO?
Yes. Although LBOs were traditionally associated with large deals, Spain has an active LBO market for SMEs with €5 million to €50 million in revenue, especially in industries with stable cash flows (B2B services, distribution, healthcare, manufacturing).
How long does an LBO deal take from start to closing?
From the first approach to closing, a typical LBO deal takes 4 to 8 months, with a longer due diligence period than in unleveraged deals because the lending banks are involved.
What happens if the acquired company can't pay the debt?
If the SPV can't meet its debt service, the banks can enforce their collateral and take control of the target company. The fund would lose its equity contribution. That's why sensitivity analysis of future cash flows is critical before closing an LBO deal.
