Is the Traditional LBO Model Broken in a High-Rate Era?

In an environment where interest rates have surged to multi-decade highs, the private equity (PE) playbook, particularly the traditional leveraged buyout (LBO) model, is being tested like never before. For decades, LBOs thrived on cheap debt, allowing firms to use significant leverage to amplify returns. However, the sharp pivot in monetary policy by central banks since 2022 has dramatically changed the economics of these deals. As the cost of capital rises and financial engineering becomes less reliable, many in the industry are asking: is the traditional LBO model still viable?

At its core, the LBO model involves acquiring companies using a large proportion of borrowed funds, often structured with debt multiples as high as 6 times EBITDA during low-rate environments. This model relied heavily on low interest rates to sustain affordable debt servicing while generating high internal rates of return (IRRs). According to Bain & Company’s 2025 Global Private Equity Report, the average interest expense as a percentage of EBITDA has nearly doubled since 2021. As rates rise, valuation compression and shrinking arbitrage opportunities have made deal-making far more challenging.

The shift has not only influenced the ability to finance deals but has also fundamentally altered deal structure. Data from S&P Global Market Intelligence shows that covenant-lite loans, once a hallmark of the LBO boom, have declined significantly, with lenders now demanding stricter covenants and reduced leverage ratios. As a result, PE firms are increasingly contributing more
equity to deals. The average equity check for LBOs has risen from roughly 30% to over 50% of enterprise value in many cases, according to McKinsey’s 2025 Global Private Markets Review.

These structural changes have had downstream effects on exit strategies and return profiles. With refinancing more expensive and IRRs harder to meet under traditional timelines, holding periods have extended across much of the industry. Preqin data suggests the median holding period for PE portfolio companies has increased by more than a year since 2020. Sponsor-to-sponsor exits, a route during the low-rate era, have declined, replaced by delayed exits or sales to strategic buyers who are less debt-dependent.

In response, firms are shifting their focus from financial engineering to genuine value creation with an emphasis on operational improvements, digital transformation, pricing optimization, and environmental, social, and governance (ESG) initiatives. Bain & Company emphasizes that the majority of PE value creation now comes from operational improvements rather than multiple expansions or leverage. Furthermore, the firm highlights the increasing adoption of total value creation (TVC) frameworks, which look beyond the internal rate of return (IRR) and business transformation metrics to include customer growth and strategic sustainability.

Despite the headwinds, the LBO model is evolving. Firms that can adapt by focusing on organic growth, aligning debt structure with business realities, and developing operational playbooks will continue to thrive. As Boston Consulting Group noted in its 2024 Sustainability in Private Equity report, the winners in this high-rate era, those who create value through the business itself and exogenous societal change, not just through balance sheet maneuvers.

In conclusion, the high-rate environment has rendered many traditional LBO assumptions obsolete, but it has also created a healthier discipline in private markets. With leverage no longer the primary driver of returns, the private equity industry is undergoing a necessary transformation, one that favours strategic thinking, operational excellence, and genuine innovation over financial alchemy.

Sources:
Angelo Vidal, K., & Thomas, D. (2025, February 7). Private debt’s share of LBO financing \
grows; Asia-focused fundraising sinks. S&P Global Market Intelligence. https://www.spglobal.com/market-intelligence/en/news-insights/articles/2025/2/private-debts-share-of-lbo-financing-grows-asiafocused-fundraising-sinks-87449811
Edlich, A., Croke, C., Dahlqvist, F., & Teichner, W. (2025, May 20). Global Private Markets
Report 2025: Braced for shifting weather. McKinsey & Company. https://www.mckinsey.com/industries/private-capital/our-insights/global-private-markets-report
Entraygues, B., & Shandal, V. (2024, October). Sustainability in private equity, 2024.
Sustainability in Private Equity, 2024. https://web-assets.bcg.com/8f/95/b5c45ca343d69d5a51dc60af0272/sustainability-in-private-equity-2024-oct-2024.pdf
MacArthur, H. (2025). Global Private Equity Report 2025. Bain & Comapny.
https://www.bain.com/insights/topics/global-private-equity-report/
PREQIN. (2025). Private Capital Performance - Data Guide. Private Capital Performance Data
Guide. https://docs.preqin.com/pro/Private-Capital-Performance-Guide.pdf