Why Private Equity firms dislike cyclical businesses

Private equity (PE) firms typically dislike cyclical businesses because these companies experience unpredictable swings in performance tied to economic conditions. Cyclical firms, like those in the auto, travel, construction, or luxury goods sectors, often see revenues and profits surge during booms but collapse during downturns. PE investors aim for predictable, stable cash flows to support debt repayments and ensure consistent returns. In contrast, cyclical companies introduce high risk into the investment due to revenue volatility, reduced cash flow reliability, and limited control over external market forces. For example, the automotive industry is notoriously cyclical. During the 2008 financial crisis, U.S. auto sales dropped from 16 million units in 2007 to around 10 million in 2009. Many firms faced bankruptcy, including General Motors, which had to be bailed out. A PE firm heavily invested in a car manufacturer during such a cycle would’ve faced major losses or total write-offs. This level of vulnerability to macroeconomic shocks makes it unattractive for leveraged buyouts, where stable performance is key. PE firms use leverage (debt) to enhance returns. The issue with cyclical businesses is that during economic downturns, they might not generate enough cash to service this debt, increasing the risk of default. PE’s success depends on financial engineering, operational improvements, and exit strategies like IPOs or sales. If cash flows dry up due to a recession, the firm might breach debt covenants, miss payments, or even lose the asset to lenders. This risk-reward imbalance deters investment in businesses where performance can’t be managed internally or projected with confidence.

The cyclical company’s EBITDA fluctuates wildly, making debt coverage and valuation volatile. The stable company, often in healthcare or consumer staples, shows steady, reliable performance, perfect for PE models.

Furthermore, exit timing becomes difficult with cyclical businesses. If the PE firm plans to exit during a downturn, valuations are depressed, and buyers are scarce. For instance, a PE firm invested in a luxury cruise line in 2018 might have seen strong performance in 2019, but COVID-19 decimated the industry in 2020–2021. The planned IPO or sale would have had to be delayed for years, tying up capital and harming internal rates of return (IRRs). In contrast, investing in non-cyclical businesses like software, medical devices, or B2B SaaS offers smoother exit windows.

Thus, private equity shuns cyclical businesses because of their unpredictable earnings, higher default risk under leverage, and timing-dependent exits. PE thrives on control and predictability, while cyclical industries are often at the mercy of external, uncontrollable forces.