Why might a private equity firm avoid maximizing leverage in an LBO?

In a leveraged buyout (LBO), a private equity firm typically finances the acquisition of a company using a significant amount of debt. While high leverage can potentially amplify returns if the investment performs well, it can also increase the financial risk associated with the investment.

By avoiding excessive leverage, a private equity firm can significantly reduce the overall risk of default. High levels of debt make the company more vulnerable to financial distress, especially if it faces downturns in revenue or increased operational costs. Lower leverage means that the firm has more equity cushion to absorb losses, which can protect its investment and help ensure that the company can meet its debt obligations even during challenging economic times. This approach not only helps maintain the financial health of the acquired company but also enhances the firm's chances of achieving a successful exit, ultimately leading to better long-term performance.

A more balanced capital structure might also support growth investments that are essential for the company’s success, further mitigating risk and improving prospects. Therefore, opting for lower leverage is a strategic choice aimed at sustaining the stability and viability of the investment over the long run.