Margin of Safety in LBO Model
Is it possible to calculate a Margin of Safety for LBO purposes, to assess whether there is a sufficient amount of margin of safety to invest in the company? If so, how would I calculate it? I know it would be expected growth/sales minus break even, but would this mean breakeven with regards to IRR or just sales vs. COGS?
Margin of safety is subjective and dependent upon the investment. Almost all LBOs are intermediated and as such you are rarely able to acquire a profitable company at a meaningful discount to intrinsic value. As such, in practice, PE firms just run multiple cases and pursue investments/capital structures that have an attractive distribution of outcomes across all likely cases. I have done a couple of proprietary deals where a growing company could literally shrink during my period of ownership and still service debt/generate a positive return to the equity, but such deals are total unicorns.
In a more distressed situation you might derive a margin of safety based on liquidation value or a low multiple of the profitability from, for example, a particular business segment that is obscured by other unprofitable operations. But those aren't really "LBOs"
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