Selecting an LBO fund: selection criteria, fund expectations, pitch and positioning. How to target and attract the right investment partners.
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When considering a leveraged buyout (LBO), choosing the right investment fund is crucial to the success of your project. Investment funds are not only sources of capital but also strategic partners who can provide valuable expertise, resources, and a network. It is therefore essential to understand who these funds are, how to select them wisely, and what criteria your company must meet to attract the best investors.
LBO funds target high returns (IRR of 20–25%) by acquiring companies using leverage, over a typical 5–7 year holding period.
They can be split into specialist funds (focused on a specific sector) and generalist funds (diversified portfolio), backed by institutional LPs.
Investment funds can vary depending on their strategy, size, and objectives. There are several categories of funds, including:
LBO funds not only provide equity capital but also sophisticated financial structuring to optimize the return on investment.
Some of the best-known LBO funds include: KKR (Kohlberg Kravis Roberts & Co.), The Carlyle Group, Blackstone, TPG Capital, Apollo Global Management, Eurazeo, etc.
These LBO funds can be classified into two broad categories: specialized funds and generalist funds.
LBO funds have significant amounts of capital to invest, typically raised through investment vehicles such as private equity funds. These vehicles are financed by institutional investors, also known as LPs ( Limited Partners), which include pension funds, insurance companies, and family offices. The funds are required to invest the money entrusted to them by their LPs. It is therefore essential for them to successfully close deals in order to generate returns and meet their investors’ expectations.
However, to invest these funds, LBO funds must meet numerous obligations, including:
The primary objective of LBO funds is to generate high returns for their investors by increasing the value of the acquired companies. This is achieved through operational improvements, organic growth or growth through acquisitions, and rigorous financial management. To be able to leverage these factors, LBO funds select their portfolio companies based on rigorous criteria that ensure strong returns.
When a fund receives a teaser for an LBO transaction, several criteria are generally analyzed:
By evaluating these criteria, investment funds can make informed decisions about whether to invest in a company, thereby ensuring that the LBO transaction is aligned with their financial and strategic objectives.
LBO funds typically have a defined investment horizon, often ranging from 5 to 7 years. During this period, their primary objective is to maximize the value of the acquired company. This is achieved through operational improvements, strategic expansion, complementary acquisitions, and rigorous financial management. The funds realize their returns by selling the company at a price higher than the initial purchase price, often through a sale to another investor, an initial public offering (IPO), or a sale to the company’s management. Return-on-investment targets are very high, around 20%–25% IRR, which explains the rigorous selection of their targets.
Thus, to maximize returns, LBO funds seek out companies that meet specific criteria. Typical characteristics of a target for an LBO transaction include:
Understanding the funds’ investment horizon, their mechanisms for generating returns, and their key selection criteria is crucial to grasping the investment strategy of LBO funds and their expectations regarding the companies in which they invest. But while the funds’ criteria are high, so too must be those for their investment targets. Selecting the right fund to provide long-term support is essential, and many success stories would never have come to fruition without the right partner.
When choosing a fund for an LBO transaction, several criteria must be taken into account. Here are the main ones:
New LBO transactions involving the infusion of fresh capital often provide the company with an opportunity to access additional support on matters related to its growth. This also allows for a transition, if necessary, to larger funds with additional financing capacity. These funds can help the company take its development projects to the next level by providing additional resources and expertise to support more ambitious expansion.
The number of funds to invite into an LBO process is significant: too few, and you lose out on competition; too many, and you risk diluting the quality of the offers. This decision warrants careful consideration with your M&A advisors.
Opening the process widely in Phase I allows you to maximize the number of Letters of Intent (LOIs) received and stimulate competition among funds, which can lead to more attractive initial offers. However, a process that is too broad can sometimes send a negative signal: some funds, believing their chances of success are too low, might withdraw or fail to invest fully in their offer.
This issue is even more acute in the context of a dual-track process involving both private equity funds and strategic buyers. Funds may then fear they cannot match the valuations proposed by industrial buyers (which are often higher due to their ability to capitalize on synergies with their group) and hesitate to commit significant resources to an uncertain outcome.
The challenge, therefore, is to calibrate the number of participants to maintain genuine competitive pressure without undermining the credibility of the process.
In Phase II, it is generally recommended to shortlist three funds. This number maintains sufficient competitive pressure while allowing each candidate to commit seriously, knowing that it has a real chance of winning. It also lightens the burden on management, which is particularly strained during the due diligence phase.
If a single offer stands out clearly, granting exclusivity may be a wise move to speed up negotiations and simplify the process. But this decision must be handled with discretion: a fund that realizes it is the sole bidder (and that the company is struggling to find a buyer) will not hesitate to take advantage of the situation to lower its terms.
Maintaining a tight timeline and competitive pressure—even if artificial—remains one of the best ways to secure the most favorable terms. It is precisely in this careful management of the pace that the guidance of an experienced M&A advisor makes all the difference.
Conclusion
In summary, the success of an LBO transaction depends on a careful selection of investment funds, a clear understanding of the obligations and responsibilities of each party, and a rigorous assessment of investment criteria. By taking into account experience, expertise, financing capacity, and alignment of objectives, companies can maximize their chances of success. Managing a structured and well-orchestrated process is also crucial for attracting the best partners and securing optimal investment terms. Ultimately, choosing the right fund and implementing a well-defined investment strategy are essential for achieving high returns and ensuring the company’s growth and long-term sustainability.
Venture capital invests in high-potential but risky startups, while an LBO fund targets mature, profitable companies, which it acquires using debt to maximize equity returns.
Leverage amplifies returns: by financing part of the acquisition with borrowing, the fund invests less equity and mechanically increases profitability if the company’s value rises.
The main exit options are a sale to another investor (a fund or a strategic buyer), an initial public offering (IPO), or a sale to the company’s management via a management buy-out.
No. Some funds invest as minority shareholders, allowing management to retain operational control while benefiting from capital and strategic support.
Beyond the reported IRR (Internal Rate of Return), you should assess the fund's MOIC (Multiple on Invested Capital), the consistency of its performance across different vintages, its ability to achieve successful exits (rather than relying solely on unrealized portfolio valuations), and the average holding period of its investments. The fund's behavior during periods of market disruption, such as 2020 and 2022, is also a valuable indicator of the quality of its partnership approach.
Exclusivity is typically granted after the signing of a Letter of Intent (LOI) or Term Sheet, giving the parties an exclusivity period of approximately four to eight weeks to complete due diligence and negotiate the definitive transaction documents, including the Share Purchase Agreement (SPA) and the shareholders' agreement. This is a critical stage of the transaction: management must remain fully available to support the due diligence process while continuing to run the business. It is essential for the company and its management to be advised by independent M&A advisors and legal counsel who are not acting for the fund.
Yes. Management co-investment is almost universal in LBO transactions, as it aligns the interests of management and the private equity sponsor while reinforcing management's long-term commitment. The investment may take the form of a cash subscription for shares in the acquisition holding company, a management incentive package (such as ordinary shares or performance shares), or a combination of both. The minimum investment amount and the applicable terms (including sweet equity and ratchet mechanisms) are negotiated in the shareholders' agreement.
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