LBO Debt Capacity
Definition
Debt capacity is the maximum debt a business can prudently support in a buyout, determined by its cash flow stability, market leverage norms, and lender appetite. In practice it is framed as a multiple of EBITDA — recent US large-cap LBOs have commonly supported around 4–6x total debt/EBITDA, with senior secured tranches around 3.5–4.5x (all highly market- and credit-dependent).
The real test is serviceability: projected free cash flow (EBITDA minus cash interest, taxes, capex, and working capital) must comfortably cover interest and required amortization across a downside case, with adequate coverage ratios (e.g., EBITDA/interest well above 2.0x at underwriting) and a path to deleveraging.
Factors that raise capacity: recurring revenue, high margins, low capex, low cyclicality, asset collateral, and diversified customers. Factors that lower it: cyclicality, customer concentration, capex intensity, and secular decline. Debt capacity plus sponsor equity effectively sets the price a financial buyer can pay.
Why interviewers ask
"How much debt can this company support?" is a core LBO and leveraged finance interview case. Strong answers combine a market multiple anchor with a cash-flow serviceability argument rather than quoting a single number.
Related terms
Interviews don't test definitions — they test recall under pressure.
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