Table of Contents
1.
2.
Module 1: Introduction and Overview
Introduction
1
Welcome to the PE Prep Package
4
Industry Overview
5
Here’s An Easy Way to Think of Carry
16
Know This 1 Fact About PE History / For Your PE Interviews
17
Fundraising & Deal Volume
18
PE Deal Types
20
PE Deal Types: The 2 You Need to Know Best
22
PE Firm Types
23
PE Firm Types–3 Key Takeaways for Recruiting
27
Fund Economics
28
Titles, Roles and Compensation
31
“Show Me the Money!” / How to Find Relevant PE Compensation Data
36
Module 2: Industry Operations
Deal Process
37
The One Dirty Little Secret on Sourcing
39
3 Actual Examples of a Teaser, NDA, and CIM
40
The Sacred Investment Committee Memo
41
Staple Financing 101: What is it and Why do Banks Offer it?
42
3 Material Adverse Changes (MACs) to Watch Out For
43
Deal Selection
44
The 7 Traits of The Perfect Deal and… One That Is More Important than
All of Them Combined
46
Deal Funnel and Lifecycle
47
Common Diligence Topics
50
Common Due Diligence–Why Does it Matter?
55
How PE Makes Money
56
Bonus Webinar: Sources of Value Creation in Private Equity
64
What is the True Driver of Returns? Financial Engineering vs
Operational Improvement
65
3.
Module 3: Recruiting Overview
Common PE Career Paths
66
5 Examples of Where People Go After Their PE Career is Over
68
How to Build a PE Background
69
Big Fish in Small Pond or Swim with the Sharks?
84
What firms and groups give you the best shot at PE?
85
Bonus Webinar: Private Equity Success Story from a Non-target
Engineering Major
4.
5.
86
PE Business Development Roles - Another Way to Break In
87
Recruiting Cycle
88
PE Recruiting Timing: Game Theory In Action
92
How to Work with Recruiters
93
3 Crucial Tips When Dealing with PE Recruiters/Headhunters
99
How to Choose an Offer
100
3 Ways to Find the Dirt and Get a Good Grasp of Private Equity Firms
106
Bonus Webinar: PE Recruiting Process in Detail
107
How to Write Your Resume
108
Resume Prep for Private Equity Interviews
112
5 Common Mistakes on PE Resumes that Can Hurt You
113
Module 4: Interview Preparation
Interview Process
114
Why LBOs Use Leverage and 3 Other Ways to Boost Returns
118
3 Financial Statements
119
Why You Should Care About Changes in Net Working Capital
130
Capital Structure
131
4 Capital Structure Tiers to Know Well
137
Common Valuation Techniques
138
Common Calculations
146
How Would You Calculate a Firms WACC and How Would You Use it?
154
“Walk Me Through a DCF”
155
Here is How You Do IRR Quickly in Your Head
156
Module 5: Interview Questions
Top 30 Technical Questions & Answers
157
Sample Deal Walk Through, One Good, One Bad
176
Bonus Webinar: How to Speak About Your Investment Banking Deals In
a Private Equity Interview
How to Prep for a PE Megafund Interview
178
What if you can’t value a company using DCF or multiples?
179
Why You Should Care About Changes in Net Working Capital (Repeat)
180
Bonus Webinar: PE Investment Case Presentation and How The Deal
Process Works
DCF vs. Trading Multiples vs. Transaction Multiples… Which provides
the Highest Valuations?
The 7 Traits of The Perfect Deal and… One That Is More Important Than
All of Them Combined (Repeat)
6.
7.
181
182
183
Top 15 Fit Questions & Answers
184
PE Firms Get Jealous Too: Here is Proof
200
Bonus Webinar: Transition from Investment Banking to Private Equity
201
Top 10 Brainteaser Questions & Answers
202
Follow These 5 Steps if You Get Stuck on a Brainteaser
207
Module 6: LBO Modeling
Introduction to LBO Modeling Tests
208
The Paper LBO
209
Paper LBO Example 1
216
The Basic (1-Hour) LBO
217
Basic LBO Example 1
236
Final Thoughts on LBO Modeling Tests
237
Module 7: Private Equity Cases
Private Equity Case - Paysmart
239
Private Equity Case - Oilfield Services
240
Private Equity Case - Transnational M&A
241
Private Equity Case - Creating Value Through Operational Change Apparel Industry
8.
177
Module 8: Appendix
242
Paper LBO Example 2
243
Paper LBO Example 3
244
Basic LBO Example 2
245
Basic LBO Example 3
246
Full LBO Example 2
247
Full LBO Example 3
248
Common Terms Glossary
249
Module 1: Introduction and Overview
Introduction
Introduction
Introduction
About the Author
Daniel Sheyner has worked as a Private Equity investment professional for four years, the most
recent three years at Bain Capital Partners in Boston, MA. Before Bain Capital he spent one year at
Fidelity Equity Partners, a middle market growth-LBO fund. Prior to private equity, Daniel worked
for three years as a management consultant with Oliver Wyman in Chicago. He is a graduate of the
Math Methods in Social Sciences (MMSS) program at Northwestern University and is currently an
MBA student in Harvard Business School. Daniel’s industry expertise stems from his years as a preMBA Associate, study of the industry at HBS, and over a hundred interviews with dozens of PE firms
of various types and sizes.
Why I Wrote This Course
My journey into PE featured innumerable ups, downs, and false starts. Throughout the process I
never felt sure that I was doing the right things to succeed, and the many setbacks I experienced
caused me to consider giving up several times. When I first set out to recruit for PE, I searched
everywhere for a single resource which could teach me the bulk of what I needed to know, but no
such resource existed. I owe my success in equal parts to perseverance, luck, and the aid of several
friends who cumulatively taught me enough bits and pieces to finally get my foot in the door. This
course is the single resource I wish I had when I was recruiting. In writing this course, my aim is to
demystify the PE recruitment process and give future candidates the tools they need to approach it
with confidence. My sincere hope is that readers of this course will have a much smoother ride in
landing their dream job than I did.
What This Course Will Teach You
This course will help you stand out by teaching you not only the technical aspects of the PE industry,
but also its history and the operating principles which drive it. Some candidates assume that
technical expertise is enough to break into PE, but there are far more technically competent
candidates than there are available PE jobs. This course will help you graduate from sounding like an
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Module 1: Introduction and Overview
Introduction
analyst to thinking like an investor. Topics covered in this course include:
• PE history so you can better demonstrate your passion for the industry
• What a career in PE looks like so you can decide if it’s a good fit for you
• How PE firms differ in investing and recruiting so you can better target your search
• Which recruitment channels PE firms use so you can position yourself in advance
• How the recruiting cycle and the interview process are structured
• How PE firms make money so you can demonstrate your “investor judgment”
• The most important accounting, finance and deal-related concepts
• How to prepare your resume to increase your odds of getting interviews
• How to answer common Technical, Fit, and Brainteaser questions based on hundreds of real life
interview questions
• How to build and interpret an LBO model to pass a modeling test
• How to best utilize recruiters and choose between multiple offers
You will notice throughout the course that there are video placeholders. These are videos we plan to
add for the next version of the course (they will redirect to the WSO Video Library) to make it more
interactive and in order for us to dive deeper into particular concepts you should focus on. We expect
to complete final production on these videos within 12–18 months of the initial release of this
package. As always, you are entitled to any and all upgraded versions of the course for free. We will
make an announcement on WSO and e-mail all previous customers when the new version is ready, so
there is no need to do anything at this time.
How to Use This Course
This course, along with its companion Excel files and 1-year access to the WSO Company database
are designed to teach you the bulk of what you need to know to succeed in PE recruiting all in one
comprehensive package. I assume a basic level of proficiency with finance and accounting, but most
of this course should be accessible to any serious candidate. I focus on Leveraged Buyout PE firms in
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Module 1: Introduction and Overview
Introduction
the USA, but the principles are broadly applicable to both earlier stage and international firms. I
encourage you to read through the course in the order presented, but feel free to skip around if you
are already familiar with certain sections. Do not forget the resources available to you in the nine
companion Excel modeling tests and in the WSO Company database which contain data on hundreds
of PE firms and their individual recruitment processes.
Common Traits of Successful PE Candidates
• Plans months or years in advance for his/her opportunity to break in
• Is passionate about the industry and knowledgeable about its history
• Has a strong grasp on the PE investment process and due diligence practices
• Has the required technical and quantitative skills down cold
• Has excellent communication skills and displays their “investor’s judgment”
• Prepares diligently for interviews and leaves as little as possible to chance
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Module 1: Introduction and Overview
Welcome to the PE Prep Package
Welcome to the PE Prep Package
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Module 1: Introduction and Overview
Industry Overview
Industry Overview
Industry Overview
This lesson is a high level overview of the industry and it evolved. This lesson also explains the
differences between various deal types, firm types, and professional roles, and discusses both PE
fund economics and compensation.
Industry Structure
Private equity and venture capital (henceforth referred to collectively as PE) is an industry which
primarily buys pieces (equity) of companies with the goal of selling this equity 3–7 years later at a
profit. The funding for these investments comes primarily from a group of investors known as limited
partners (LPs). Typical LPs include endowments, pension funds, sovereign wealth funds, wealthy
individuals, and large corporations. Funding pledged by these LPs is pooled into individual PE funds
which are managed by general partners (GPs) who are co-owners of a PE firm. These PE firms use the
money in their respective funds to make investments (deals) in a broad range of public and private
companies with the hope of selling them some day for large profits. When these investments make a
profit, the PE firms return about 80% of profit to their LPs along with the LPs’ original investment
and keep the remainder. This remainder, referred to as carried interest or carry, is split among the
GPs. In addition to this carried interest, LPs also pay an annual management fee to PE firms,
amounting to about 2% of total assets under management (AUM)1. When a PE firm is close to fully
investing one of its funds, it usually attempts to raise a new fund for further investments.
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Industry Overview
Brief Industry History
The exact origin of PE is hard to pin-point because people have been making private investments in
various assets for centuries. However, the modern asset class we know as Private Equity traces its
roots to the 1940s and has grown to its tremendous size through an escalating series of booms and
busts.
Origin (1946–1950s)
Prior to 1946, private equity and venture capital investments, then known as development capital,
were done on an ad-hoc basis by wealthy groups and individuals using their own capital. The modern
PE industry began in 1946 with the founding of American Research and Development Corporation
(ARDC) and J.H. Whitney & Company (JHW). These early PE firms raised 3rd party (limited partner)
capital to make some milestone investments. For example, in 1957 ARDC invested $70 thousand in
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Industry Overview
Digital Equipment Corporation (DEC), a stake valued at $355 million by 1968 during DEC’s IPO
(500x+ MoM return). JHW’s most famous investment was in Florida Foods Corporation, now known
as Minute Maid, which was sold to Coca-Cola in 1960. The headline grabbing successes of these two
innovators brought several imitators to market, and a new industry was born.
Early Growth Stage (1950s–1981)
The halcyon days of early stage venture capital focused on providing start-up and growth capital to
technology-related companies, mostly in or around Silicon Valley. In Menlo Park, the first wave of
venture capitalists clustered around Sand Hill Road to be near the action. This was the time when the
famous “2 & 20” model of 2% management fees and 20% carried interest coalesced as the industry
standard. Many of today’s blue chip VC firms got their start in those days including Sequoia, Draper
Fisher Jurvetson, and Kleiner, Perkins, Caufield & Byers. Some of today’s top growth equity firms
also got their start during this period including TA Associates, Apax Partners, New Enterprise
Associates and Oak Investment Partners. These companies were instrumental in financing the
inception and expansion of many of the era’s most successful technology firms including Genentech,
Apple Inc., Electronic Arts, Compaq and Federal Express. Industry growth during this stage was
steady with the exception of a bust in 1974 which coincided with a recession that same year.
During the same period, late stage PE got its start. The first practitioners of leveraged buyout-style
(LBO) investing actually weren’t PE funds, but rather were publica ly traded holding companies which
employed leverage to buy other companies to form conglomerates. Early practitioners of this model
included Warren Buffett of Berkshire Hathaway, Victor Posner of DWG Corporation, Nelson Peltz of
Triarc, and Saul Steinberg of Reliance Insurance. These investors may be seen as the forbearers of
independent, pure-breed LBO funds because they frequently targeted the same types of investments
and used similar methods. In fact, Victor Posner is commonly credited with popularizing the term
“leveraged buyout”.
What we now think of as late stage LBO firms came into being in the mid-1970s with the formation of
Kohlberg Kravis Roberts (KKR) and Thomas H. Lee Partners (THL). Jerome Kohlberg, Henry Kravis
and George Roberts had spent the1960s and 1970s at investment bank Bear Stearns using leverage
to buy family-owned companies too small to go public and no interest in selling out to a larger
competitor. Some of their earliest deals included Orkin Exterminating Company (1964), Stern Metals
(1965), Incom (1971), Cobblers Industries (1971), and Boren Clay (1973). In 1976, after a dispute
with Bear Stearns, the three partners founded KKR and closed their first institutional fund of $30
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Industry Overview
million in 1978. During that year KKR set the record for the largest take-private to-date with their
acquisition of Houdaille Industries for $380 million. Founded in 1974, THL had actually beaten KKR
to the punch in focusing on LBOs of mature businesses. However, because THL’s early deals were
smaller, they did not shoot to the top of the industry until the 1990s. Other top tier LBO firms that
got their start during this period and are still in business today include Cinven; Welsh, Carson,
Anderson & Stowe; Candover; and GTCR.
The first boom and bust (1982–1992)
The LBO industry took off like a rocket in the 1980s with fundraising growing tenfold from ~$2.4
billion to ~$22 billion annually between 1980 and 1989. Many factors drove this growth:
• The Employee Retirement Income Security Act (ERISA) of 1974 allowed corporate pension fund
managers to invest in PE and in the leveraged loans which fund LBOs.
• In 1981 the tax rate on capital gains (which is how carry is taxed) fell from 28% to 20%.
• Relaxed lending standards allowed LBO companies to buy targets with little equity (and
correspondingly high equity returns). The most famous example of this phenomenon is Wesray
Capital’s acquisition of Gibson Greetings in 1982 for ~$80 million while paying only ~$1 million
in equity and the rest in debt. This deal made Wesray a $66 million profit when Gibson Greetings
IPOed at a $290 million valuation sixteen months later.
• Strong economic growth and a rising stock market created attractive exit opportunities.
• The high yield debt (or “junk bond”) market, driven by Michael Milken of Drexel Burnham
Lambert ballooned during the mid-80s and provided cheap, abundant leverage.
Several of today’s PE titans were founded during this period including Bain Capital, the Blackstone
Group, The Carlyle Group, and Hellman & Friedman. There are countless famous deals during this
period which peaked in 1989 with KKR’s $31 billion LBO of RJR Nabisco, the largest LBO of all time
for 17 years and inspired the book Barbarians at the Gate.
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Industry Overview
The industry hit a major speed bump during the early 1990s for the following reasons:
• The reckless use of leverage in the mid-late 80s took a toll as several high profile LBOs went
bankrupt including Federated Department Stores, Revco Drug Stores and Walter Industries.
Even the famous Nabisco ran into trouble and required an additional $1.7B equity infusion from
KKR.
• The high yield debt market collapsed in 1989 as Michael Milken was charged with stock
manipulation and Drexel Burnham Lambert went bankrupt, drastically increasing the cost of
leverage and making some refinancing impossible.
• The Savings & Loan crisis triggered a recession and forced many banks to exit the high yield
market.
Despite this challenging environment several top PE firms such as Apollo Management, TPG Capital,
and Madison Dearborn were founded in the early 1990s.
The second boom and bust (1993–2002)
PE regained its stride in 1993 and grew steadily through the rest of the decade, buoyed by a strong
bull market and the resurgence of leverage financing. Fundraising, which had stagnated at ~$21
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Industry Overview
billion in 1992, surged to ~$240 billion by 2000. Some key developments during this era include:
• In the 1980s, fairly or not, PE was associated with corporate raiders, hostile take-overs, and
asset stripping (e.g. Wall Street, the movie). Many firms were wary of PE in the 1980s and
adopted defensive measures such as poison pills to ward off would-be interlopers. In the 1990s,
however, PE gained a newfound public respectability as most PE firms focused on partnering
with management teams instead of employing adversarial tactics. PE’s focus shifted toward
building businesses and turning around struggling companies rather than optimizing capital
structures. Consequently, corporate boards and management teams became better disposed to
PE advances.
• One of the best examples of this contrast is TPG’s friendly turn-around of Continental
Airlines in 1993 vs. Carl Icahn’s hostile takeover of Trans World Airlines (TWA) in 1985.
Icahn stripped and sold pieces of TWA to pay down the debt he had used to acquire the
company. TPG, on the other hand, saved Continental from liquidation by recruiting a better
management team, increasing aircraft utilization, and refocusing on profitable routes.
• Whereas leverage levels of 85-95% of total purchase price were common in the 1980s, the post
junk bond bubble world normalized closer to 70-80%. This development forced PE firms to put
“more skin in the game” and discouraged some of the wild gambling and speculation which
characterized PE’s “wild west” days.
• With PE’s newfound respectability many large, conservative, institutional money managers
became interested in PE’s high returns. David Swensen, the Chief Investment Officer of Yale
University’s endowment fund, was one of the first major proponents of endowment investment
in alternative assets like PE. Pension funds like CALPERS also got into PE in a big way for the first
time in the 1990s. Since endowments and pension funds manage capital pools of tens or
hundreds of billions of dollars they quickly became and remain the dominant funding source for
PE.
The bursting of the internet bubble in 2001 and the subsequent recession again put the brakes on
PE’s growth as credit markets dried up. Furthermore, many PE firms, who invested heavily in
telecommunications and technology companies, got burned. The highest profile PE casualties of this
downturn were two of the industry’s earliest titans, Forstmann Little & Company and Hicks Muse.
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Industry Overview
Both fundraising and the rate of new investments stalled in 2001–2002. In 2000 there had been 27
LBOs in excess of $500 million, but only six such transactions occurred in 2001. The European LBO
market surpassed the US for the first time (oh no!). Although there were fewer large deals during this
period, the low multiples paid during the depths of the recession ensured that most of the deals that
were done became unusually successful.
The third boom and bust (2003–2009)
PE’s most recent boom, sometimes referred to as “the golden era”, brought PE to unprecedented
heights. In 2006, PE companies completed $696 billion worth of deals, roughly 5x higher than the
2003 total. In 2007, PE raised $663 billion of fresh commitments, ~3x higher than the 2000 peak. 13
of the 15 largest deals of all time happened between 2005 and 2008. For the first time ever, PE
companies began to go public themselves, with IPOs by the Blackstone Group and KKR between
2006 and 2008. Deal sizes ballooned to massive proportions. The record was set in 2007 when KKR,
TPG and Goldman Sachs bought Texas utility TXU for a whopping $44 billion. Other mega deals
included Equity Office Properties ($39 billion by Blackstone), Hospital Corporation of America ($33
billion by Bain Capital, KKR and Merrill Lynch), and First Data ($29 billion by KKR and TPG). For a
while it seemed like any company could be a PE target. There were rumors that LBOs of old blue
chips like IBM and General Motors had been considered. For a few years, PE bosses replaced bulge
bracket bankers and hedge fund managers as the kings of Wall Street.
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Industry Overview
This unprecedented boom was driven by several factors:
• The mid 2000s witnessed a huge swell in securitization by investment banks through
instruments such as Collateralized Debt Obligations (CDOs) and Collateralized Loan Obligations
(CLOs). Investment banks were able to raise large amounts of leverage capital by bundling
leveraged loans into aggregated pools and slicing them into different tranches which were rated
to have different levels of riskiness including some which were rated AAA (very safe). This
securitization allowed banks to raise leverage capital from many new investors with limited or
specific risk appetites. For example, some investors like insurance companies considered
leveraged loans too risky and therefore did not historically invest in them. However, insurance
companies were happy to invest in the AAA-rated tranches of CLOs/CDOs. Securitization
significantly increased the supply of leverage available for LBOs while simultaneously lowering
its interest rates.
• As more investors rushed in to provide leverage financing, investment banks began to compete
with each other for their share of the lucrative financing and securitization market. In order to be
chosen as debt providers, banks relaxed their lending standards by requiring less equity and
offering covenant-lite loans. Consequently, the looser lending standards allowed PE firms to
push the limits of their risk tolerance in their deals.
• Endowments and pension funds further increased their PE allocations, having seen terrific
overall returns over the past 10-15 years. In addition, new institutional investors began to
heavily allocate so PE, including Sovereign Wealth Funds, which manage hundreds of billions of
dollars of capital on behalf of national governments.
• One of the hallmarks of this era was the “club” deal. Nearly all of the largest deals were done
jointly by two or more PE sponsors. When a deal required an equity check which was too large
for any single sponsor, PE firms routinely formed consortiums that bid on assets jointly to share
the risk and equity commitment.
The party came to an abrupt halt in 2008 with the onset of the mortgage meltdown, credit crunch
and Great Recession. When the lights came on and everyone saw what kind of loans they had gotten
in bed with … things got ugly pretty fast. Credit markets seized up and CLO/CDO markets stopped
operating virtually overnight. The stock market plummeted as did the value of publicly traded
leveraged loans. Many LPs were hit by a “denominator effect” when the market values of their public
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Module 1: Introduction and Overview
Industry Overview
portfolios fell along with the stock market. For example, some LPs were bound to hold no more than
5% of their total assets in PE. When the value of their total portfolio fell by ~30-40% suddenly their
remaining commitments to PE represented much more than 5% of the total. Such LPs attempted to
sell their PE stakes on the secondary market at fire-sale prices and could not fund additional
commitments. Even though PE firms nominally had a lot of money to spend from their 2005-2007
fundraising, few owners wanted to sell during the recession and were focused on keeping their
existing portfolio companies afloat. As a result, deal volumes fell by 75–85% and fundraising fell by
more than 50% (buoyed somewhat by the long-cycle nature of fundraising). Practically the only few
who did well in this environment were distressed debt investors, restructuring advisors and
everyone’s favorite: bankruptcy lawyers.
Recovery and The Industry’s Future (2010–)
The PE industry has experienced a tepid recovery from “The Great Recession” between 2010 and
2013, mirroring those of the US and global economies’. Both fundraising and deal activity rebounded
from their recent lows but remain far below their 2007 peaks. The following are some of the
important developments that have taken place during the ongoing recovery period:
• The leveraged debt markets have recovered as investors search for yield in a low interest rate
environment. Leverage multiples are back near their ’05-’07 levels while the cost of leveraged
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Module 1: Introduction and Overview
Industry Overview
debt is near all-time lows. This development has brought life back into large LBOs as each year
brings several LBOs with values between $1 billion and $10 billion. However, there have been no
mega LBOs over $10 billion and almost no club deals.
• PE portfolio companies largely experienced far fewer defaults than initially feared as PE firms
successfully cut costs and refinanced debt.
• The strong stock market rebound has finally given PE firms an opportunity to exit long-held
investments, leading to a rush of PE-backed IPOs between 2011 and 2013.
• LPs have begun to shift LBO commitment dollars away from mega buyout firms and toward
middle market firms thus accelerating several trends:
• The mega funds are all seeing their fund sizes shrink from the peak in some cases by as much
as 50%
• In response, mega funds are continuing to diversify into other asset classes such as public
equities, debt, middle market and wealth/asset management
• Some middle market funds have done well and raised larger funds (e.g. Berkshire Partners,
Leonard Green, Hellman & Friedman, GTCR)
• Since LPs have shown a strong interest in emerging markets, global PE firms are raising local-
currency funds in the BRIC nations and beyond.
• The industry shakeout is ongoing and will continue for some time. Since PE funds are committed
for periods of 10+ years, there are still many “zombie” PE firms out there which are still in
business from their 2005-2008 fundraising but will never raise another fund.
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Module 1: Introduction and Overview
Industry Overview
• There are no reliable statistics on industry hiring levels, but the general feeling is that it’s a
“buyer’s market”. There are fewer opportunities than before: many professionals who were
hired during the peak are looking for jobs, fewer people are being promoted and promotions are
taking longer to achieve.
Thoughts for the future
• The PE industry is maturing so it is no longer as financially attractive as it once was. However,
the industry remains one of the most interesting and rewarding careers you could choose.
• While the employment outlook is a little dull at the moment, look to history and take heart. The
industry has experienced three busts already and has come back stronger than ever.
• As an industry veteran once quipped, “There will always be another bubble … just make sure that
when it comes you’re sitting in the right chair.”
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Module 1: Introduction and Overview
Here’s An Easy Way to Think of Carry
Here’s An Easy Way to Think of Carry
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Module 1: Introduction and Overview
Know This 1 Fact About PE History / For Your PE
Interviews
Know This 1 Fact About PE History / For Your PE Interviews
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Module 1: Introduction and Overview
Fundraising & Deal Volume
Fundraising & Deal Volume
Fundraising & Deal Volume
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Module 1: Introduction and Overview
Fundraising & Deal Volume
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Module 1: Introduction and Overview
PE Deal Types
PE Deal Types
PE Deal Types
PE deals come in all shapes and sizes. There is no easy or perfect way to characterize the full universe
of PE deals, but the following charts provide a useful guide:
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PE Deal Types
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Module 1: Introduction and Overview
PE Deal Types: The 2 You Need to Know Best
PE Deal Types: The 2 You Need to Know Best
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PE Firm Types
PE Firm Types
PE Firm Types
Much like deal types, there are many distinguishing characteristics of PE firms which impact how
they operate and whom they hire. The following five dimensions highlight the major differences:
Dimension 1: Fund size
• DESCRIPTION: The larger a firm’s latest fund size, the larger its average deal size. PE firms don’t
want to invest too much of their available funding in any single deal because the deal may lose
money. As a good rule of thumb, a PE firm wants to make on average 10–12 investments out of
each fund to remain diversified.
• EXAMPLES: GTCR’s 2011 fund is ~$3 billion so they’re unlikely to invest more than ~$300
million of equity in any single deal. Hellman & Friedman’s 2009 fund is ~$9 billion so their
average deal size is likely to be roughly 3x that of GTCR’s.
• IMPACT ON HIRING: PE firms want to hire investment professionals (IPs) with experience
doing the types of deals in which they specialize. For example, Hellman & Friedman is more likely
to hire an associate from a bulge bracket bank like Morgan Stanley, whereas GTCR may look
more favorably on applicants from middle market banks like Harris Williams. Meanwhile, smaller
PE firms are, in general, somewhat more likely to consider candidates with non-traditional
backgrounds.
Dimension 2: Deal Stage
• DESCRIPTION: Most PE funds fall roughly into the three target lifecycle stage categories from
the previous section: Early Stage (Startup), Mid Stage (Growth) and Late Stage (Mature). Most
PE firms focus on targets and deal types within their deal stage category. Of course some firms
that focus on a particular stage do some deals in other stages. For example there are many VCs
that focus on early stage deals but do some growth equity deals opportunistically. There are also
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PE Firm Types
some growth equity specialists that have done LBOs, while some LBO shops have done growth
equity. While it’s not unusual for the lines to get a little blurred, it’s rare for firms to stray too far
from their focus since deals at different stages require very different expertise and relationships,
and they drive their returns in different ways. If single firm does want to focus on multiple stages,
it typically creates separate targeted internal funds and divisions to do so. Another general rule
is that firms that focus on later stages usually (but not always) have larger fund sizes because
later stage deals usually require larger equity checks. In fact, some successful firms over time
tend to migrate up the stage ladder to increase their AUM (and associated fees).
• EXAMPLES: Clayton Dubilier & Rice is a classic example of a dedicated late stage firm. Summit
Partners is a famed mid-stage player. Flybridge Capital is an early stage VC. Meanwhile,TPG is
an example of a firm that participates in all stages through different internal funds: TPG Capital
pursues large late stage LBOs, TPG Growth pursues mid stage growth buyouts and growth
equity, and TPG Biotech funds early stage life sciences startups. Bain Capital is an example of a
firm founded originally to focus on early stage venture deals but has since migrated over the
decades to the large cap LBO space.
• IMPACT ON HIRING: Deal stage focus has the largest impact on hiring of all five dimensions
because doing deals at different stages require different skills, relationships, and expertise:
• Late stage firms tend to use a lot of leverage and take majority positions in larger companies.
Therefore, they require investment professionals with LBO modeling experience and
relationships with large banks and CEOs of mature businesses. Consequently, late stage
firms tend to heavily focus on hiring investment bankers and, to a lesser degree,
management consultants with large cap finance and due diligence experience.
• Early stage firms don’t use leverage and rarely build detailed models because their
investments are highly unpredictable. Therefore early stage firms focus much less on hiring
people with a deep finance background or modeling skills but require access to a broad
network of entrepreneurs and deep vertical expertise in order to choose future winners.
They also tend to need operating expertise because some of the startups they fund need
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Module 1: Introduction and Overview
PE Firm Types
help with both setting and executing strategy. As such, early stage firms tend to hire people
with startup experience, domain expertise (engineering, bio-tech, software, etc.) and
operating skills.
• Mid stage firms require a blend of expertise somewhere between the two stage extremes, so
they tend to hire a more unpredictable blend of IPs from both camps. Mid stage firms are, as
a general rule, more open to management consultants than late stage firms.
Dimension 3: Vertical Focus
• DESCRIPTION: Some firms are generalists and will look at any type of business whereas others
specialize in a single industry or a handful of industries.
• EXAMPLES: KKR’s PE group has invested in businesses across 15 verticals and would consider
an investment in nearly any industry. Berkshire Partners, on the other hand, generally limits
itself to Business Services, Communications, CPG/Retail, Industrials and Transportation. On the
other extreme, Silver Lake is known for focusing almost exclusively on technology and techenabled businesses.
• IMPACT ON HIRING: PE firms generally favor applicants with experience in their target
verticals.
Dimension 4: Geographic Focus
• DESCRIPTION: PE firms focus on different ranges of geographies depending on where they
have offices, where they have local expertise, and which industry verticals they target. A PE firm
typically won’t invest much in a region where they have no office. There are about 12-15 large
PE firms with a truly global footprint, hundreds of regional firms, and thousands of national/local
firms.
• EXAMPLES: Large firms like Carlyle and Bain Capital have offices in and focus on dozens of
countries globally. Smaller firms like Madison Dearborn and Hg Capital focus on single regions
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Module 1: Introduction and Overview
PE Firm Types
(North America and Europe respectively). There are also even smaller firms which focus on a
single country or niche geography like Gavea Investimentos and Teakwood Capital (Brazil and
Texas, USA respectively).
• IMPACT ON HIRING: PE firms generally favor candidates with ties to and experience in their
target geographies. Local language skills are also valued where English is not the primary
language. For companies with many regional offices, candidates may have the most luck applying
to offices in geographies to which they have ties.
Dimension 5: Diligence Philosophy
• DESCRIPTION: This dimension is least clearly defined and most open to dispute. However, there
is some difference between firms with an “industry diligence” philosophy vs. a “financial
engineering” philosophy. There are some firms which have especially excellent lender
relationships and capital structure optimization skills. Such firms tend to focus a bit more of their
diligence effort on the finance side and outsource a bit more of their industry diligence to 3rd
party advisors. A few other firms view industry diligence as core to their investment process and
tend to do more of it in-house. Firms founded by ex-bankers gravitate somewhat to the financial
engineering side while firms founded by ex-consultants gravitate somewhat to the industry
diligence side.
• EXAMPLES: KKR and Blackstone both carry heavy banker genes and have a reputation for a
historical focus on financial engineering (though they would likely dispute this categorization
today). Bain Capital and its offshoots like Golden Gate and Audax come from a consulting lineage
and focus a lot on in-house industry diligence.
• IMPACT ON HIRING: Most PE firms hire investment bankers, but the firms with a financial
engineering skew hire bankers almost exclusively. Just take a look at their investment
professionals’ bios online. The few firms who focus deeply on industry diligence hire more
consultants but are still typically open to bankers.
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Module 1: Introduction and Overview
PE Firm Types–3 Key Takeaways for Recruiting
PE Firm Types–3 Key Takeaways for Recruiting
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Module 1: Introduction and Overview
Fund Economics
Fund Economics
Fund Economics
While the full details of PE fund economics are very complex, at a high level it is simple. PE funds
generate nearly all of their revenue from management fees and carried interest.
Management Fees
Management fees are meant to cover a PE firm’s annual operating budget. Fees enable the firm to
make new investments and manage their existing portfolio. Since new PE investments take several
years to pay off, LPs pay management fees to the PE firm based on a percentage of the PE firm’s
Assets Under Management (AUM). This percentage differs from fund to fund and year to year. It can
be calculated based on assets committed or actually deployed by the PE firm. As many PE firms’ fund
sizes have ballooned rapidly, their revenues from management fees have grown faster than their
operating expenses and have become a source of significant profit. However, limited partners have
gotten wise to this game, and management fees are declining from their historical 2% rate, especially
for large funds.
Carried Interest
Carried interest is the PE firm’s share of profits generated by its investments and is the primary
incentive for GPs to make highly profitable investments. The basic concept is that GPs use LPs’
money to make investments and keep a percentage of the profits (usually ~20%) after returning
principal. The lion’s share of carried interest is reserved for a PE firm’s senior MDs, with junior IPs
participating on a limited basis or not at all. Carried interest can be earned on profits from successful
exits and dividend recapitalizations. In order to earn full carried interest, a PE fund typically has to
generate returns in excess of a hurdle rate (usually ~7-8%). Because the way performance vs. hurdle
rate is calculated and the way carried interest is actually paid out to GPs in real life can get very
complicated, it won’t be covered in this guide.
Other Revenue Sources
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Fund Economics
PE firms get revenue from other sources which typically produce less than 10% of the total:
• DEAL FEES: When a PE firm closes a deal, it frequently charges the target a deal fee calculated
as a small % of the total deal size. These fees are often shared with LPs.
• MONITORING FEES: Portfolio companies frequently pay nomina fees to their PE owners as
compensation for the owners’ ongoing monitoring and managerial assistance.
Illustrative Fund Economics Example
A successful PE fund is highly lucrative. A ~$2 billion fund with standard terms can generate ~$900
million of revenue over 10 years if it achieves a ~20% gross IRR. Even if management fees are eaten
up by operating expenses, that still leaves ~$600 million of carried interest for the GPs to split among
8-12 partners and 20-30 total IPs. The other important issue to note is that many people assume the
way to win big in PE is to grow fund size to generate more fees and grow “dollars at work”. However,
this is true only if the fund’s performance stays constant. The sensitivity table below demonstrates
how changes in a fund’s IRR impact total proceeds. Larger funds are frequently harder to invest
successfully than smaller funds so GPs must consider optimal fund size carefully, especially since LPs
are more likely to commit to the next fund if the current one generates strong returns.
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Module 1: Introduction and Overview
Fund Economics
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Module 1: Introduction and Overview
Titles, Roles and Compensation
Titles, Roles and Compensation
Titles and Roles
Titles and their associated roles vary between PE firms. The following are the most common titles,
roles, and qualifications:
Analyst
• ROLE: Most PE firms don’t use the analyst title. Analysts at PE firms typically fall into one of two
categories: deal sourcing and deal support. Some large PE firms with proactive sourcing models
hire analysts to generate deal flow through cold-calling company CEOs. Other large firms with
reactive sourcing models hire analysts to work primarily on deal support such as financial
modeling, due diligence, and industry research. Most analysts are hired for a 2-3 year program,
after which they are expected to attend a top tier business school in order to advance further.
However, some PE firms do promote analysts to associates without an MBA. Due to the lack of
standardization of titles between PE firms, some firms label associate-level positions as analysts,
or vice versa.
• PRIOR EXPERIENCE: Most analysts are hired directly out of top undergraduate schools, while
some have 1-2 years of experience in analyst programs such as banking or consulting
• TECHNICAL SKILLS: Since most analysts, as defined here, are hired directly out of
undergraduate programs, there is less focus on technical skills upon initial hire. Analyst
recruiters typically look for candidates with a strong quantitative academic background
(mathematics, finance, economics, engineering, accounting, physics, etc.) and a demonstrated
interest in finance (prior internships, finance clubs, etc.). Specific financial and technical skills are
learned during a formal training program or on-the-job.
Associate
• ROLE: Associates are the most junior investment professionals at most PE firms. At firms with a
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Titles, Roles and Compensation
proactive sourcing model, this role is often heavily focused on finding deals by researching
attractive industry sectors, cold-calling CEOs of potential target firms, and attending industry
conferences. At firms with a reactive sourcing model, associates typically focus on helping to
model potential deals, conducting due diligence and assisting with portfolio company
management. Many PE firms hire associates for 2-3 year programs, after which they are
expected to attend a top tier business schools in order to advance further. However, some PE
firms do promote associates without an MBA.
• PRIOR EXPERIENCE: Most associates are hired after completing a traditional 2–3 year analyst
program at an investment bank or top tier management consulting company. A small percentage
of associates are hired after 2 or more years with a less traditional program or employer.
• TECHNICAL SKILLS: Associates often do the majority of the technical tasks at a PE firm.
Common technical skills vary somewhat but frequently include:
• LBO and cash flow modeling
• Acquisition due diligence and accounting
• Analysis of financial statements
• Industry and market research
• Expertise in Excel, PowerPoint and other common tools such as CapitalIQ
Senior Associate / Vice President (VP)
• ROLE: Sr. associates / VPs typically oversee the work of associates and play a larger role in the
structuring of the diligence process. Not all firms use both titles, but when both are used, VP is
more senior.
• PRIOR EXPERIENCE: Sr. associates / VPs are typically hired directly out of top business schools,
often after having completed a summer internship with a PE firm. Most senior associates have
investment banking or consulting backgrounds prior to business school and most also have some
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Titles, Roles and Compensation
pre-MBA PE experience. Some PE funds, however, promote senior associates directly from their
associate ranks without an MBA.
• TECHNICAL SKILLS: Senior associates are typically required to have all of the skills of an
associate, along with a deeper understanding of the PE investment process that comes with
more experience.
Vice President (VP) / Principal
• ROLE: VPs / principals typically manage all of the day-to-day activities of deal teams and work
closely with partners on deal strategy and negotiation. They are often asked to generate
investment ideas and lead the more junior staff in pursuing these ideas. Not all firms use both
titles, but when both are used Principal is more senior.
• PRIOR EXPERIENCE: VP / Principals typically have at least 2–4 years of post-MBA PE
experience. Some Vice presidents and principals have 5–8 years of total PE experience without
an MBA.
• TECHNICAL SKILLS: VPs and Principals are typically required to be very familiar with the
associate / sr. associate skill set, but this is no longer their focus. While they must understand all
of the relevant financial, legal and accounting principles, they are typically directing and
supervising the technical work of associates rather than doing it personally.
Partner / Managing Director (MD)
• ROLE: Partners / MDs are the most senior members of a PE firm and are usually its co-owners.
Most partners / MDs have 8+ years of post-MBA level PE experience.
• PRIOR EXPERIENCE: Those who have been promoted to partner from vice president or
principal typically have at least 6 - 8 years of post-MBA PE experience. However, some partners
may have less PE experience if they are hired by a PE firm at the partner level due to some
special industry expertise or connections.
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Titles, Roles and Compensation
• TECHNICAL SKILLS: Partners typically do little technical work and focus more on deal
origination, negotiation and strategic decision making.
Non-Investment Professionals
Moving from a non IP role to an IP role can be difficult because IP roles are usually more competitive
and require specialized skills. Keep this in mind if you try to get your foot in the door via a role in
finance, operations or business development. The most common non-IP positions are:
• PORTFOLIO GROUP: Improving performance of existing portfolio companies
• ADMINISTRATIVE SUPPORT: Schedules, copies, etc.
• BUSINESS DEVELOPMENT: Generating deal flow
• EXECUTIVE IN RESIDENCE (EIR): Typically a former entrepreneur or executive who provides
industry expertise and sometimes takes over as CEO of a new acquisition
• FINANCE: Fund accounting and financial reporting
• HUMAN RESOURCES: Recruiting, payroll, benefits, training, etc.
• LEGAL: Providing legal advice and negotiating of contracts
• INVESTOR RELATIONS: Brand-building and fundraising
Compensation
Compensation PE compensation for investment professionals is typically composed of a base salary,
an annual bonus and a share of the fund’s carried interest. The sum of the base salary and the annual
bonus are referred to as “cash compensation”. Larger funds tend to pay higher cash compensation
because they tend to generate more management fee revenue per investment professional.
Trends in PE compensation depend heavily on the industry’s ability to raise capital as well as on
compensation levels at investment banks and hedge funds which compete with PE in the hiring
market. Prior to the ongoing credit crunch, PE compensation had been climbing steadily due to
record-setting fundraising levels and rising compensation at investment banks and hedge funds. The
credit crunch and economic downturn have dampened PE fundraising. Investment banking
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Titles, Roles and Compensation
compensation has taken a well-publicized fall. As a result, PE compensation has also stagnated
somewhat. Future trends depend heavily on how fundraising and returns look over the next few
years. The following compensation table provides rough guidelines for average cash compensation
by role and fund size. This data does not include carried interest which accounts for the bulk of
compensation at the more senior levels. Keep in mind that the data on “All PE / VC funds” averages
across many small VC and PE funds which generally pay less than larger competitors.
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“Show Me the Money!” / How to Find Relevant PE
Compensation Data
“Show Me the Money!” / How to Find Relevant PE Compensation Data
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Module 2: Industry Operations
Deal Process
Deal Process
Deal Process
The deal process varies substantially in terms of steps and timeline as well as internally from PE firm
to PE firm, but there is a standard path that many deals follow. The following template focuses on a
typical LBO of a public company by a large PE firm, usually the most complex type of deal with many
steps and the longest time horizon. As a general rule, other types of deals follow a subset of the steps
outlined here:
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Module 2: Industry Operations
Deal Process
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Module 2: Industry Operations
The One Dirty Little Secret on Sourcing
The One Dirty Little Secret on Sourcing
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3 Actual Examples of a Teaser, NDA, and CIM
3 Actual Examples of a Teaser, NDA, and CIM
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Module 2: Industry Operations
The Sacred Investment Committee Memo
The Sacred Investment Committee Memo
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Module 2: Industry Operations
Staple Financing 101: What is it and Why do Banks
Offer it?
Staple Financing 101: What is it and Why do Banks Offer it?
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Module 2: Industry Operations
3 Material Adverse Changes (MACs) to Watch Out
For
3 Material Adverse Changes (MACs) to Watch Out For
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Module 2: Industry Operations
Deal Selection
Deal Selection
Deal Selection
Attractive PE deals come in all shapes and sizes, but most LBO firms look for deals which have at
least a few of the following characteristics:
• STRONG COMPETITIVE POSITION: Highly levered LBOs can default and lose all invested
equity if the portfolio company’s performance deteriorates. Companies with strong competitive
positions are more likely to weather macroeconomic headwinds and industry upheaval without
losing profitability because they can take advantage of weaker rivals during tough times. Strong
competitive positions are often signaled by high market share, high margins, rapid growth,
valuable brand, high barriers to entry, and strong customer retention.
• PREDICTABLE CASH FLOW: LBOs must usually make large ongoing cash interest payments, so
enough cash flow to cover them is essential. The cash flows of some business models tend to be
more predictable than others, even controlling for competitive position. For example, the cash
flow of a market-leading movie studio is less predictable than that of a 2nd tier breakfast cereal
manufacturer because the movie studio relies on unpredictable hit movies, whereas the demand
for breakfast cereal is very stable. Common characteristics of predictable cash flow business
models include: predictable customer demand, agnostic to commodity and macroeconomic
cycles, high percentage of recurring revenue.
• LONG-TERM MARKET TAILWINDS: PE firms like to invest in businesses which are positioned
to benefit from favorable market trends which are usually more stable and predictable than the
fortunes of a single company. For example, the US has seen a decades-long movement toward
healthy and organic foods. This trend played a large role in Leonard Green’s investment in Whole
Foods Market, Apollo’s investment in Sprouts Farmers Market, and Oak Hill’s investment in
Earth Fare.
• CONCRETE IMPROVEMENT OPPORTUNITIES: PE firms feel like they are getting a bargain
when they can identify several important operational issues that they can improve. Common
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Module 2: Industry Operations
Deal Selection
areas of potential improvement include: hiring better management, aligning employee
incentives, optimizing pricing, cutting unnecessary overhead, culling unprofitable customers,
selling non-core assets, expanding geographically, rolling-up smaller competitors, and upgrading
IT infrastructure.
• FAVORABLE DEAL DYNAMICS: No matter how attractive the target, PE firms rarely feel
comfortable bidding aggressively for it unless they can identify a good reason why they are
particularly likely to win the deal at an attractive price. The following dynamics make PE firms
excited to compete for an asset: The seller is highly motivated, there are few natural bidders for
the asset, they have a particularly strong understanding of the industry, they believe the seller
prefers them as a buyer, or they are uniquely positioned to improve the asset’s performance.
• STRONG MANAGEMENT TEAM: Most PE firms cannot or do not want to operate the target
business day to day. For this reason it is important for the business to either already have a
terrific management team in place, or for the PE firm to have likely replacements in mind.
• “FAN OF OUTCOMES” UPSIDE: Every deal has a “base” expected outcome, as well as a series of
downside risks and upside opportunities. PE firms like a deal’s “fan of outcomes” if the likely
downsides aren’t fatal, and there are numerous potential scenarios to hit a home run.
• INVESTMENT CRITERIA: For most firms these days, the following are minimum criteria for
being interested in a deal:
• The deal fits the firm’s investment mandate as agreed to with LPs
• The deal generates at least a 20% equity IRR, the minimum rate of return most LPs are
looking for
• The deal generates least a 2.0x MoM equity return because carried interest is paid on profit
dollars rather than on IRR
• The equity check on the deal represents between ~2% and ~10% of the firm’s latest fund
size; anything less is not worth the bother while anything more is too risky
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Module 2: Industry Operations
The 7 Traits of The Perfect Deal and… One That Is More
Important than All of Them Combined
The 7 Traits of The Perfect Deal and… One That Is More Important than All of
Them Combined
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Module 2: Industry Operations
Deal Funnel and Lifecycle
Deal Funnel and Lifecycle
Deal Funnel
PE firms are highly selective in which deals they bid on and usually conservative with what they are
willing to pay because their LPs demand high rates of return on their capital (typically 20% or more).
The PE industry is highly competitive, and firms which under-perform even over a single cycle can
face difficulty raising future funds. Consequently, PE firms typically evaluate a large number of
potential deals for every one which they ultimately close. As described in previous section, there are
a number of natural decision points during which a PE firm might exit a deal process. The funnel chart
below approximates how many deals make it to each process stage in an average year at a typical PE
firm which is investing a single fund.
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Deal Funnel and Lifecycle
Deal Lifecycle
After a deal is closed, the PE firm holds and manages the investment as one of its portfolio companies
until exit. During this holding period, the PE firm usually stays involved with the investment in many
different ways. All deals are different, and PE firms choose to have different levels of involvement
with their portfolio companies, but the following is a list of common PE activities during the holding
period:
• Put MDs and sometimes more junior IPs on the portfolio company’s board
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Deal Funnel and Lifecycle
• Recruit new or supplemental company management
• Monitor the company’s performance and report quarterly to LPs
• Help the company set strategic direction
• Help the company look for and execute add-on acquisition
• Help the company manage its capital structure
• Help the company execute important initiatives (this is more common if the PE firm has a
dedicated in-house portfolio management group stocked with people with operating/consulting
experience)
• Decide when the time is right to exit the investment via IPO, strategic sale, or secondary sale
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Common Diligence Topics
Common Diligence Topics
Common Diligence Topics
Due diligence is the process every PE firm undertakes to confirm its investment thesis before any
deal is struck. Diligence topics fall into four broad categories: commercial, valuation, accounting, and
legal. The following section describes each category and lists topics which are commonly explored
within each category:
Commercial Diligence
Commercial diligence centers on projecting the target’s operational and financial performance.
Commercial diligence includes investigation of: market growth, historical performance, the target’s
competitive position, the target’s business model, key performance drivers, supply chain analysis,
customer analysis, etc. Commercial diligence is usually executed by a combination of the PE firm’s
deal team alongside 3rd party advisors such as management consultants. PE firms with an “industry
diligence” philosophy like Bain Capital tend to do more of the commercial diligence in-house,
whereas firms with more of a “financial engineering” philosophy like KKR tend to outsource more of
it. Issues commonly addressed during commercial diligence include:
MARKET ISSUES
• How fast is the industry growing and what are its primary drivers?
• How will these growth drivers evolve and how will that impact future growth?
• Which industry segments are likely to over/under perform?
• Is the industry consolidating? If so, what are the implications?
• How large is the target’s total addressable market (TAM)?
• How cyclical is the industry and where is it in its cycle?
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Common Diligence Topics
COMPETITIVE POSITION
• How unique is the target’s value proposition and how essential is it to customers?
• How is share distributed among competitors and how/why is it shifting?
• How is the target’s brand positioned and how strong is it relative to competitors?
• What is the target’s bargaining power relative to customers and suppliers?
• How concentrated is the customer / supplier base?
• How high is the threat from new entrants? How strong are barriers to entry?
BUSINESS MODEL
• What is the target’s margin structure? What % of costs is fixed vs. variable?
• How much of revenue is stable / recurring / locked into long-term contracts?
• What is the target’s free cash flow (FCF) generation profile?
• What is the normalized FCF margin?
• Capital intensive vs. light? Is Capex needed for maintenance or growth?
• Positive or negative working capital requirements?
HISTORICAL PERFORMANCE
• How has the business grown over the past few years and what drove its growth?
• Price growth vs. units sold growth?
• New store growth vs. same-store-sales?
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Common Diligence Topics
• Growth in core business lines vs. line extensions?
• Domestic vs. international growth?
• Organic growth vs. acquisitions?
• Industry growth vs. winning share?
• How much more runway is there for the most important growth drivers?
• What is happening with profit margins and why?
• COGS: what is driving labor, material, transport cost, etc?
• Opex: what is driving overheard, marketing, occupancy cost, etc?
Valuation Diligence
Valuation diligence centers on determining the current fair market price for the asset and the
multiple it could be sold for at exit. This analysis serves to assure the firm that it’s paying a fair
current price and helps to forecast its profits at exit. Valuation diligence is usually conducted by the
PE firm’s deal team, occasionally with some input from its investment bankers. Common types of
valuation diligence analyses include:
COMPARABLE (COMPS)
• At what multiples are the target’s most direct competitors or comparable companies trading in
the public market?
• What are the comps’ average trading multiples over a few years and macroeconomic cycles?
• Regression analysis to determine how historical growth rates have impacted trading multiples
for comps
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Common Diligence Topics
PRECEDENT TRANSACTIONS
• What prices and multiples have been paid for recent transactions involving competitors and
comparables?
NEXT FINANCIAL BUYER (NFB) ANALYSIS
• What would another PE firm be willing to pay for a secondary buyout of the target in a few years
if the target achieves its projected base case performance?
SUM OF THE-PARTS ANALYSIS
• If the target is made up of distinct and separable divisions, then the above analyses may be
performed on individual divisions and added together
Accounting Diligence
Accounting diligence focuses on confirming that the target’s reported financials accurately represent
the fundamentals of the business. This work is important because valuation depends on reported
financials which are susceptible to mistakes as well as intentional manipulation. Accounting diligence
is highly detailed and specialized, usually executed by 3rd party accountants during either the Deep
Due Diligence or Closing Diligence phase, so we will cover it here only at a high level. The most
common topics of accounting diligence include:
ACQUISITION / DIVESTITURE ACCOUNTING: Are any reported pro-forma statements accurate
and reliable?
ADJUSTMENTS / NON-RECURRING ITEMS: Have the target’s accountants or investment bankers
added back any questionable items to historical EBITDA?
DEBT VS. WORKING CAPITAL: Accountants make sure that any outstanding liabilities are
categorized properly as debt or working capital. This is important because debt is subtracted from
the purchase price, so sellers have an incentive to classify iffy items as working capital instead of debt.
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Common Diligence Topics
QUALITY OF EARNINGS: Are historical reported earnings/profits reflective of the businesses’ true
normalized level of profitability?
REVENUE AND EXPENSE RECOGNITION: Has all reported revenue been truly earned? Have the
right cost items been expensed vs. capitalized?
TAX ISSUES: Is the target tax compliant? Are there any unmentioned tax liabilities lurking? How can
taxes related to the deal be minimized? Etc.
Legal Diligence
Legal diligence focuses on confirming that the target is not subject to any material unreported legal
liabilities. Legal diligence is highly detailed and specialized, usually executed by 3rd party lawyers
during either the Deep Due Diligence or Closing Diligence phase, so we will cover it here only at a
high level. The most common topics of legal diligence include:
PENDING LITIGATION: Ensure that any liability from either pending or possible lawsuits is well
understood and manageable.
INTELLECTUAL PROPERTY (IP): Ensure that the target’s IP is valuable and unencumbered.
CORPORATE STRUCTURE: Ensure that the corporate structure (holding companies, operating
subsidiaries, off-shore subsidiaries, etc.) is well understood and legal.
3RD PARTY CONTRACTS: Ensure that the target has lawful title to all material PP&E as well as solid
contracts with important customers, suppliers, and debt holders.
EMPLOYEE CONTRACTS: Ensure the target has solid contacts with key managers, especially
related to compensation and non-compete clauses. Also ensure any employee retirement or health
and welfare plan liability is well understood and adequately funded.
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Common Due Diligence–Why Does it Matter?
Common Due Diligence–Why Does it Matter?
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module2-industry-operations/common-due-diligence-why-does
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How PE Makes Money
How PE Makes Money
How PE Makes Money
Ever since its inception, PE has aimed for and usually achieved high returns. This section discusses
why PE needs to generate high returns to survive and describes common methods PE firms use to
achieve these returns.
Why PE Must Generate High Returns
• PE investments are illiquid. An average PE investment takes about 5 years to pay off, but some
PE investments have been held for ten years or longer. Unlike with the stock market and even
some hedge funds, LPs cannot easily get their money out of a PE fund when they need it.
• PE has the reputation for being especially risky because it uses large amounts of leverage. High
leverage levels increases the likelihood that portfolio companies will default and wipe out the
invested equity.
• PE investments are “lumpy” and their timing is not predictable. When LPs commit to a new PE
fund, their capital may be “called” for a new investment at any time over the next several years.
There is little predictability to when new investments will happen or how large they will be. In
one year the fund might do zero deals and in the next year it might invest half of its entire fund.
This uncertainty is difficult for LPs to manage, especially for pension funds and endowments
which must make predictable cash distributions.
Method #1: Buy Cheap
This is the most tried and true investment method of all time and is a hallmark of nearly every kind of
investing, not just PE. However, there are some unique reasons and situations where PE is able to
buy assets for less than other potential buyers:
• BETTER UNDERSTANDING OF ASSET VALUE: A core competence of most PE firms is having
the best estimates for the worth of the businesses they bid on. PE firms accomplish this by
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constantly working to track and understand industry trends and valuation drivers. PE firms are
also experts at gleaning valuation information from the due diligence process because they have
more experience and frequently commit more resources than other types of bidders.
Comprehensive industry knowledge combined with differentiated diligence findings sometimes
allow PE firms to discover that the intrinsic value of an asset is actually much higher than for
what it is selling or where it is trading on the public market.
• RELATIONSHIPS WITH MANAGEMENT AND SELLERS: PE partners spend a lot of time getting
to know potential sellers and the management teams of potential targets. PE partners attend
many conferences, schmooze CEOs, sit on common boards, and continually maintain their
professional and business school networks. They are also proactive in promoting their
reputations both as experts in their investment areas and as value-added financial sponsors.
These efforts can help PE firms buy companies at a discount in two ways. First, management
teams sometimes have a lot of leverage over which buyer gets preferential treatment based on
which buyer they prefer to work with post buyout. For this reason PE firms with close CEO
relationships and good reputations sometimes get better deals. Second, sellers don’t always sell
their entire stake in a business when they transact with a PE buyer. In order to maximize the
value of any remaining stake in the business, referred to as “roll-over equity”, some sellers are
willing to sell companies at a discount to PE firms who they believe will add the most value to the
company going forward.
• ABSENCE OF OTHER NATURAL BUYERS: Some assets don’t have natural buyers other than
PE, so sellers of such assets have no choice but to accept the relatively high cost of PE money.
For example, distressed businesses (bankruptcies, loan defaults, etc.) and complex carve-outs
are common sources of deals with few bidders outside of PE because distressed deals are very
risky and require a lot of specialized legal and restructuring expertise. Distressed deals also
frequently require tough/unpopular choices about layoffs and contract renegotiations. Some PE
firms such as Sun Capital and Cerberus Capital have the nerve and the expertise to dive into
deals nobody else will touch. Carve-outs/spinoffs also sometimes have no bidders outside of PE
because it is operationally difficult to turn a former division of a large company into a functional,
stand-alone entity. Carve-outs frequently require finding new management, renegotiating
contracts, and setting up internal systems and processes which used to be handled by the
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corporate parent (IT, HR, Accounting, Procurement, etc.). Few other buyers outside of PE have
the risk appetite and the expertise to support this process.
• ACCESS TO INVESTMENT CASH DURING DOWNTURNS: PE firms’ funding commitments
from LPs are contractually guaranteed over periods of many years. This feature can be helpful
during economic downturns and stock market crashes when asset values plummet. At a time
when other investors are scrambling for safety and hoarding cash, some PE firms are able to take
advantage of the downturn and put money to work at attractive valuations.
• FASTER DEAL CLOSING: There are times when it’s important to a seller that the sale closes
quickly. This is commonly the case when the seller needs cash quickly for other purposes or
when having the asset “in play” for a long time could damage its value. The sale process of a
company can be highly distracting to management and can create a lot of uncertainty for
employees, customers, and suppliers. Businesses which are sensitive to uncertainty can be
damaged by sales processes which drag on too long. PE firms are uniquely positioned to close
deals quickly because they have a lot of experience doing deals and because they usually require
permission from only their internal investment committee (as opposed to bureaucratic boards,
diverse shareholders, lenders, etc.). Some sellers are willing to accept less money for a faster
close.
• MORE CERTAIN DEAL CLOSING: Related to speed of close but somewhat distinct is certainty
of close. Many deals fall apart between signing and closing for various reasons including
regulatory hurdles, shareholder dissent, and adverse findings or developments during the
closing process. PE firms are less exposed to shareholder dissent than public company bidders
and tend to face less scrutiny about anti-trust issues than strategic bidders. In addition, PE firms
can credibly claim that they are less likely to try to back out of deals than strategic buyers
because their entire business is built on their reputation as reliable deal makers. Many assets
would be damaged by a “broken” deal process, so some sellers are willing to take less money in
exchange for more certainty.
Method #2: Financial Engineering
Financial engineering is the practice of extracting value from an asset by optimizing the way it is
financed / capitalized. Financial engineering used to be the dominant driver of PE returns in the
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1980s, and many say financial engineering is still one of the dominant drivers. However, its relative
importance is waning because companies are more commonly employing PE-inspired practices to
optimize their own balance sheets. In addition, the term financial engineering has acquired a
pejorative connotation. Most PE firms deny that financial engineering is an important driver of their
returns. However, for the purposes of interviews, an understanding of how financial engineering can
drive returns, in theory, is important:
• BETTER BALANCE SHEET MANAGEMENT (MORE DEBT): To make a complex issue simple:
debt financing (aka leverage) is “cheaper” than equity financing because equity is riskier than
debt. The interest rate debt providers charge is usually lower than the rate of return demanded
by equity investors. See the section on capital structure for more details. When you finance a
company with a higher % of debt and a lower % of equity during an LBO, its cost of capital
(WACC) decreases. Finance literature argues that this decrease in WACC doesn’t increase the
risk-adjusted return to equity (which is what PE firms are interested in) because extra debt
makes the underlying equity riskier. If this interpretation is correct, then PE firms make higher
returns by accepting more equity risk. It is possible, however, to make the case that PE-owned
companies are better able to manage high leverage levels than public ownership. If this
interpretation is correct, then PE companies can create equity value by using more leverage.
Some reasons PE firms may be better at utilizing leverage include:
• PE firms have excellent long term relationships with many debt providers, making it easier
for PE companies to raise debt on better terms or refinance debt should a levered portfolio
company face financial distress.
• PE firms have more ready access to additional equity capital that could prevent default
should a levered portfolio company face financial distress.
• Because they don’t have to answer to a diverse, fragmented group of public shareholders,
PE firms are able to make cost-cutting decisions faster in order to forestall financial distress.
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How PE Makes Money
• INTEREST TAX SHIELD: A corollary to “more debt” is that interest paid on debt can be deducted
from a company’s taxable earnings. Adding more debt increases the interest tax shield which
raises a company’s cash flow and earnings, thereby increasing its value.
• DEBT PAY-DOWN: PE firms use the cash flow generated by portfolio companies to pay down
the debt they used to finance their initial acquisition. Consequently, when the portfolio company
is ultimately sold, less of the proceeds go toward repaying any remaining net debt and more of
the proceeds accrue to the equity holders. Debt pay-down from cash flow is an important source
of returns for most LBOs. However, it is important to stress debt pay-down does not create
additional value. Debt pay-down is an important driver of returns simply because LBO
candidates are always profitable companies which create profits for their owners every year.
Imagine you buy a company for $100mm which produces $15mm of cash flow every year. You
will make a ~15% IRR on this investment even if the value of the business stays flat. For this
reason, debt pay-down is an important driver of returns but is not a creator of value.
Method #3: Improve Operations
Most PE firms claim to be value-added investors because they can help the companies they own
become more valuable. How much value PE adds as an asset class is a difficult and open question, but
there are certainly many examples of PE firms adding exceptional value to portfolio companies by
using some of the following methods:
• IMPROVE MANAGEMENT: PE firms frequently cultivate extensive networks of former and
current executives with varied skill sets, often leveraging these networks to find better
managers for their portfolio companies. There is some evidence that PE firms are willing to give
management a larger share of equity upside which may allow PE firms to attract more talented
management.
• OPTIMIZE INCENTIVES: Some companies have poorly aligned incentives prior to PE ownership.
Misalignments may stem from bureaucratic friction, political tension, inadequate analytics, or
simply good old mismanagement. PE firms can sometimes be more objective, analytical, and
dispassionate about incentives than previous ownership. Perhaps top management needs more
equity upside to take advantage of their entrepreneurial capabilities. Perhaps the sales force
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How PE Makes Money
needs to be compensated based on the profits rather than the revenue their accounts generate.
Perhaps separate divisions need to be given reasons to cooperate rather than protect their own
fiefdoms. Such changes are sometimes easier to make for PE owners as opposed to founders /
private family owners / public companies.
• FUND AND SUPPORT ACCRETIVE M&A: This is commonly referred to as the “roll-up”
strategy. There are many highly fragmented industries out there which are ripe for
consolidation. Some PE companies buy one of the leading competitors which they see as a
“scalable platform” and then help it to buy and integrate several smaller rivals. This strategy
creates value in a couple of ways. First, truly scalable businesses realize synergies when they
merge and become more profitable together. Second, larger companies with higher market share
are generally seen as stronger and more stable competitors that should trade at higher multiples.
For this reason, “tuck-in” acquisitions can frequently be done at multiples which are lower than
that of the “platform” business, a phenomenon known as “multiple arbitrage”.
• CUT COSTS: Public companies and family-owned businesses are sometimes unwilling or unable
to cut costs which are economically suboptimal or outright wasteful. PE firms are generally less
skittish about cutting overheads, extravagant perks, and redundancies. During the 1980s
corporate raider days, PE firms sometimes made a lot of money simply by cutting management’s
excessive travel and “entertainment” budgets. These days most public companies are under
more judicious oversight, but prudent cost cutting opportunities still abound.
• RESTRUCTURE OR TURN AROUND A BUSINESS: Some businesses require difficult long term
changes to reposition them in changing markets. Such restructurings frequently require shortterm pain, investment, and patience to realize long-term success. PE is uniquely positioned to
support such restructurings because its investment horizon can be several years or longer and it
does not have to keep up with the quarterly public markets earnings treadmill.
• PROFESSIONALIZE A SMALL OR FAMILY BUSINESS: Many middle market PE firms add value
simply by purchasing under managed family businesses or small companies who are looking to
grow to the next stage and introducing standard business practices. We’re talking about
“Management 101” stuff here such as investing in IT systems, standardizing accounting
practices, creating talent management systems, introducing activity-based costing, optimizing
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pricing, etc. The trading multiple of a business can go up by quite a bit simply by bringing the
business up to professional standards.
• DRIVE SYNERGIES BETWEEN PORTFOLIO COMPANIES: Some PE firms with large portfolios
have been able to drive value by getting their portfolio companies to collaborate. For example,
some of the mega funds have recently started an initiative to consolidate the massive combined
purchasing power of the companies they control. In this manner they have been able to decrease
the costs of some of the common goods and services their portfolios companies buy. Another
example is when a PE firm buys a company which is a natural customer of or supplier to other
existing portfolio companies. The PE firm can facilitate these companies coming together (where
it makes economic and strategic sense of course) in order to make one or both better off.
NOTE: The list above is only a partial sample of some of the more common ways PE firms add value to
their portfolio companies. There are countless other ways PE firms have attempted to improve the
performance of their portfolio companies.
Method #4: Exit Right
PE firms can sometimes squeeze a little extra value out of portfolio companies when they realize
returns or make exits because firms are very flexible in terms of both the timing and the method of
the exit:
• FLEXIBLE EXIT TIMING: Some investors have limited choice for when to sell their holdings. The
capital which funds hedge funds is usually less patient than PE funds and monitors annual or
even quarterly returns. Mutual funds have the same constraint, plus they’re under strict
regulations to invest in assets according to their prospectus and have to sell assets which
migrate outside of their mandate. Corporate owners sometimes have to sell assets for nonfinancial “strategic” reasons. PE firms, on the other hand, are pretty flexible with the timing of
their realizations/exits because their primary concern is maximizing financial returns and their
funding is committed for several years or longer. Since markets are cyclical, the flexibility to
choose exit timing allows PE firms to practice patience and avoid selling in downturns until the
rebound arrives.
• FLEXIBLE EXIT METHOD: PE firms frequently have several options on how to realize gains from
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an investment. The most common options include selling to another financial sponsor (secondary
buyout), selling to a corporate/strategic buyer, selling to the public (IPO), or deferring a final sale
but taking out a dividend via a debt recapitalization. Different exit markets are all cyclical, but
not uniformly so. Sometimes the IPO window is “closed” while the debt markets are hot and
dividend recapitalizations are attractive. Sometimes strategic buyers are hoarding cash while
financial sponsors are hungry for new acquisitions. The ability to realize returns via any of these
methods gives PE firms flexibility to choose the one which promises the best return at any given
point in time.
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Module 2: Industry Operations
Bonus Webinar: Sources of Value Creation in Private
Equity
Bonus Webinar: Sources of Value Creation in Private Equity
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module2-industry-operations/bonus-webinar-sources-of-value
Relevant Files:
sources_of_pe_value_creation_wso_aug_18_2014.pdf
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What is the True Driver of Returns? Financial Engineering
vs Operational Improvement
What is the True Driver of Returns? Financial Engineering vs Operational
Improvement
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Module 3: Recruiting Overview
Common PE Career Paths
Common PE Career Paths
Common PE Career Paths
Because PE firms want applicants who can hit the ground running on day one, they rely on standard
recruitment channels which consistently deliver qualified applicants. That is why the most common
PE career path is: Undergrad --> Investment Banking Analyst Program --> PE Associate --> MBA -> PE Sr. Associate/VP -->VP/Principal --> Partner/MD. Other paths into the industry are possible,
including via consulting or a post-MBA career switch, but non-traditional paths are much rarer and
usually require a lot of personal networking to succeed.
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Common PE Career Paths
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5 Examples of Where People Go After Their PE
Career is Over
5 Examples of Where People Go After Their PE Career is Over
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Module 3: Recruiting Overview
How to Build a PE Background
How to Build a PE Background
How to Build a PE Background
The single best thing that you can do to increase your odds of breaking into PE is plan ahead. If you
get yourself on the “common path” as early as possible, your odds increase dramatically. This section
is broken down by the stage of your education or career to help you figure out your most direct path
into PE.
High School Students
Is it crazy to worry about what steps you need to take in order to break into PE while you are still at
least 5–8 years way from a likely entry point? Perhaps it is. However, since breaking into PE takes
long-term planning, you might as well have the right information as early as possible. The following
accomplishments can dramatically increase your odds of eventually breaking into PE, as well a host
of other attractive careers:
• GET INTO A TARGET SCHOOL: The most direct path into PE out of undergrad is via an analyst
program with a top investment bank or consulting firm. These programs are often as selective as
PE itself, and they typically select most of their hires from a few select “target” institutions
where they do on campus recruiting (OCR). Getting into one of these programs can be difficult if
you attend a non-target college. Before making a final decision on where you go to school, you
may wish to ask each school’s career center to provide you with a list of which analyst programs
typically do OCR and how many graduates usually make it into these programs. You can get into
a top tier analyst program coming out of a non-target school, but you will face longer odds and
have to do more legwork.
• CAVEAT 1: I would NOT advise selecting your undergrad based primarily on its investment
banking and consulting career placement. The university you choose has much more
meaning and impact on your life than simply what job you get upon graduation. The advice in
this section should be taken into consideration only by those very few who already know
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How to Build a PE Background
with certainty what career they want before college.
• CAVEAT 2: Some people believe that doing an undergraduate business program such as the
ones at U. Penn and U. Michigan is the surest way to get into a top analyst program. Such
programs do matriculate many graduates into top analyst programs, but they are no better
in this regard than many other quantitative programs at other target schools.
• CAVEAT 3: Most top analyst programs recruit candidates for multiple national and
international offices. Many regional offices focus on target schools in their vicinity. You may
find it easier to get an offer in your preferred location if you attend a target school in the
vicinity. For example, the same consulting firm may recruit most of its NYC analysts from
Columbia and Princeton, most of its San Francisco analysts from Stanford, and most of its
Chicago analysts from Northwestern and U. Chicago.
• ACE THE SATS: Believe it or not, your SAT score remains relevant after you’re accepted to
college. Many analyst programs encourage, and some even require, that you list your SAT scores
(or equivalents) on your resume. As a rough guide, a combined math and critical reading score
above 1400 can boost your odds, while a combined math and critical reading score below 1300
may be a headwind.
Top Target Schools
The following undergraduate programs are known for attracting top tier investment banking and
consulting analyst programs to recruit students on campus, and for consistently placing at least a few
alumni into these programs each year. These rankings should be seen as approximate and may not
include all undergraduate programs which consistently place alumni into top tier programs.
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Undergraduate Students
Undergraduate Students The most common path into PE out of undergrad is via an analyst program
at a top tier investment bank or consulting firm. Such programs hire only a few thousand undergrads
per year in the US. Hundreds of candidates submit a resume for each opening, and many qualified
candidates have trouble getting so much as an interview. Consequently, the most crucial step to
eventually landing a seat in PE is building a resume that is appealing to analyst program recruiters.
The following guidelines can help you build such a resume:
• ACADEMICS: Candidates with proven quantitative skills are preferred because analyst
programs involve quantitative and financial analysis. Examples of preferred majors include
finance, economics, engineering, physics, math, computer science, etc.
• CAVEAT 1: Whatever your choice of major, maintain a high GPA is helpful because top
analyst programs often have GPA minimums for granting interviews. A common minimum is
a GPA of 3.5 out of 4.0.
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• CAVEAT 2: Some candidates get analyst program interviews without quantitative majors
and / or lower GPAs, but they usually still signal their quantitative aptitude with relevant
work experience and extracurricular activities.
• EXTRACURRICULAR ACTIVITIES: Recruiters prize leadership qualities because leaders are
often high achievers who are driven to excel. You can increase your odds of getting interviews if
you can list several high-profile leadership positions in such organizations as student
government, athletic teams, community service groups, fraternities & sororities, financial clubs,
etc. Attaining leadership positions in one or two high profile organizations helps you more than
simply being a member of a dozen groups. In addition, recruiters prefer candidates who have a
demonstrated interest in business and finance. You can demonstrate this interest by founding or
being active in applicable organizations. Examples of such organizations include investment
clubs, consulting clubs, and business fraternities.
• CAVEAT: Recent graduates of your school now working for you intended employer are
frequently the first to screen resumes. They likely still have friends on campus, so be careful
not to earn a reputation as a shameless resume builder. Also be careful not to make a
position sound much more significant than it really is.
• WORK EXPERIENCE: Analyst programs prefer candidates with relevant job experience.
Summer internships and part-time jobs are a great way to build experience and display your
interest in business. Seek out jobs where you can learn the basics of finance, research, business,
accounting, and economics, and where you can exercise quantitative abilities, independent
thinking, and teamwork. Work experience that allows you to learn to use PowerPoint and Excel,
both of which are essential in investment banking and consulting, is especially helpful. Many
consulting companies and investment banks offer summer internships for undergrads between
their junior and senior years. Getting one of these internships can be extremely helpful because
many analyst programs extend full-time offers to top performing interns.
Sample Resume Scoring Template
Top analyst programs often get hundreds of resume applications for each opening. Recruiters often
select which candidates to interview via a set of screening guidelines. One such set of guidelines from
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a top tier consulting company is shown below. In order to have a chance for an interview, resumes
have to score a weighted minimum of 3.5 according to this template:
Undergrad Recruiting Cycle
The investment banking analyst recruiting cycle is driven by the firms’ competition for talent, as well
as the school calendars of target universities. Since the school year typically ends in the spring, the
start date for most internships is in June, and most full-time programs start in mid-summer or early
fall. Top tier firms want to have their pick of the elite candidates, so they kick off recruiting for fulltime positions as soon as the internships end in the summer after junior year. Mid-tier firms’
recruiting often overlaps the top tier firms, or follows soon thereafter.
Some firms also recruit undergraduate juniors (and occasionally sophomores) for summer
internships even earlier. Such internships tend to be offered by the larger and more prestigious
firms because they have the scale to consistently find work for interns and use the internship
programs to audition the best talent for full-time positions. A small number of full-time positions are
also occasionally filled off-cycle on an ad-hoc, as-needed basis throughout the course of the year.
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Undergrad On-Campus Recruiting (OCR)
Students at target schools have a tremendous advantage because some PE firms and many analyst
programs that are feeders into PE recruit candidates every year through on campus recruiting. If you
are a student at a target school, you should talk to a counselor at your career counseling office as
soon as possible and find out which firms typically recruit at your school. You should also find out the
timing of their recruiting process, whether any of the firms recruit for summer internships and what
criteria candidates typically have to meet in order to get interviews. Your career counseling office
also probably has a schedule of events such as career fairs and information sessions which are
sponsored and attended by top firms and analyst programs. I highly recommended that you attend
these events in order to find out more information about your target firms and meet some of their
recruiters. When you attend these events follow these guidelines:
• Wear a suit, unless expressly told not to by an event coordinator.
• Peruse the websites of attending firms so that when you talk to the recruiters you can ask
insightful questions which demonstrate your interest in their firm.
• Have copies of your resume on-hand in case a recruiter proactively asks you for a copy; never
force a recruiter to read it or take it.
• Many firms actively collect the resumes and names of all students who visit their information
sessions and career fair booths. Some firms interpret consistent attendance of their events as
interest in their firm. Demonstrated interest may occasionally influence which candidates are
selected for interviews.
• Politely ask every recruiter you meet for a business card and email them a very brief thank you
note the following day. If they respond, ask a few simple follow-up questions about their firm to
further demonstrate your interest.
• Treat everyone you meet as if they have sole discretion over the recruiting process.
• The recruiters you meet may or may not have some discretion over which candidates ultimately
get interviews and job offers. Some recruiters who attend campus events are later charged with
screening resumes and conducting interviews. In some cases, recruiters may make a note of
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candidates who make either an exceptionally favorable or unfavorable impression in person.
These notes can sometimes influence whether the candidate is selected for an interview. Keep
this possibility in mind at all times when you are in the presence of recruiters and other
employees.
Undergrad Non OCR Recruiting
It is difficult to get interviews for top tier analyst programs which do not recruit on your campus.
Most firms allow non-target school candidates to submit applications via their website, but such
applications face long odds. A referral from a current employee greatly increases your odds at an
interview. Non OCR opportunities also arise occasionally when analyst programs recruit off-cycle.
These opportunities arise when fewer analysts from target schools accept offers than expected,
when analysts leave the program unexpectedly, and when a firm has an unexpected surge of work to
do. This off-cycle recruiting is often open to non-target candidates and horizontal transfers from
other firms. Persistence, vigilance, personal connections, and networking skills often determine the
outcome of non OCR recruiting attempts.
Choosing an Offer a Post-Undergrad Analyst Program Offer
The following general guidelines can help you determine which jobs are most likely to give you the
most exit opportunities into PE:
• Investment banking, all else being equal, offers the best exit opportunities into PE because it
teaches the most common PE skills and provides exposure to the most PE firms
• Within investment banking, the groups with the most exit opportunities into PE are transaction-
oriented groups such as M&A, leveraged finance, and financial sponsors. The same principal is
also true within other professional services firms such as consulting and accounting. Due
diligence, financial services, private equity, M&A advisory, valuation, and corporate finance are
all examples of groups and practices which offer exit opportunities into PE.
• PE firms are increasingly hiring management consultants, but they still make up only 15–20% of
PE professionals, and most of them come from McKinsey, BCG, and Bain.
• Size and prestige matter. Larger firms tend to have more exit opportunities into PE than smaller
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firms. However, a firm’s prestige often trumps size. For example, many people feel that BCG
offers better exit opportunities into PE than Accenture, and Lazard offers better exit
opportunities into PE than Citibank.
• The size, industry, type, and geography of the deals you work on strongly affect your exit options
into PE. A PE firm is much more likely to take interest in your resume if you can cite transactions
that you worked on that are similar to the PE firm’s investment mandate.
• The table on the next page shows the types of firms that often provide exit opportunities into PE,
and some guidelines about the kinds of exit opportunities they provide.
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Pre-MBA Investment Bankers
Investment banking analysts, especially in M&A-related groups at well-known banks are the most
heavily recruited pool of PE candidates. However, unless you are a star analyst at a premier bank, a
job in PE is not guaranteed. Whether you are a star candidate or not, there are still several things you
can do to increase your odds of getting the position you want most:
• IMPRESS YOUR MD: It should go without saying that impressing your supervisor has a great
deal of influence over your marketability, not only for PE, but also for most other opportunities.
Most PE recruiters will at least ask to speak with your MD as a reference. Some recruiters may
even contact your MD before they decide who to interview, in order to identify the firm’s star
analysts with interest in PE.
• POSITION YOURSELF: The industries you work on and the types of deals you work on affect
your marketability to various PE firms. If you have a list of target firms in mind, then you should
try to find out what kind of deals they typically do, and try to work on as many similar deals as
possible.
• GET YOUR NAME OUT EARLY: Even if you expect to be contacted by recruiters at some point,
you may want to consider reaching out to them early to put yourself on their radar screen. If you
have a close relationship with your supervisors, it may be a good idea to make them aware of
your interest in PE early on. It’s possible that they can help you work on roles which bolster your
PE credentials. Many MDs fully expect some of their analysts to pursue opportunities outside of
banking after the completion of their program. Some banks are actually happy to place their
analysts into top tier PE firms because it increases their prestige and builds closer ties to the PE
firms which can be a big source of investment banking fees. You should, however, be extremely
careful to never give the impression that you’re not fully committed to your current job, or you
see it primarily as a stepping stone.
• DEVELOP YOUR INVESTMENT JUDGMENT: Many banking analysts are so focused on
managing their insane workload that they never take the time to consider the merits of a deal
they’re working on. While PE associates are still expected to build models and crank out
presentations, they are also asked to exercise investment judgment. When you are working on a
model or a pitch book, ask yourself why the deal makes sense and what the major risks are. You
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are likely to be asked these questions during PE interviews and can distinguish yourself if you are
able give thoughtful answers. Take every opportunity to further develop your investment
judgment by discussing with your supervisors the logic behind various deals and decisions.
Pre-MBA Management Consultants
Although PE is still heavily dominated by former investment bankers, the percentage of consultants
in the industry is rising because firms are taking more active roles in the management of their
portfolios. An increasing number of PE firms are hiring one or two consultants for every few
investment bankers to help round out their team’s overall skill set. A small number of PE firms,
mostly small or mid-sized, actually make much of their associate hires from consulting programs. On
the other hand, large and mega-sized PE firms, with the exception of Bain Capital, focus on exbankers for IP roles. A consultant’s best chance for breaking into PE is to target firms which routinely
hire consultants. Consultants should, of course, pay particular attention to PE firms which have hired
alumni from their firm in the past. The following are some factors that may make a PE firm more
likely to hire a consultant for a pre-MBA associate position:
• EARLY STAGE FOCUS: Earlier stage deals typically don’t involve as much complex financial
modeling for which investment bankers are generally preferred
• CONSULTING FIRM AFFILIATION: Some PE firms, such as Bain Capital, Monitor Clipper, and
Parthenon Capital, were founded by consultants and still hire many consultants
• PROACTIVE SOURCING MODEL: The proactive sourcing role is heavy on research, cold-calling,
and networking where consultants are usually at no disadvantage to bankers. Prominent PE
firms that employ a proactive sourcing model include Summit Partners, TA Associates, Spectrum
Equity Investors, and Battery Ventures.
• OPERATIONAL FOCUS: PE firms which focus on assisting portfolio company management with
operations are more likely to hire consultants for their strategic planning, market research,
operational improvement, and management advisory skills.
• CAVEAT: Some large PE firms have captive operations groups that help to manage and
improve the performance of portfolio companies. For example, KKR’s captive consulting
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group is called Capstone. These groups are often filled with former management
consultants. While such positions are highly desirable to many consultants, aspiring
investment professionals should know that captive operations consultants are not usually
involved with investment decisions. There may not be a clear path from a portfolio group
role into an investment professional role.
• SPECIAL INDUSTRY FOCUS: A PE firm is more likely to be interested in a consultant who has
significant experience in an industry on which the PE firm focuses, especially if that experience is
transactional.
Other Pre-MBA Backgrounds
Candidates from non-traditional backgrounds face an uphill battle. PE recruiters likely won’t call you
proactively with interview offers, and most job descriptions probably won’t include your background
under the requirements section. However, several hundred non-traditional candidates do break into
PE every year from such varied backgrounds as accounting, corporate M&A, IT consulting, equity
research, and credit rating. If you are trying to break into PE from a non-traditional background, be
wise and realistic about you options, and target the firms where you have the best odds of success.
Most successful non-traditional candidates cite patience, tenacity, and creative networking as the
keys to their success. The following strategies have been employed by non-traditional candidates to
successfully break into PE:
• Network aggressively with PE recruiters, alumni of your current employer who work in PE, and
other personal or family connections who are connected to PE
• Target smaller firms in less competitive geographies where candidates with a similar background
have been hired in the past and where associates don’t focus heavily on financial modeling
• Leverage rare language skills or citizenships, special knowledge of or experience in a particular
industry, and special knowledge of or experience with one of a PE firms’ portfolio companies
•
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Consider alternate stepping-stones into a PE investment professional role such as:
• MBA at target program
• Pro: Chance to do OCR with PE firms
• Con: Most post-MBA PE hires also have pre-MBA PE experience
• PE Fund-of-funds
• Pro: More open to non-traditional backgrounds; Chance to learn more about PE
• Con: Easier to move from traditional PE into Fund of Funds than vice versa
• Non-investment professional PE role such as finance or operations
• Pro: More open to non-traditional background; Chance to get foot in the door
• Con: No guarantee of opportunity of transfer into investment professional role
• Horizontal transfer to analyst program in investment banking or consulting
• Pro: Learn necessary PE skills and enter the traditional recruiting channel
• Con: May be hard to enter from current position; May require a step down in title or
compensation
MBA Students with Prior PE Experience
The majority of MBA students with pre-MBA experience in PE have historically found post-MBA
positions. In recent years, however, fund sizes are shrinking and the number of IP positions is
stagnating. This, in turn, has made competition for partner-track post-MBA positions a lot fiercer.
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The following guidelines can help you remain on track to land your most desired post-MBA offer:
• ACADEMIC CONCENTRATION: Since it’s likely that you already have the common PE skills,
you can use your classes to broaden your horizons and become a more rounded candidate. If you
were primarily a deal execution associate, consider taking some marketing or strategic planning
classes. Above all, concentrate something you are passionate about. When recruiters ask you
about your choice of concentration, you can impress them if you demonstrate your passion.
Don’t forget, however, that whatever your concentration, you need to maintain a strong
academic performance if your school has grade disclosure. You don’t want any red flags to ruin
your candidacy.
• SUMMER: Once again, your prior experience in PE allows you some flexibility in your summer
internship choice. Feel free to explore options like hedge funds, consulting firms, and operational
positions with portfolio companies. However, if you wish to pursue a full-time position with a PE
firm which is substantially different from your previous firm, you should probably go for an
internship with a PE firm closer to the kind you ultimately want to target. The same is true if you
worked at a very small or unheralded PE fund prior to your MBA.
• RECRUITING STRATEGY: If you are a rock star associate from a brand name PE firm and are at a
top tier MBA program, then you shouldn’t have to do much more than apply for jobs available
through your school’s OCR. If, however, you’re nearer the middle of the pack, you shouldn’t take
anything for granted. Proactive networking with classmates, professors, and recruiters is
recommended. Join finance clubs and take leadership positions. Participate in your school’s
finance/PE conference if there is one. Go on treks to meet PE employers if such events are
available.
MBA Students without Prior PE Experience
Candidates without previous PE experience face a daunting but not necessarily insurmountable
challenge. Most PE firms are hesitant to hire a post-MBA candidate without prior experience since
these firms typically have their pick of candidates already with PE experience. Candidates with no
prior experience likely need to be aggressive, persistent, and creative in their approach to breaking
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into PE. The following guidelines can help you overcome the odds:
• ACADEMIC CONCENTRATION: You should consider using your classes to fill any gaps in your
financial skillset and signal your strong desire to work in principal investing. If you lack
experience with PE staples such as accounting, financial modeling, strategic planning, etc., you
can use your classes to fill the gaps and signal your aptitude by earning top grades.
• SUMMER: Your summer internship is your best chance to get on the right track because PE
firms are more likely to take a chance on a “risky” internship candidate than they are on a fulltime candidate. You likely have little chance of interning with large, established PE firms because
they have too many other more proven applicants to consider. However, you can greatly
increase your odds of eventually getting a full-time offer if you spend your internship with a
middle-market or early-stage firm. If you are unable to intern in PE, the next best option is to
intern with a brand name investment bank, hedge fund, or consulting firm. At the very least,
doing so will add an attractive name to your resume and signal your aptitude for PE-type work.
• RECRUITING STRATEGY: In order to get a PE internship or full-time offer, you likely face the
tough challenge of beating out someone with PE experience. Your best strategies for success are
aggressive networking and geographic flexibility. Other candidates in your position have
succeeded by getting leads and referrals from their classmates and well-connected professors.
Flexibility on offer location and firm type can also make the difference. You may want to target
middle-market and early-stage firms in less competitive geographies. The most promising
targets are firms with a history of hiring candidates with your background, especially if the firm
has alumni of your MBA program but isn’t interviewing on campus because they are too small or
too far away.
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Big Fish in Small Pond or Swim with the Sharks?
Big Fish in Small Pond or Swim with the Sharks?
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What firms and groups give you the best shot at
PE?
What firms and groups give you the best shot at PE?
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Bonus Webinar: Private Equity Success Story from a Nontarget Engineering Major
Bonus Webinar: Private Equity Success Story from a Non-target Engineering Major
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PE Business Development Roles - Another Way to
Break In
PE Business Development Roles - Another Way to Break In
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Recruiting Cycle
Recruiting Cycle
Recruiting Cycle
Pre-MBA
The pre-MBA recruiting cycle is driven by PE firms’ competition for top tier talent, as well as the
recruiting cycle of the analyst programs from which PE firms select most of their candidates. Most
analyst programs conclude in late spring or summer, so most on-cycle pre-MBA PE associate
programs have start dates in the summer or early fall. The timing of when on-cycle offers are made
partially depends on how active and healthy the PE industry is in a given year. When PE deal making
activity is high and fundraising is strong, PE firms are usually anxious to grow and thus compete for
the best candidates earlier in the cycle. On the other hand, when deal making activity is low or
fundraising is weak, PE firms are cautious about making new hires and make on-cycle offers later in
the year. For example, during the peak year of 2007 some firms made on-cycle offers in April (16
months prior to start), whereas during the current, ongoing credit crunch, few on-cycle offers are
being made prior to July.
On-cycle PE recruiting typically occurs in three stages. During the first stage, the mega and large
buyout firms compete over top ranked analysts at the most prestigious investment banks. Such firms
often proactively reach out to managing directors at top tier banks and inquire about recruiting their
top ranked analysts. The banks are sometimes receptive to these requests because having alumni at
top buyout firms increases their prestige and helps ensure that they maintain a close relationship
with the buyout firms which often pay them large fees for arranging deals. In addition to contacting
managing directors, some PE firms also reach out to targeted candidates directly via recruiters and
headhunters. Candidates who are eligible for this stage are usually aware of it because they are being
proactively recruited as early as half way through the first year of their analyst program.
The second stage is when the majority of middle market firms make their on-cycle offers. The
duration of this stage varies considerably because there are more middle market PE firms than large
ones. During this stage, offers may be made anywhere from late summer all the way through the
winter. As with the first stage, PE firms and their recruiters actively reach out to their top candidates.
However, this stage allows for a greater range of candidates to break into the process because
smaller firms are more open to candidates of various backgrounds. During this stage, many
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candidates from lower profile programs and non-traditional backgrounds are able to break into PE
alongside the more traditional candidates.
The third stage occurs in the spring, when many early stage firms do their recruiting. Such firms are
often most open to candidates with non-traditional backgrounds. These firms’ have a much larger
pool of candidates who do not need to be locked up a year in advance.
Post-MBA
The post-MBA recruiting cycle is driven by PE firms’ competition for scarce talent, as well as the
school calendar of the MBA programs from which PE firms select many of their candidates. Most
MBA programs last for two regular academic years, with one summer in the middle. Therefore, most
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post-MBA full time positions have start dates in the summer. In addition, some PE firms recruit first
year MBA students for summer internships in order to audition them for full time positions after
graduation. The timing of when on-cycle offers are made partially depends on how active and healthy
the PE industry is in a given year. When PE deal making activity is high, and fundraising is strong, PE
firms are usually anxious to grow, so they compete for the best candidates earlier in the cycle. On the
other hand, when deal making activity is low, or fundraising is weak, PE firms are cautious about
making new hires and make on-cycle offers later in the year. For example, during the peak years of
2006 and 2007, many PE firms began their on-cycle recruiting near the beginning of the school year.
However, during the current environment, many processes are being pushed back closer to winter.
As with pre-MBA recruiting, the larger and more established firms are usually out of the gate first.
These funds aggressively pursue the most pedigreed candidates at the most prestigious MBA
programs. In a robust hiring environment, top tier candidates are likely to be actively contacted by
recruiters from premier PE and hedge fund firms for on-cycle interviews as early as September. Since
this pool of employers and candidates is relatively small, this phase of on-cycle recruiting can be over
in just one or two months.
Middle market buyout firms and early stage firms typically conduct their recruiting a little later in the
cycle and over a longer period of time. These firms, especially early stage firms, are typically a little
more open to candidates without top tier pre-MBA experience, and even without pre-MBA PE
experience altogether. Due to the large number of small and mid-sized firms, this phase can easily
stretch through the winter. Some early stage firms even hand out offers as late as the spring.
PE firms also do off-cycle recruiting year-round for post-MBA positions when they have an
unexpected vacancy. For example, off-cycle opportunities arise when firms experience unexpected
turnover, fail to sign up enough candidates via on-cycle channels, or raise more capital than
anticipated. PE firms typically fill these opportunities by reaching out to their network, or by
employing recruiters. These opportunities may be open to MBA students as well as lateral hires. The
best way to access off-cycle opportunities is to always stay on recruiters’ radar screen and keep in
touch with as many professional in the industry as possible.
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PE Recruiting Timing: Game Theory In Action
PE Recruiting Timing: Game Theory In Action
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How to Work with Recruiters
How to Work with Recruiters
How to Work with Recruiters
For most PE candidates, working with recruiters is an essential part of their job search. Most PE firms
have limited internal recruiting personnel and don’t have time to sift through hundreds of resumes.
As such, most PE firms rely on outside recruiters, also known as executive search firms and
headhunters, to help source and filter qualified candidates. The following frequently asked questions
section summarizes what you need to know in order to get the most traction with PE recruiters:
What do recruiters do?
• Find candidates who meet their client’s requirements.
• Screen qualified candidates and make sure they are interested in the available position.
• Present CVs of qualified and interested candidates to the client for interviewee selection.
• Act as liaison between the candidate and the client during the interview process, if needed.
• Recruiters DO NOT decide which candidates are selected for interviews or get offers. These
decisions are in the hands their clients. However, if recruiters have a particularly close
relationship with their client, they may have some influence on these decisions.
How do recruiting firms differ?
• SIZE: Some boutique firms have only a single or a handful of recruiters. Larger recruiting firms
often have several dozen or even several hundred recruiters.
• GEOGRAPHIC FOCUS: Some recruiters focus on individual cities or regions. Other typically
larger recruiters focus on entire countries or multiple countries.
• INDUSTRY FOCUS: Some recruiters focus on a niche market such as PE firms and hedge funds.
Other recruiters focus on entire industries such as finance. Some large recruiters service many
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diverse industries.
• ROLE FOCUS: Different recruiters sometimes focus on filling different corporate roles such as
investment professionals, finance, and marketing. Some recruiters also specialize in filling
positions of different seniority levels such as junior level, mid-level, and senior level.
• SEARCH TYPE: Some recruiters work primarily on a retained basis, while others work primarily
on a contingency basis. Some recruiters work on both a retained and a contingency basis
depending on their client. Retained recruiters are given an exclusive mandate to fill a certain
position for a client and are paid a retainer fee in addition to a success fee once the position is
filled. Contingency recruiters typically don’t have a mandate to fill a position. Instead, they
opportunistically introduce qualified candidates to the client and are paid a success fee if the
candidate is hired.
Whose side are recruiters on?
Recruiters are good at sounding like they are on your side. While this may very well be true, keep in
mind that recruiters don’t work for you; they are paid by their clients. When recruiters work on
retainer, they get paid regardless of who gets the job. They want to make clients happy by helping
them find and sign the most qualified candidate as quickly as possible. It may be in their best interest
to steer you toward taking their clients’ offer even if you might find better opportunities. When
recruiters work on contingency, their financial incentive is to place as many candidates as possible as
quickly as possible. They may just be playing a matching game where they try to line up their most
promising candidates with the most imminent opportunities. They may push you toward whichever
opportunity they feel is likely to generate a quick offer. Recruiters can be very useful in your search,
but you should always keep their motivations in mind when they offer you advice.
Should I work with recruiters?
The only potential downside to working with recruiters is that it makes you a more expensive hire.
Recruiters are paid a success fee, 25–33% of your cash compensation on average, for every new hire
they introduce to a PE firm. Given a choice between two equally attractive candidates, a PE firm
might possibly pick the candidate that doesn’t come with having to pay an additional commission fee.
As such, if you have a great personal connection to your target employer, you may wish to contact
them directly. However, most PE funds, especially the more established ones, fully expect to pay
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hiring commissions as a normal part of doing business. In addition, most candidates cannot possibly
establish a relationship with as many potential employers as recruiters can on their behalf. For these
reasons it is highly advisable for most candidates to make recruiters an important part of their job
search.
How do I contact recruiters?
If you work for a top tier investment banking or consulting program, PE recruiters will likely reach
out to you or your supervisor. If recruiters aren’t reaching out to you proactively, or if you want to
work with a larger number of them, then you should follow these steps:
• UPDATE YOUR RESUME: It’s crucial that your resume clearly and concisely summarizes your
qualifications for PE. Recruiters are much more likely to respond to you if they can quickly
determine that you are a qualified candidate. If you already have contacts with experience in
financial recruiting, you would be wise to ask their assistance.
• BUILD AN INITIAL TARGET LIST: Refer to the appendix for a list of PE recruiting firms. These
firms’ websites typically contain the firm’s main contact information, individual recruiter contact
information, and resume submission information. If possible, augment this list with recruiters
you find on your own or hear about from your contacts. Depending on how strong your
qualifications are and how robust the hiring environment is, determine how wide to cast your
net. If you have a strong background and the hiring environment is good, you may wish to limit
your recruiter contacts to a smaller set most likely to have the best opportunities. If you have a
non-traditional background, or if the hiring environment is slow, you may wish to initially reach
out to as many recruiters as possible because opportunities for you may be scarce.
• ASK FOR REFERRALS: Many recruiters are overwhelmed with candidates, and getting their
attention can be difficult. Your response rate will increase if you can get one of your contacts to
send a referral email to their recruiter contacts. Another good approach is to ask your contacts if
you can reference them when you reach out to recruiters with whom they have a relationship. If
you get permission, make the subject line of your introductory email something descriptive like
“M&A group referral from <name of your contact>”. Recruiters are more likely to read your
email if the subject line includes attractive buzz words, the word referral, and the name of
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someone they recognize.
• SEND INTRODUCTORY EMAIL: Some recruiting firms have a specific resume submission email
addresses or resume submission form on their website. Feel free to use these submission
channels because they can help you make sure your resume is sent to the right recruiter,
especially within larger firms. However, contacting recruiters directly, if possible, is a good idea.
Your initial email to any recruiter should include your resume, a summary of the types of
opportunities you are interested in, and a summary of what makes you qualified for such
opportunities. Your message should also request a 10 minute introductory phone call at the
recruiter’s convenience. Many recruiting firms have information about their firm and
biographies of their recruiters on their website. Your odds of a response increase if you find a
way to use this information to make your email sound more personal and thoughtful. Keep this
message to fewer than 250 words.
• FOLLOW UP: If you don’t get a response within a week, follow up with another email or phone
call. When you follow up, acknowledge that the recruiter must be very busy and avoid sounding
whiny or entitled. If you include some sort of update about your job search in your follow up, you
can lend it an element of news instead of coming off as demanding or complaining. Reiterate your
desire to schedule a 10 minute introductory phone call at the recruiter’s convenience. If your
follow up fails to generate a response, you may wish to move on and focus your time on other
recruiters.
How do I get the most out of recruiters?
The following guidelines can help you ensure that recruiters work hard to match you with the right
opportunity and strongly advocate your candidacy.
• IMPRESS THEM: Recruiters look for candidates that have a desirable background and a
presentable demeanor because such candidates are the easiest to place. If you have a desirable
background, you are already a step ahead but can still damage your chances if you do not impress
on the phone or in person. If you have a non-traditional background, then you may have to
convince recruiters to take you seriously. The following guidelines can help you come across as
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an impressive candidate:
• Be 100% thoughtful and professional in all interactions, including email.
• Have a clear 3 minute response to the “please walk me through your resume” question.
• Be able to summarize exactly what types of positions interest you and what makes you
qualified.
• When speaking with a recruiter on the phone, pretend that it’s an interview. Convey your
confidence and excitement about PE through both your words and your voice. Speak at a
calm pace.
• Ask for an in-person meeting whenever possible. This is especially critical for candidates
who need to overcome a weaker background by making a great impression. Treat meetings
with recruiters as interviews. They are asking themselves whether they can picture you
impressing a PE interviewer. Wear a sharp conservative suit (grey or blue).
• COMMUNICATE WHAT YOU WANT: Be clear and specific about the opportunities that
interest you. If possible, provide recruiters with preferences about the size, location, industry
focus, and investment type of your desired employer. Doing so creates the impression that you
have thought carefully about what you want to do and ensures that you hear about all
opportunities that fit your interests.
• STAY IN TOUCH: Periodic check-ins help keep your name near the top of recruiters’ minds.
Recruiters also appreciate when you keep them updated about the status of your search so that
they don’t waste their time and their clients’ time.
• DROP THE ATTITUDE: Are you God’s gift to finance? Great. Keep it to yourself. Most recruiters
have seen it all before. Avoid acting entitled, arrogant, or impatient. Diva-like behavior won’t
impress anyone and may cost you a recruiter’s fulsome support.
• BE DISCREET: Recruiters often consider the names of their clients and the status of their
searches as confidential. Don’t be loose with this information, especially when working with
more than one recruiter at a time. If you spill confidential information, recruiters may fear you
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will spill their confidential information to others.
• BE HONEST: Recruiters appreciate candidates who are always honest about their background,
the status of their search, and their interests. Be careful not to give them the impression that you
would take an interview for practice rather than out of genuine interest. During the interview
process, be as honest as possible about how you think the process is going and whether you
would strongly consider an offer if it were given. Recruiters may lose faith in a candidate who
professes to be excited about an opportunity but turns down the offer if it comes.
• CONTROL YOUR RESUME: Make sure that recruiters never send your resume to a firm without
your permission. Also, keep a list of all firms your resume is sent to. You don’t want your resume
to end up in the hands of an unexpected person or to be sent to a firm from multiple recruiters.
• DO THEM FAVORS: If you decline a potential opportunity or are eliminated from a process,
consider referring another qualified candidate to the recruiter. If you hear about a new, nonconfidential search within their area of focus, let them know about it. The more you are able to
help your recruiters, the more they will like you and want to help you.
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3 Crucial Tips When Dealing with PE
Recruiters/Headhunters
3 Crucial Tips When Dealing with PE Recruiters/Headhunters
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module3-recruiting-overview/3-crucial-tips-when-dealing
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How to Choose an Offer
How to Choose an Offer
How to Choose an Offer
When PE professional evaluate an offer, they most commonly consider the upward mobility, job
security, and exit opportunities of their new position. Of course, they also consider how much they
would personally enjoy their new role, but in this guide we focus only on the first three categories.
Topic 1: Upward mobility
PE is a destination industry. Many people use consulting and investment banking as stepping stones
into a long term career in PE. In fact, most PE professionals who go to business school return to PE,
which is a retention rate few industries can match. The goal for most professionals in PE is to work
their way up to a partnership position where the bulk of the decision making power and financial
rewards reside. Therefore, one of the most important elements of an offer is how quickly it can lead
to a partnership position. The following factors can help you evaluate this criterion:
• MBA REQUIREMENT: If you are considering a pre-MBA role, then you may wish to know
whether an MBA is required to advance past the associate level. If an MBA is required, you may
wish to know whether the firm sponsors its associates for business school (pays their tuition)
with the intent of bringing them back for a career track position. If so, you should find out what
criteria associates must meet in order to be considered for sponsorship or to be brought back for
a career track position without formal sponsorship. If an MBA is not required, which is
increasingly common, then you may wish to find out what percentage of associates typically
make it further up the ladder and what criteria are used to make those decisions.
• PARTNERSHIP OPPORTUNITY: The following guidelines can help you determine how much
opportunity an offer gives you to attain partnership:
• Past precedent: How long it took current and former members to advance up the ladder
may be a useful proxy for how long you could expect it to take you, especially if your firm is a
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larger, mature organization with well-defined roles and career progressions.
• Growth opportunity: The fastest way to make partner is usually by joining a growing firm
where new partnership opportunities are created rather than waiting until a partner leaves
or retires. Partnership opportunities are typically created when a PE firm raises new funds,
increases the size of its AUM and expands into new geographies or new investment foci.
• Current partners’ plans: Another source of partnership opportunities is when current
partners retire or move on. If you can glean any information on current partners’ career
plans, this information can help you assess your own partnership opportunity. You should, of
course, be extremely careful and discreet when gathering this information.
Topic 2: Job Security
As with any new job, most applicants care very much about the stability of their employer and their
own job security. This concern is especially relevant in PE because not only is finding a similar job if
you are laid off difficult, your personal reputation is partially tied to the performance and reputation
of your firm. The following factors can help you evaluate the stability of your prospective employer:
• TURNOVER: Partnership positions in PE are extremely lucrative and scarce. If any partners
have left recently it raises a host of possible questions. Did they retire, leave PE, defect to a
competitor, or were they fired? Is there discord or any other drama amongst the partnership? Is
the firm’s target market slowing down? Is fundraising going badly? Are there any major negative
surprises in the company’s portfolio? Likewise, if any junior staff have left recently during an odd
time (i.e. before their program naturally concluded), it’s wise to discover why. Did they underperform? Did they jump ship for a better opportunity? Did they dislike the culture?
• FUNDING: A PE firm’s funding is its lifeblood. If funding dries up, then the firm stops making
investments, partners leave, bonuses shrink, and junior staff gets laid off. There are a number of
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ways to assess a firm’s financial health:
• Fundraising cycle: How much dry powder does the firm have remaining and when will it
need to raise its next fund? Have the firm’s most recent funds exceeded or fallen short of
target funding levels? If the firm needs to raise capital soon, is the fundraising environment
weak or strong?
• Recent track record: Is there any recent positive or negative news about the firm’s portfolio
companies or the sectors in which its portfolio companies operate? Has the firm made any
recent successful exits? Have any of its portfolio companies declared bankruptcy, been
written down, or been downgraded by a ratings agency?
• Deal activity: Has the firm been making deals at a healthy pace? Is it actively pursuing new
deals?Does it have a healthy pipeline of new deals? Are there any deals currently under
letter of intent (LOI)? Have any recently announced deals failed to close?
• Limited partner base: How diversified is the firm’s LP base? How longstanding is the firm’s
relationship with its biggest LPs? Has there been any recent troubling news about the firm’s
LPs or the sectors in which they operate? Have any of the LPs recently attempted to reduce
or sell their stakes?
Topic 3: Exit Opportunities
Although PE is a destination industry, many candidates still care very much about how marketable
their new position makes them should they ever choose to go to graduate school, leave PE, or pursue
a position with a different PE firm. The following guidelines can help you evaluate how a particular
position is likely to affect your future options:
• EXPERIENCE: The nature of your role and experience strongly affects the exit opportunities for
which you are seen as qualified. Consider how the following factors will affect you if you ever
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move on from your firm:
• Deal activity: One of the first questions you are asked during interviews is, “Tell me about
the deals you worked on?” If you can point to a number of completed deals on which you
played a significant role, future recruiters will see it as proof that you have what it takes to
bring a deal across the finish line. Having a lot of completed deals on your resume also allows
you to showcase your investment judgment when you discuss the merits and challenges of
each deal.
• Deal size: Working on a $10 billion dollar deal is a very different from a $1 billion deal,
which is very different from a $100 million deal or a $10 million deal. Larger deals often
mean larger deal teams, more legal and accounting issues, a more complex capital structure,
and more operating units, in addition to other differences. As a general rule, individuals who
work on smaller deals are responsible for a greater portion of the overall deal, but may not
get the opportunity to tackle additional complexity. For this reason, professionals who have
successfully overseen large deals find it easier to transition to doing smaller deals than vice
versa.
• Deal stage: Another experience differentiator is whether you work on primarily early stage,
mid stage, late stage, or distressed deals. The more that you specialize in one particular
stage, the more attractive you become to other firms that focus on that stage. On the other
hand, it may be difficult to transition between stages. For example, someone who has
worked primarily on early stage deals may have to work hard to convince a late stage firm
that he or she can handle the additional complexity of late stage deals. Someone who has
worked primarily on late stage deals might have to work hard to convince an early stage firm
that he or she has the requisite breadth of industry knowledge and passion for startups.
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• Industry focus: If you work for a generalist fund it may be difficult for you to transition to a
more sector or industry-focused fund in the future. On the other hand, if you work for a
highly specialized fund, you may find it difficult to break out of that niche. As a general rule,
you should look to specialize in an industry only if you are passionate about it and want to
work in it for a long time.
• Role: The final major experience differentiator is which parts of the deal process you are
responsible for. If you focus on sourcing, investment theme development, execution, due
diligence, or portfolio management, then you are more marketable for positions which focus
on your area of expertise. The general rule is, the more roles you play, especially in an
oversight capacity, the greater your range of exit opportunities.
• BRAND: A strong brand can be helpful if you ever leave the firm to go to graduate school,
transition to another PE fund, or look for a job outside of PE. A firm’s brand is a combination of
some of the following factors:
• Size: Larger firms tend to be more prestigious for two reasons: First, they tend to work on a
larger number and higher profile deals, so more people are likely to have heard of them.
Second, LPs tend to give PE firms larger capital commitments when the PE firms perform
well and hire reputable partners. It is common to see partners from larger firms moving to
smaller firms, but it is less common to see professionals from smaller firms moving to larger
firms.
• Performance: Strong historical performance often goes hand-in-hand with larger firm size
and is a big component of a firm’s brand. Being associated with a strong performer enhances
the cachet of your resume. Strong performance is especially important for more senior
positions because they are the ones with the ultimate decision making power.
• History: PE is a relatively young industry, one in which succeeding consistently is difficult.
Funds that have a long track record are more likely to be well known and respected.
• Team pedigree: It’s a mistake to read too much into the biographical details of a PE firm’s
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partners and team members. However, there is truth in the notion that people with
prestigious backgrounds tend to seek prestigious positions and attract other people with
similar backgrounds. If most of a firm’s team members hail from prestigious firms and
universities, and if most of its alumni transition to other prestigious institutions, then that’s a
signal the firm’s brand is well regarded.
How do I evaluate these topics?
As a PE professional, your job is to do your due diligence before you make an important decision.
Since choosing your employer is one of the most important decisions you will ever make, get as many
of your questions answered as possible. You should be able to get answers to many of these
questions by asking your interviewers and by researching information available on the firm’s
website. You will find that a firm’s junior staff is often more candid than its partners and HR staff. A
firm’s recent alumni are another great source of information. Any associates who have recently
entered business school or transitioned to a different firm are often more candid than current
employees. You should always ask to speak with as many current employees as possible and ask for
the names of any recent alumni before accepting an offer. Finally, finance message boards, blogs, and
news wires can be a goldmine of information. Refer to the appendix for a list of websites you should
visit.
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3 Ways to Find the Dirt and Get a Good Grasp of
Private Equity Firms
3 Ways to Find the Dirt and Get a Good Grasp of Private Equity Firms
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module3-recruiting-overview/3-ways-to-find-the-dirt-and-get
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Bonus Webinar: PE Recruiting Process in Detail
Bonus Webinar: PE Recruiting Process in Detail
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module3-recruiting-overview/bonus-webinar-pe-recruiting
Relevant Files:
wall_street_oasis_webinar_pe_recruiting_process_6_11.pdf
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How to Write Your Resume
How to Write Your Resume
How to Write Your Resume
A recruiter will take no more than a minute to scan your CV out of a pile of hundreds, so every word
has to count and there can be no errors.
What Your CV Must Say About You
Your CV should make it obvious that you possess to a superior degree the following characteristics
which PE recruiters look for:
ANALYTICAL SKILLS
• Any jobs or roles which required quantitative analysis
• Academic credentials in quantitative courses
• Examples of completed projects which required analysis of large data sets
• Examples of academic or work-related studies which followed a hypothesis-driven investigative
approach
• Examples of a time you discovered a problem and fixed it or figured out a way to make an
existing process even better
• Examples of building complicated operating or projection models
ATTENTION TO DETAIL
• Zero grammar and formatting errors on your CV
• Not a single comma out of place; standardized abbreviations; aligned margins; consistent fonts,
etc.
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EXCEPTIONAL WORK ETHIC
• Examples where you went above and beyond your assigned responsibilities
• Achieved particularly strong academic, personal, or professional results
• Exceptional grades in tough courses
• Major athletic accomplishments
• Rapid promotion in a demanding job
EXCEPTIONAL COMMUNICATION SKILLS
• Written communication experience
• Slide presentations, articles, academic papers, memos, etc.
• Verbal communication experience
• Oral presentations, speeches, leading meetings, leading negotiations, etc.
FINANCIAL MODELING PROFICIENCY
• Examples of jobs or roles which involve financial modeling
• Examples of times you have built financial models like LBOs, DCFs, valuations, comparable
analysis, etc.
• Examples of finance classes you have taken either in school or via specialized training programs
like WallStreetPrep
• Any financial certificates you have like the CFA
INDEPENDENCE
• Examples of times you took initiative or structured your own work
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LEADERSHIP AND TEAMWORK SKILLS
• Membership or leadership positions in collaborative activities like boards, sports teams,
fraternities/sororities, clubs, community service organizations, etc.
• Experience working on deal teams, project teams, case teams, etc.
• Experience working on academic group projects
• Examples of times you led or influenced a group of people to accomplish a goal
CV Tips
• Use the resume template which comes with this guide or borrow one from a friend who works in
investment banking. PE recruiters expect this format. There is no up-side in this case to getting
creative.
• Keep your CV at no longer than 1 page.
• Have your colleagues and career mentors check your CV for content, grammar, and formatting.
• Tailor your resume to individual firms (e.g. if you have particular domain experience that you
know they are looking for).
• Quantify the results of your work whenever possible; estimate when necessary (e.g. “saved my
deal time ~50 hours of work by …”).
• Use common industry lingo where appropriate because recruiters sometimes look for certain
buzz words as they scan a CV (e.g. “LBO”, “restructuring”, “deal”, “due diligence”, “IPO”,
“benchmarking”, “M&A”, etc.).
• Start role, task, and project descriptions with past tense verbs like “led”, “developed”,
“performed”, “designed”, “presented,” etc.
Standard PE Resume Template
Investment banking analysts are the most common PE recruits, and junior investment bankers use a
near-universal template for their resumes. Consequently, this template, with minor variations, has
become the industry standard for PE recruiting. It is highly advisable that you use this template for
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your CV and refer to the sample CVs in the appendix as a guide:
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Resume Prep for Private Equity Interviews
Resume Prep for Private Equity Interviews
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module3-recruiting-overview/resume-prep-for-private-equity
Relevant Files:
wso_webinar_resume_prep-pe_interviews_march_2.pdf
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5 Common Mistakes on PE Resumes that Can Hurt
You
5 Common Mistakes on PE Resumes that Can Hurt You
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module3-recruiting-overview/5-common-mistakes-on-pe-resumes
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Module 4: Interview Preparation
Interview Process
Interview Process
Interview Process
The PE interview process for pre-MBA and MBA OCR varies from firm to firm. Some firms do all or
only some of the following steps, and the order can vary somewhat (especially if there is a modeling
test), but the following process is common:
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Interview Process
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Interview Process
What is an LBO?
Definition of an LBO and why it uses leverage
An LBO is the acquisition of a company where the buyer contributes some of its own money (equity)
along with a lot of borrowed money (“debt” or “leverage”) to fund the purchase. Debt makes up
50–80% of the purchase price of a typical LBO. The buyer uses the cash flow of the target company
to make interest payments on the debt and pay down the principal over time. If the buyer is a PE firm,
it will hold (own) the target for ~5 years and then look to sell it for a profit. By using debt to fund the
acquisition, the PE firm risks only a fraction of the purchase price and increases the return on its
equity. Consider the following simplified example:
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Why LBOs Use Leverage and 3 Other Ways to Boost
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Why LBOs Use Leverage and 3 Other Ways to Boost Returns
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3 Financial Statements
Income Statement Overview
The income statement presents a company’s sales over a period of time (usually a fiscal year or
quarter) along with the expenses which were incurred to generate these sales. The purpose of the
income statement is to match sales up with their associated expenses as closely as possible in order
to show how profitable the company is during a particular period.
SALES (AKA REVENUE): Sales measures how much goods or
services a company sells during a particular period. Simply put,
sales is the number of units of goods or services the company has
sold multiplied by the average price per unit customers agreed to
pay. One caveat is that sales made are not the same thing as cash
actually received. In order to be recognized as sales on the
Income Statement, a particular transaction must meet an
accounting standard of being both “earned” and “realized,” but
no cash necessarily needs to change hands. For example, if a
manufacturer sells a widget to a customer and delivers said
widget, the manufacturer may recognize the sale on its income
statement before the customer actually pays for it as long as the
customer is considered credit-worthy.
COST OF GOODS SOLD (COGS): COGS measures what expenses the company incurred in the direct
production and/or delivery of the goods and services recognized as sales. Different businesses
classify different expense categories as COGS, but the most common categories are the cost of
materials and direct labor. Some companies also classify other expense categories such as
transportation and commissions paid to sales people under COGS. COGS are usually relatively
variable with sales. For example, if a company sells 1,000 fewer units of its product, it won’t need to
procure as much raw materials and might not need to employ as many hourly laborers during the
income statement period.
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GROSS PROFIT (AKA GROSS MARGIN): Gross profit equals sales less COGS. Gross profit as a % of
sales is a metric which is commonly tracked as an indicator of a company’s profitability.
OPERATING EXPENSES (AKA OPEX OR SOMETIMES SIMPLY SG&A): Opex measures the
expenses a company incurs during the income statement period but are not directly incurred in the
production and/or delivery of specific goods or services. Expense categories which fall under Opex
are typically those which are relatively fixed from period to period regardless of how many units of
its products the company sells. Common Opex categories include administrative overhead,
occupancy costs, advertising and marketing, and R&D.
OTHER INCOME: Other income refers to profits the company receives from non-core operations or
minority interest in other companies. Other income is rarely at issue during PE interviews. If you ever
need to model it you can usually just keep it constant from period to period because it is by definition
not a core part of whatever company you are looking at.
EBITDA (EARNINGS BEFORE INTEREST, TAX, DEPRECIATION, AND AMORTIZATION): IBITDA
is Gross profit less Opex plus Other Income. EBITDA is critically important in PE because it is
frequently a quick proxy for a company’s cash generating capability. The Total Enterprise Value
(TEV) of a company is frequently calculated and quotes as a multiple of EBITDA. How much debt a
company could take on as part of an LBO is also commonly calculated and quoted as a multiple of its
EBITDA. Note that for the purposes of EBITDA Opex must not include depreciation and amortization.
DEPRECIATION AND AMORTIZATION (D&A): D&A are non-cash expenses which are meant to
proxy the aging and decay of a company’s capital plant and intangible assets. At a high level, not all
expenses companies incur show up on their income statements right away. Some expenses are
instead categorized as Capital Expenditures (or Capex) and appear on the Cash Flow Statement
instead because they support the generation of revenue far into the future instead of just during the
current period. Examples of such expenses may include the construction of a factory, the purchase of
patents and trademarks, and even some forms of R&D. Such assets tend to become less valuable over
time as factories break down and patents become obsolete. D&A captures this process of
obsolescence as a percentage of the initial cost of these long-term assets.
EBIT (AKA OPERATING INCOME OR OPERATING PROFIT): IBIT is EBITDA less D&A. Note that
some companies include D&A as part of Opex. For such companies EBIT and EBITDA essentially
switch places in the income statement. In order to get to EBITDA, D&A has to be added back to EBIT.
Company valuations and debt levels are frequently calculated and quoted as a multiple of its EBIT,
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either instead of or in addition to EBITDA multiples.
NET INTEREST: Companies pay interest on their debts to others and receive interest payments on
their loans to others. Net interest is simply the sum of interest payments and receipts. Interest is not
counted as an operating expense (and therefore isn’t taken out of EBIT) because it typically depends
on how a business is capitalized rather than how inherently profitable it is. Net interest can be
positive or negative, but is almost always negative for companies which become highly levered via an
LBO.
EBT (AKA EARNINGS BEFORE TAX): EBT is EBIT less Net Interest. EBT is important only insofar as
corporate taxes are calculated based on a percentage of EBT.
INCOME TAX: These are all of the taxes a company pays on its taxable profits. Tax rates vary
dramatically across geographies and industries due to different tax regimes and corporate
structures. Taxes also depend on whether the company has any Net Operating Losses (NOLs) to
offset current-period taxes due to operating losses in the past.
NET INCOME (AKA EARNINGS): Net Income is EBT less taxes. Net Income is meant to be the most
accurate measure of a company’s real profitability and is the most common basis for measuring the
equity value of a company. Note that Net Income accrues only to the equity holders of a company
because debt holders have already taken their pound of flesh in the form of interest.
DILUTED SHARES OUTSTANDING (DSO) AND EPS: DSO refers to the number of shares, or pieces,
a company’s total equity is broken up into if all outstanding equity-granting instruments (like options,
stock grants, warrants, etc.) were exercised. Earnings per share (EPS) is the quotient of Net Income
over DSO. EPS is the most common basis for valuing a single share of a company’s stock.
Balance Sheet Overview
The balance sheet is a snapshot of a company’s financial condition and book value on a particular
date (usually the last date of a fiscal year or quarter). Items in the balance sheet all fall under the
categories of Assets, Liabilities, and Shareholder Equity. The balance sheet gets its name from the
fact that Total Assets must always equal Total Liabilities plus Shareholder Equity. Assets are defined
as resources which are controlled by the company and are useful for generating an economic benefit.
Liabilities are monetary obligations that the company owes to outside parties. Shareholder Equity is
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the difference of Assets less Liabilities.
Cash Flow Statement Overview
The cash flow statement (CFS) tracks how much cold hard cash a company generates within a given
timeframe (usually a fiscal year or quarter). The CFS is essential because companies need enough
cash to perform their daily operations. No matter how profitable a company is on its income
statement how well capitalized it is on its balance sheet, losing sight of the cash flow statement can
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lead to bankruptcy. The cash flow statement is broken down by three different categories of sources
(and uses) of cash: operating activities, investing activities, and financing activities.
The cash flow statement looks complex but its governing principles are simple:
FINANCING ACTIVITIES: Tracks the cash received or spent related to the purchase or sale of equity
or debt. This section also tracks cash spent on payments of shareholders’ dividends.
NET INCOME: Comes directly from the income statement for the same period as the cash flow
statement to give us a starting point to make our cash adjustments.
DEPRECIATION & AMORTIZATION (D&A): We add these non-cash expenses from the income
statement back in the cash flow statement because they have no current-period impact on cash.
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These expenses stem from the obsolescence and decay of tangible and non-tangible assets which
were acquired from previous periods.
DEFERRED TAXES: Deferred taxes are usually an asset on the balance sheet. Therefore, when they
increase, cash decreases and must be subtracted from Net Income on the CFS. When deferred taxes
decrease, cash increases and must be added back to Net Income on the CFS.
EQUITY COMPENSATION (AKA STOCK-BASED COMPENSATION): Some companies pay their
employees (especially senior managers) with equity such as stock options or grants instead of cash
(salaries and bonuses). This form of compensation is expensed on the income statement as part of
operating expenses, but no cash is actually paid during the current period, so equity compensation is
added back to Net Income in the CFS.
INVENTORIES: Inventories are an asset. Refer to the table above for their impact on the CFS.
ACCOUNTS RECEIVABLE (AR): AR is an asset. Refer to the table above for its impact on the CFS.
ACCOUNTS PAYABLE (AP): AR is a liability. Refer to the table above for its impact on the CFS.
DEFERRED REVENUE: Deferred revenue is a liability. Refer to the table above for its impact on the
CFS.
CAPITAL EXPENDITURE (CAPEX): Capex (aka payment for PP&E) is cash spent on the acquisition
of assets (usually long-term noncurrent assets) that will benefit the company in future periods. Since
capex expense does not support the company’s generation of sales or profits in the current period, it
is not included as an expense on the current period Income Statement. However, since capex is a real
cash expense in the current period, it must be treated as a use of cash on the CFS.
OTHER INVESTING ACTIVITIES: Most CFSs break out Other Investing activities into such line
items as the purchases and sales of securities, investments, and corporate divisions/entities. These
items are rarely an important part of an LBO model so we won’t dive deeply into them here. Just
remember that when a company sells items of this nature cash from Investing Activities goes up, but
when the company buys items of nature cash from Investing Activities goes down.
CASH FROM DEBT: When a company issues debt (borrows), its debt liabilities go up on the balance
sheet and cash from Financing Activities on the CFS increases from the debt proceeds. When a
company repays its outstanding debt principal, its debt liabilities go down, and its cash from
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Financing Activities also goes down since the repayment is made in cash.
CASH FROM EQUITY: When a company issues new equity (shares), its shareholder equity liability
on the balance sheet goes up and cash from Financing Activities goes up from the equity issuance
proceeds. Shareholder equity decreases when a company buys back its shares with cash, while cash
from Financing Activities decreases.
SHAREHOLDER DIVIDENDS: When a company pays cash dividends to its shareholders, cash from
Financing Activities decreases.
Financial Statement Connections
Understanding how the major financial statements connect is critical for modeling a company’s
financial performance and for answering common PE interview questions. This section highlights the
high level links, and the LBO modeling section delves into more detail.
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NOTES:
• Depreciation reduces Net PP&E and amortization reduces non tangible assets. More of these
assets on the balance sheet usually leads to more D&A on the income statement
• Current and long-term debt is what generates interest expense. More debt on the balance sheet
usually leads to higher net interest on the Income Statement.
• Net Income from the income statement is added directly to Shareholder Equity
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NOTES:
• The only major direct connections between the income statement and the cash flow statement
are that the Net Income and the D&A portions of the Cash from Operating Activities come from
the income statement.
• The rest of the connections between the income statement and the balance sheet go through the
balance sheet.
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NOTES:
• PURPLE: Balance sheet cash is the beginning cash of one CFS period and the ending cash of
another CFS period
• YELLOW: D&A decreases PP&E, non-tangible assets, and goodwill; capex and some other
investing activities increases PP&E, non-tangible assets, and goodwill.
• GREEN: Increases in these assets on the balance sheet decreases cash from operating activities;
decreases in these assets increase cash from operating activities.
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• RED: Increases in these liabilities on the balance sheet increase cash from operating activities;
decreases in these liabilities decrease cash from operating activities.
• BLUE: Increases in debt increase cash from debt, and decreases in debt reduce cash from debt;
increases in cash from equity increase shareholder equity, and decreases in cash from equity
reduce shareholder equity; shareholder dividends reduce shareholder equity.
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Why You Should Care About Changes in Net Working
Capital
Why You Should Care About Changes in Net Working Capital
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Capital Structure
Capital Structure
Capital Structure
The capital structure of a company refers to how the company is financed, who has an ownership
claim on the company and its assets, and the seniority of those claims. Every company needs some
form of financing to get off the ground and to fund daily operations because every company needs to
buy raw materials, pay employees, etc. A company may be financed through equity or debt or a
combination of both. There are many different types of equity and debt, and each of them has
different characteristics including riskiness, expected rate of return, and seniority. Understanding
capital structure is important because LBOs usually radically change the target’s capital structure
and derive a great deal of their returns from these changes.
Equity
Equity holders are investors who have provided the company with cash financing in exchange for a
direct ownership stake in the company. Equity holders own shares of the company and can usually
vote on important matters such as who sits on the company’s board and who should be the
company’s CEO, CFO, etc. Equity holders control the company’s strategic direction and investment
decisions through the people they appoint to run the company. In addition, equity holders are the
direct beneficiaries of a company’s net income profits. Equity holders can decide whether the
company pays its net income out to them via dividends/share repurchases or re-invests its net
income to grow the business and generate more net income in the future. Equity holders have a lot of
control over the company and benefit from nearly all of the financial upside when the company
grows.
On the other hand, equity holders own the most junior/least senior claim on the company’s profits
and assets. Equity holders do not get paid until the company has paid any interest and principal owed
to debt holders. If the company fails to make any scheduled payments to debt holders, the company is
in default, and the equity holders can lose their entire ownership claim. In the event of default, debt
holders can take all of the equity away from the original equity holders and take control of the
company. In the event of bankruptcy, equity holders do not get a penny until debt holders have been
repaid in full. If the company does not have enough asset value to repay the debt holders in full, then
all residual value goes to debt holders while the equity holders get nothing. For these reasons,
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owning the equity of a company is the riskiest investment you can make in a company, so equity
holders usually demand high expected returns relative to more senior investors. Since equity
investors tend to to tolerate higher risk in exchange for higher reward, they also frequently want to
take an active role in the management of the company. There are several common ways investors
might become equity holders of a company:
• Provide bootstrap / angel / VC funding during start-up in exchange for shares
• Buy stock shares during an IPO or on the open market once the company goes public
• Buy options, warrants, or other equity-granting instruments, and exercise them for stock
• Be granted stock, options, or warrants in lieu of cash compensation (common for executives and
board members)
• Provide some or all of the equity portion of the financing of an LBO of the company
Debt
Debt holders are investors who provide the company with cash financing in exchange for a
contractual promise to be repaid over a set period of time with a set amount of interest (yield). Any
investor that lends money to a company becomes one of its debt holders. Debt holders typically have
little or no say over the company’s strategy or daily operations with the exception of certain
contractual covenant rights (explained later). As long as debt holders are paid their stipulated
interest and principal on time they are generally happy to sit back and watch the money trickle in. As
long as the company avoids default, debt holders have no claim to a financial upside beyond their
contractual interest payments when the company grows. Excepting special distressed debt
situations, debt holders have only downside if the company defaults or goes bankrupt.
On the other hand, debt is more senior than equity in the capital structure. Debt holders gain a
massive amount of power if the company ever defaults on its debt payments. In case of default, debt
holders may force the equity holders to do their bidding or take over control of the company directly.
In case of bankruptcy, debt holders are repaid in full before equity holders get any of the remaining
scraps (if there are any). For these reasons, owning a company’s debt is the safest investment you can
make in a company. Since debt is less risky than equity, the interest rate (yield) that debt holders
receive is lower than the rate of return equity holders expect. Debt investors are generally risk
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averse and want to minimize the odds of losing any of their principal. Characteristics of different
types of debt are listed in the table below.
LBO Capital Hierarchy
LBOs are typically executed with a mixture of capital sources, many of which fall in different levels of
seniority. The following tables lists the most common types of LBO capital sources along with their
associated characteristics and annual return expectations:
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Covenants
Covenants are contractual agreements between lenders and borrowers. Lenders typically have little
control over a company’s strategy and the utilization of its capital as long as the company is current
on its debt payments. However, debt holders are risk averse and want extra protections to ensure
they get their due payments in the future. Covenants give lenders certain rights and protections. The
two main types of covenants are incurrence and maintenance.
• INCURRENCE COVENANTS are common for both bank debt and subordinated debt (bonds).
The objective of such covenants is to prevent the company from taking actions which would
harm the covenant holder, unless the covenant holder agrees to such actions action after
negotiating appropriate compensation with the company. Common types of incurrence
covenants:
• The company may not incur debt which is more senior in the capital structure than that of
the covenant holder. This type of covenant is crucial to debt holders because, as explained
above, the security of their investments depends on being senior in the capital structure.
• The company may not incur more debt of any kind which would cause it to exceed a total
leverage ratio or total debt quantum
• The company may not spend its cash on certain types of capital investments or acquisitions
or shareholder dividends without the lenders’ approval
• There are no periodic tests for incurrence covenants, unlike maintenance covenants below
• MAINTENANCE COVENANTS are common for bank loans. The objective of such covenants is
to ensure the company maintains a sufficient cash and profitability cushion to never even
approach default. If the company ever fail (or “trips”) one of these covenants, then the company
may be declared in default and the lenders could take control of it or force the equity holders
into negotiated concessions. The following are common maintenance covenants:
• The company must always keep its debt ratio below a certain ceiling (e.g. Debt / EBITDA
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must never exceed 4.0x or Debt / Equity must never exceed 2.0x)
• The company must always maintain an interest coverage ratio above a certain floor (e.g.
EBIT /Total Annual Interest expense must never be below 3.0x)
• Maintenance covenants are subject to periodic (usually quarterly) tests, a crucial distinction
between maintenance covenants and incurrence covenants. The company must routinely
prove its compliance with its maintenance covenants after every period to avoid default.
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4 Capital Structure Tiers to Know Well
4 Capital Structure Tiers to Know Well
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Common Valuation Techniques
Common Valuation Techniques
Common Valuation Techniques
There are several ways to value a company, different situations call for different techniques. It is
important to understand the most commonly used techniques as well as their pros and cons.
Comparable Multiples
Multiples are the most commonly used type of valuation (and metric) in PE. A multiple is simply the
ratio of the value of a company relative to some quantitative measure of its performance. The most
common multiple in PE is Total Enterprise Value (TEV) / LTM EBITDA. For example, a 7.0x EBITDA
multiple for a company which generated $100 million of EBITDA over the past twelve months implies
that the Total Enterprise Value of that company is 7x * $100 million = $700 million.
Investors are willing to pay higher multiples for companies which they expect will perform better in
the future. For example, all else being equal, investors willing to pay higher multiples for companies
with stronger competitive positions and exposed to more attractive industries because such
companies are likely to become larger and more profitable in the future. Investors are willing to pay
more today for companies which will be more profitable in the future. For example: Companies A and
B each currently have $100 million of EBITDA, but Company A’s EBITDA will grow by 10% per year
while company B’s EBITDA will decline by 10% per year. All else being equal, any sane investor would
pay a much larger multiple of company A’s current EBITDA compared to company B.
You can use multiples to value a company by comparing it to a group of companies which have similar
characteristics (often referred to as “comparables”, or “comps” for short). For example, let’s say we
need to value car manufacturer “A” that has $100 million of LTM EBITDA and is projected to grow at
10% per year. Let’s say we found the following list of publicly traded comparable car manufactures:
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From this list you could conclude that a valuation range of 8.5x–11.0x LTM EBITDA is reasonable and
that 10.0x is a good estimate. These comps would lead you to conclude that company A is worth
roughly $100mm * 8.5x-11.0x = $850mm–$1,100mm with an estimate around $100mm * 10.0x =
$1,000mm.
Good comps are frequently competitors or companies in the same industry, companies that perform
similar functions, or companies that have similar profiles as the target. Choosing the closest comps is
sometimes as much an art as it is a science. The trick is to find companies which most closely mirror
the characteristics of the target that investors care about most, such as growth, profitability, and
competitive position.
In addition to TEV / EBITDA, other common multiples include:
TEV / EBIT
• EBIT is a better metric than EBITDA when comparing companies with different levels of D&A
which EBITDA doesn’t capture. Different levels of D&A are commonly found in companies which
have different levels of capital intensity (i.e. different levels of capital investment into PP&E).
Price / Earnings (aka P/E Ratio)
• This metric typically equals the market value (market capitalization) of the equity of a publically
traded company over its LTM Net Income. This is the most common valuation multiple for
publically traded stocks. Keep in mind that this metric applies only to the equity value of the
company rather than its TEV. This is because net income belongs to a company’s equity holders
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since debt holders are paid interest before any money flows to equity holders.
TEV / Revenue
• This metric is used for companies which aren’t profitable or have highly cyclical levels of
profitability (such as commodity businesses).
There are many other useful multiples, but the above should cover you in the vast majority of
interview situations.
Pros of multiples
• Multiples are a quick way to gauge the relative value of companies of different sizes. They scale
in a way which makes it possible to glean valuation information about a company from the
valuation of other companies which are both larger and smaller.
• Multiples are less volatile and less prone to assumption-driven swings than bottoms-up
valuation methodologies such as the Discounted Cash Flow.
Cons of multiples
• If the market’s valuation of the comps is wrong, then your valuation of your target will be equally
wrong.
• No single comp is a perfect proxy for a different target company. Finding enough solid comps to
average out the idiosyncratic differences can be difficult.
Precedent Transactions
Comparable multiples can be used with precedent transactions data just as effectively as with
publicly traded stock data. Companies and investors are constantly making deals to purchase either
entire companies or divisions of companies. During such transactions, buyers are paying some price
for assets which have certain performance characteristics (revenue, EBITDA, EBIT, earnings, etc.).
When the right data is available, comparable multiples may be based just as easily on precedent
transactions as on public markets trading data. For example, let’s say it is 2014, and we are trying to
value a women’s apparel retailer which has $100mm of EBITDA. We have assembled a list of the
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following precedent transactions of women’s apparel retailers over the past 5 years:
From this data you might conclude that the value of your target women’s apparel retailer is
~7.5x–12.5x its EBITDA, or ~$750mm - $1,250mm, with an estimate around $1,050mm
Pros of precedent transactions
• Precedent transactions include the premium buyers sometimes pay to gain control of a target in
order to make operating improvements, exploit its cash generating capacity, and take advantage
of any synergies.
• Precedent transactions data is sometimes available on private companies where public market
trading information is not available.
Cons of precedent transactions
• Precedent transactions have all the same cons as comparable multiples.
• In addition, precedent transaction data is frequently sparse and spread over many years.
Precedent transactions data from previous years may be less relevant if the industry has
undergone significant change and/or the market has passed through various cycles.
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Market Value
If your target is publicly traded, estimating its value is easy because the market does the work for
you. The total market capitalization of a company is the market’s estimate of the value of its equity.
As long as the company is not in financial distress, then the face value of its long term debt less its
excess cash equals the market’s estimate of the value of its net debt. If you add market capitalization
value to the value of net debt you will get the market’s valuation of the target’s TEV. These values
fluctuate daily along with the target’s stock price. As a general rule, the larger the company, the more
heavily it is covered by stock analysts and traded by sophisticated investors. Therefore, as a general
rule, larger companies are more efficiently valued by the market than are smaller companies.
Pros of market value
• Market value is always up-to-date and is instantly available for public companies.
• Market value is determined by the individual decisions of many investors so it reflects the
collective work and judgment of many people.
Cons of market value
• The market can be wrong … sometimes by a lot … if it wasn’t then hedge funds and other public
market investors would almost never beat the market.
LBO Model
An LBO model may be used to value both public and private companies if you can project their ability
to generate free cash flow. The details of LBO modeling are covered in the next chapter.
Pros of LBO modeling
• LBO models are built from the ground up and do not depend as much on trusting the wisdom of
the public markets (which can be very wrong).
• LBO models can capture the value of optimizing a company’s capital structure (often by using
more debt than the public market is comfortable with).
• LBO models can capture the value of operational improvements private owners could enable
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that would otherwise be difficult for a public company to execute.
Cons of LBO modeling
• LBO modeling requires making many uncertain assumptions about a company’s operating and
financial performance at least 3-5 years into the future.
• LBO modeling requires access to more data and entails a lot more work than valuations based on
comparable multiples, precedent transactions, or market values.
Discounted Cash Flow (DCF)
The DCF model relies on two assumptions. First, the financial value of any company depends solely
on what cash profits or dividends it can generate for its owners over time. This assumption implies
that any two companies which will produce equivalent cash profits for their owners at all times and in
all scenarios in the future must have equal financial value. Second, the value of cash profits today is
different from (and almost always more than) the value of cash in the future. This assumption is made
because if you have cash today you can invest it and have more cash in the future. Therefore, $100
today is worth more than $100 in the future (assuming you have investment options with positive
nominal returns). For this reason, expected future cash flows in a DCF must be “discounted” to
reflect the “time value of cash”.
The first step in a DCF is to project a company’s FCF for ~5 years forward. See the section on FCF for
details of how FCF is calculated and why it is a good proxy for DCF profits. The second step in a DCF
is to calculate an appropriate discount rate for the profits projected in the first step. There are
different ways of calculating an appropriate discount rate, but the most common is called Weighted
Average Cost of Capital (WACC). See the section on WACC for details on how to calculate it and
what it means. The third step in a DCF is to project the target’s Terminal Value (TV) after the last year
of projected FCF. See the section on Terminal Value for details. The final step is to apply the following
formula to discount the value of all future cash flows back to the present day to calculate the present
total value of the enterprise:
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Pros of DCF
• DCF is the most ground-up valuation methodology available. All other valuation methodologies
rely on it either implicitly or explicitly. The market value of securities is predicated on the cash
value investors expect to receive from them in the future in the form of dividends and capital
gains (stock price appreciation). Multiples also implicitly rely on DCF principles. Investors are
willing to pay higher multiples for companies which they expect will become more profitable in
the future and lead to more dividends and capital gains.
Cons of DCF
• Despite being theoretically sound, DCF is used less frequently in PE than multiples, LBO, and
precedent transaction analysis because the assumptions which drive a DCF are very sensitive
and can lead to wildly different valuations. In addition, most of the value in many DCFs lies in the
TV which is frequently estimated using comparable multiples analysis anyway.
Sum-of-the-Parts
If the target is made up of distinct and separable divisions, then all of the above valuation methods
may be performed on individual divisions and added together. This technique is most commonly
applied if a partial or total break-up of the target is being contemplated.
Pros of sum-of-the-parts
• This analysis can capture the value of breaking the business apart either partially or entirely.
Sometimes certain parts of a business are more valuable as a stand-alone entity than as part of a
larger business. For example, Carl Icahn recently asserted that Ebay should spin off Paypal
because Paypal would be worth more as a stand-alone company than as a subsidiary of Ebay.
Cons of sum-of-the-parts
• This analysis has all of the same cons as the other valuation techniques.
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• Moreover, how much breaking up a business will cost and how the resultant pieces are likely to
perform can often be very difficult estimate.
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Common Calculations
Common Calculations
Total Enterprise Value (TEV)
TEV is the measure of the financial value of a company to all financial stakeholders, the investors who
have an ownership claim on the company. The universe of investors who have an ownership claim on
the company encompasses all equity holders in the company as well as all debt holders. Equity
holders are obviously owners because they control the company, but debt holders are also owners in
a sense because they could gain ownership/control of the company if it fails to make interest
payments or repay principal on time. Therefore, TEV = Value of Equity + Value of Debt–Excess Cash.
The value of equity is typically calculated using the market value (market capitalization) of a
company. The Value of Debt is typically calculated as the total face value of outstanding debt on the
balance sheet. Excess cash is defined as cash on the balance sheet which is not needed for the
ongoing operation of the business. Excess cash is subtracted from TEV because in the event of an
LBO the sellers will usually keep any excess cash. Another way to look at excess cash is that it doesn’t
reflect the value of the underlying business operations. Imagine a company which does nothing, has
no revenues or profits, but has $100 on its balance sheet. Such a company would nominally be worth
$100, but the value of the underlying operations is zero.
Free Cash Flow (FCF)
FCF is the lifeblood on an LBO because FCF determines how much debt a company can service which
then determines how much leverage an LBO can use. The conceptual explanation of FCF is that it is
the total amount of cash profits that a company can pay out to its owners, be they equity holders or
debt holders. Equity holders are generally paid with dividends, whereas debt holders generally get
interest payments. The fastest way to get to FCF is as follows:
• Start with EBIT on the income statement.
•
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Multiply EBIT by (1–Tax Rate) because taxes are a cash expense.
• Note: for the purposes of FCF do not subtract interest expense from EBIT. FCF is calculated
on an unlevered basis (i.e. disregarding any debt or interest expense the company has).
• Add back depreciation & amortization (D&A) because these are expenses which are captured on
the income statement but do not impact cash.
• Subtract capital expenditures because these are cash expenses that are not captured on the
income statement.
• Subtract change in working capital (this can increase FCF if change in NWC is negative) because
changes in working capital can be sources or uses of cash but don’t get captured on the income
statement. See the NWC section for more details.
• The full FCF formula is:
Weighted Average Cost of Capital (WACC)
A lot can be said about WACC. However, to keep things simple, the only thing you need to
understand for PE interviews is that WACC is a measure of the riskiness of investing in a company. It
is used as the discount rate in the denominators of the DCF equation. The TEV of every company is
made up of some percentage equity and some percentage debt. Therefore, the WACC is the sum of
the cost of equity and the cost of debt, each weighted by the percentage of TEV they constitute. The
only wrinkle is that interest payments on debt are tax deductible (this is referred to as an Interest
Tax Shield or ITS), so the cost of debt must be adjusted by multiplying it by one minus the tax rate.
The simplest way to estimate the cost of equity is to apply the CAPM model (see the section on Cost
of Equity). The simplest way to estimate the cost of debt is to use the yield on the company’s debt (i.e.
what % interest the company pays on its debt). The WACC formula is as follows:
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Cost of Equity (Via CAPM)
The Capital Asset Pricing Model (CAPM) is a model which describes the relationship between the
riskiness of assets and the rate of return investors should expect in order to willingly bear those risks.
While CAPM is a foundational theory in finance, because it isn’t used much in PE aside from using it
to estimate the cost of equity, we won’t dive into the details. Just remember the following equation:
• The Risk Free Rate is usually equal to the yield on safe government bonds (2-4% is a safe
assumption in developed markets like the US).
• The Equity Risk Premium is the premium return over the Risk Free Rate investors demand in
order to take the risk of investing in a diversified “Market Portfolio” of equities. It has historically
been estimated to be 5-6% in developed markets like the US.
• Beta is a measure of how levered a particular stock’s returns are to the diversified Market
Portfolio of equities. A Beta of exactly 1 signifies the stock is exactly as risky as the diversified
Market Portfolio. A Beta between 0 and 1 signifies the stock is somewhat less risky than the
Market Portfolio. A Beta above 1 signifies the stock is more risky than the Market Portfolio.
Common examples of stocks with low Betas are utilities and consumer staples companies
because such companies produce essential goods consumers need regardless of whether the
economy is doing well. Common examples of high Beta stocks include semiconductors and
durable assets (like cars) because demand for them soars when the economy is doing well but
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plummets during recessions.
Net Working Capital (NWC)
There are several conceptual ways of thinking about NWC. The one I find most useful for PE
interviews is that NWC is a proxy for how much cash/liquidity a company needs to fund its daily
business operations. The most basic formula for NWC is “current assets minus current liabilities” on
the balance sheet. However, cash and cash equivalents are usually excluded from the calculation, so
the most common formula for NWC is:
It is up to your judgment to decide which current assets and liabilities to exclude from the calculation.
Your guiding principle should be to ask yourself whether each particular current asset or liability is
necessary for funding daily operations. If the item is necessary and is likely to continue to be
necessary then it should be included in NWC. Note that NWC can be either positive or negative.
Positive NWC businesses tend to be ones which have to pay cash to their suppliers faster on average
than they get paid by their customers.
However, there is a caveat. Balance sheets are snapshots for only a single date, while in reality NWC
fluctuates daily. Let’s say NWC is $0 on the last fiscal date of Q1 and remains $0 on the last fiscal
date of Q2. If the company bought $500 of inventory on the first day of Q2 and sold it all two days
prior to the end of Q2, you would miss that the NWC for most of Q2 is actually close to $500 rather
than $0.
Change in NWC
Change in NWC is simply the difference between the current period NWC and the prior period
NWC. To calculate change in NWC, we usually subtract the prior fiscal year’s (or quarter’s) NWC
from the current year’s (or quarter’s) NWC so the formula is:
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If change in NWC is positive it means that the company spent additional cash to fund its operations
over the current period. If the change in NWC is negative it means that the operations were actually
self-funding and produced excess cash in addition to the company’s regular profits. Companies with
consistently positive NWC usually need more and more cash to fund their operations as they grow,
which is a drag on FCF and debt capacity. Companies with consistently negative NWC, on the other
hand, generate more and more cash from NWC as they grow, which is a boon to FCF and debt
capacity.
Calculating Returns (IRR & MoM)
PE firms typically use two metrics to gauge returns, Internal Rate of Return (IRR) and Multiple of
Money (MoM) return. MoM is also frequently referred to as Cash on Cash, or Multiple of Cash.
IRR: Unlike the definition of IRR found in text books, IRR as used in PE is not defined as the rate of
return at which the present value of a proposed project is zero. In PE, IRR is simply the nondiscounted, annualized rate of return on invested equity over the lifetime of a deal. To avoid
confusing yourself you can think of IRR simply as rate of return. The formula for IRR with more than
one return cash flow is complicated. We won’t worry about it here because you will unlikely have to
calculate it in an interview without access to Excel (which calculates it for you as you can see in the
LBO modeling section). On the other hand, the formula for IRR with a single return cash flow is
simple, and you have to know it:
For example, let’s say a PE firm invested $1 million in a deal and realized a return of $3 million after
five years. Its IRR would be (3/1) ^ (1/5)–1 = 24.6%. IRR is very important to PE firms because their
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LPs usually demand cumulative rates of return of 20% or better. PE firms also frequently have to
exceed an IRR threshold called a Hurdle Rate (usually 7–10%) before receiving any carried interest.
IRR depends not only on how much total profit a deal generates, but also how long it takes to realize
these profits. All else being equal, IRR goes down the longer it takes to exit a deal.
MoM: MoM is very easy to calculate. Add up all of the net projected equity returns generated by a
deal and divide it by how much equity the PE firm has to invest to originally win the deal:
For example, let’s say a PE firm invested $1 million in a deal and realized a return of $3 million after
any number of years. Its MoM would be 3 / 1 = 3.0x. PE firms care about MoM just as much as IRR
because total carried interest dollars are paid based on total MoM rather than IRR as long as the IRR
hurdle rate is met. A deal which generates a 10% total return (a 1.1x MoM) over a couple of months
would have an extremely high IRR (~77%), but the total carried interest dollars paid to the PE firm
would be very low. As one of my classmates in a PE Finance class once said, “You can’t take IRR to the
Ferrari dealership.” Sad, but true.
Terminal Value (TV)
The TV is a necessary calculation to complete a DCF analysis. Let’s say you have projected FCF 5
years forward in a DCF. You still need to account for the value of the enterprise for all subsequent
years, assuming it is the sort of enterprise which is meant to remain a going concern indefinitely. This
remaining value is called Terminal Value (TV). The most common way to calculate TV is called a
perpetuity equation and the formula is as follows:
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• FCF(t+1) is your forecast for FCF one period (year) after your last year of projected DCF periods.
If you made your DCF forecast for 5 years, then FCF(t+1) would be your FCF forecast for year 6.
• See the section on WACC for instructions on how to calculate it.
• The variable g is called a perpetuity growth rate. This is the average annual rate of growth you
expect the company’s FCFs to achieve in the long run. Most of the time g is estimated to be
something close to the long-run annual growth rate of either the company’s industry or the
broader economy. For mature markets like the US, 2-3% is a common range for g. If you estimate
g to be significantly higher than the long-term industry or country growth rate, you should have a
really good reason, because any company which forever grows faster than the broader economy
would mathematically eventually take over the entire economy.
• One common mistake with calculating the TV is forgetting to discount it all the way back to
present day. Remember that in a DCF both the final year cash flow and the TV must be
discounted back to present day. See the formula for DCF.
Debt Coverage and Leverage Ratios
There are two principle types of ratios which measure a company’s ability to meet debt obligations.
Coverage ratios measure a company’s ability meet its annual debt payment obligations, and Total
Leverage ratios measure a company’s total indebtedness. Both types of ratios may be found in debt
covenants in various formulations.
Common Total Leverage Ratios
• Total Debt / LTM EBITDA or LTM EBIT or LTM EBITDA less Capex
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• Total Debt / Book Equity or Market Equity
Common Coverage Ratios
• Interest coverage: Can the company meet annual interest obligations?
• Debt service coverage: Can the company meet total annual debt payment obligations
• Fixed expense coverage: Can the company meet its annual contracted expenses?
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How Would You Calculate a Firms WACC and How
Would You Use it?
How Would You Calculate a Firms WACC and How Would You Use it?
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“Walk Me Through a DCF”
“Walk Me Through a DCF”
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Here is How You Do IRR Quickly in Your Head
Here is How You Do IRR Quickly in Your Head
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Module 5: Interview Questions
Top 30 Technical Questions & Answers
Top 30 Technical Questions & Answers
Top 30 Technical Questions & Answers
Technical questions in PE interviews test your understanding of accounting, finance, valuation, LBO
modeling, and the drivers of LBO returns. PE technical questions tend to be similar to but more
advanced than investment banking technical questions because most PE interviews assume you
understand at least the basics of accounting, finance, and valuation. If you need to brush up on the
basics, the WSO Technical Interview Guide is a good resource. The following questions are common
technical PE questions as determined by the WSO Company database and the Harvard Business
School Venture Capital & Private Equity club members:
1. WALK ME THROUGH ONE OF THE DEALS ON YOUR RESUME
This is one of the most common questions in a PE interview if you come from a deal-oriented
background. The interviewer might let you choose a deal to discuss or pick one at random from your
CV. The interviewer might ask you anything from a simple high level overview all the way down to a
detailed discussion of the investment thesis, purchase price, operating forecast, and expected
returns. This type of question is used to gauge the following:
• Your investment judgment
• Your knowledge of the PE investment process
• Your ability to focus on the most important issues
• Your knowledge of PE financing, accounting, and modeling
• Your deal memory for deal facts and context
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Before you walk into any PE interview, you should reacquaint yourself with the following facts about
every deal on your CV:
• Purchase price, including the multiples of EBITDA and EBIT it represented
• Sources and uses of capital
• The investment thesis and its primary drivers
• The key diligence issues and findings
• The base operating case/projection
• Key risks and upsides
• Projected returns (IRR & MoM)
• Key members of the management team
• What your role was and what value you added to the team
• Whether you personally thought it was a good deal and why
2. HOW WOULD A $100 DECREASE IN DEPRECIATION EXPENSE ON THE INCOME
STATEMENT IMPACT ALL THREE MAJOR FINANCIAL STATEMENTS?
This is a common interview question in both banking and PE and comes in many forms (e.g. what
happens when A/R increases, Inventory decreases, tax rate increases, capex decreases, etc.) so you
need to familiarize yourself with how the financial statements connect in the Financial Statement
Connections section.
Income Statement
• When depreciation decreases by $100, EBIT and EBT increase by $100.
• When EBT increases by $100m, net income increases by ~$60 (assuming a ~40% corporate tax
rate which means an extra $40 is paid in taxes).
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Balance Sheet
• Since net income increased by $60, shareholder equity also increases by $60.
• Since an extra $40 is paid in cash taxes, cash decreases by $40.
• Since depreciation decreased by $100, net PP&E increases by $100.
• The balance sheet remains in balance since liabilities went up by $60 and assets went up by$60.
Cash Flow Statement
• Net income increased by $60 which increases cash from operations, but PP&E increased by$100
which decreases cash from operations.
• The net impact is that cash from operations declines by $40 which happens to match both the
only cash expense incurred by the drop in depreciation (taxes) as well as the drop in cash on the
balance sheet.
3. TELL ME WHY EACH OF THE FINANCIAL STATEMENTS BY ITSELF IS INADEQUATE FOR
EVALUATING A COMPANY?
Income Statement
• The income statement alone won’t tell you whether a company generates enough cash to stay
afloat or whether it is solvent. You need the balance sheet to tell you whether the company can
meet its future liabilities, and you need the cash flow statement to ensure it is generating enough
cash to fund its operations and growth.
Balance Sheet
• The balance sheet alone won’t tell you whether the company is profitable because it is only a
snapshot on a particular date. A company with few liabilities and many valuable assets could
actually be losing a lot of money every year.
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Cash Flow Statement
• The cash flow statement won’t tell you whether a company is solvent because it could have
massive long-term liabilities which dwarf its cash generating capabilities.
• The cash flow statement won’t tell you whether the company’s ongoing operations are actually
profitable because cash flows in any given period could look strong or weak due to timing rather
than the underlying strength of the company’s business.
4. IF YOU COULD CHOOSE TWO OF THE THREE FINANCIAL STATEMENTS IN ORDER TO
EVALUATE A COMPANY WHICH WOULD YOU CHOOSE AND WHY?
Choose the income statement and the balance sheet because if you have them, you can actually build
the CFS yourself. Remember that cash flow is basically equal to Net Income, plus/minus non-cash
items on the income statement, plus rise in liabilities on the balance sheet, minus rise in assets on the
balance sheet.
5. WHAT ARE COMMON WAYS OF VALUING A COMPANY AND WHAT ARE THEIR PROS AND
CONS?
See the Common Valuation Techniques section.
6. IN WHAT WAY IS DEFERRED REVENUE DIFFERENT FROM ACCOUNTS RECEIVABLE?
Deferred revenue is a liability because the company has already collected money from customers for
goods or services it has not yet fully delivered. Accounts receivable is an asset because the company
has delivered goods or services for customers and has not yet been paid.
7. WHAT MIGHT CAUSE TWO COMPANIES WITH IDENTICAL FINANCIAL STATEMENTS TO BE
VALUED DIFFERENTLY?
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The financial statements do a good job of describing a company’s historical performance, but they do
not necessarily tell us everything we need to know about a company’s future performance. Since the
value of a company depends primarily on its expected future performance, the financial statements
are insufficient. Some important things financial statements don’t tell us include, but are not limited
to:
• The future growth of the company’s industry
• The company’s competitive position including share, relationships, patents, etc.
• The reputation and capabilities of the company’s management team
• The quality of the company’s future strategy
8. WHY DOES PE GENERATE HIGHER RETURNS THAN PUBLIC MARKETS?
See the section on How PE Makes Money. The short answer is that PE LPs demand higher returns
than public market investors which causes PE investors to price their deals to an IRR of 20% or
higher. PE LPs demand these high returns for two main reasons:
• LBOs are highly levered thus making PE investments riskier than public stocks.
• PE investments are much less liquid than public stocks; it can take up to ten years to realize
returns.
9. WHY DOES PE USE LEVERAGE? OR HOW DOES LEVERAGE INCREASE PE RETURNS?
Refer to the section What is an LBO? The short answer is that PE returns are calculated based on
return on their invested equity. Using leverage to do deals allows you to use less equity which means
the ultimate returns are larger in comparison to the amount of equity initially invested. Another way
to look at it is that the cost of leverage (debt) is lower than the cost of equity because equity is priced
to an IRR of 20%+, whereas the annual interest expense on debt is usually below 10%. Yet another
way to look at it is using a lot of debt makes the return on equity much more volatile and much riskier
because the debt must be repaid before the equity gets any return. The high returns on PE equity
may be seen as the fair return associated with the extra risk associated with high leverage.
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10. HOW WOULD YOU DETERMINE AN APPROPRIATE EXIT MULTIPLE ON A PE DEAL?
There are a few common way to do this. See the sections Comparable Multiples, Precedent
Transactions, and LBO Model. Comparable multiples analysis will tell you what multiples similar
public companies are trading for on the stock market. Precedent transactions will tell you what the
multiples were on deals involving similar targets. An LBO analysis (in this case referred to as a Next
Financial Buyer analysis) will tell you what multiple a financial sponsor would be willing to pay in the
future.
11. WALK ME THROUGH A DISCOUNTED CASH FLOW (DCF) ANALYSIS
This question may come as a stand-alone question, part of a case question, or as part of a discussion
on one of your past deals. See the section and video on DCF for how it’s done.
12. WALK ME THROUGH AN LBO MODEL AT A HIGH LEVEL
See the LBO Model section for more details. This question may come as a stand-alone question, as
part of a case question, or as part of a question about one of your past deals. At a high level, there are
5 steps to an LBO:
• Calculate the total acquisition price, including acquisition of the target’s equity, repayment of
any outstanding debt, and any transaction fees (such as the fees paid to investment banks and
deal lawyers, accountants, consultants, etc.).
• Determine how that total price will be paid including: equity from the PE sponsor, roll-over
equity from existing owners or managers, debt, seller financing, etc.
• Project the target’s operating performance over ~5 years and determine how much of the debt
principal used to acquire the target can be paid down using the target’s FCF over that time.
• Project how much the target could be sold for after ~5 years in light of its projected operating
performance; Subtract any remaining net debt from this total to determine projected returns for
equity holders.
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• Calculate the projected IRR and MoM return on equity based on the amount of equity originally
used to acquire the target and the projected equity returns upon exit
13. HOW MIGHT YOU STILL CLOSE A DEAL IF YOU AND THE SELLER DISAGREE ON THE
PRICE OF THE ASSET DUE TO DIFFERENT PROJECTIONS OF ITS FUTURE OPERATING
PERFORMANCE?
The classic PE solution to this common problem is called an “Earn-out”. Sellers are frequently more
optimistic about the future performance of a business than PE investors are willing to underwrite. In
such cases either party may propose that the sellers are paid a portion of the total acquisition price
up-front, while a portion is held back (frequently in an escrow account) until the business’ actual
future performance is determined. If the business performs like the seller expects then the seller is
paid the remainder of the purchase price some months or years after the close of the deal. If the
business under-performs the seller’s expectations then the buyer keeps some or all of the Earn-out
money. This type of structure is a common way of bridging valuation gaps between buyers and sellers.
14. HOW WOULD YOU CALCULATE CHANGE IN NET WORKING CAPITAL (NWC)?
The classic formula for NWC is current assets (excluding cash) less current liabilities. For a lot of
businesses, it is sufficient to define NWC as: NWC = Accounts Receivable + Inventory–Accounts
Payable. Change in NWC is simply the difference between NWC in the current period less NWC
during the previous period. See the section Net Working Capital for more details and to learn why
NWC is important.
15. WHAT ARE SOME COMMON AREAS OF DUE DILIGENCE?
This question may be asked broadly as above, or it may be asked specifically about a particular deal
(e.g. what would you most want to diligence before buying company X?)
See the section Common Diligence Topics. If the question is asked broadly, you can describe the high
level categories (commercial, valuation, accounting, and legal) and give a few examples from each
category. If the question is asked about a specific company, you will need to use your best judgment
to decide which issues from the common diligence topics section (in addition to any personal
experience you have) are most relevant.
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16. WALK ME THROUGH THE PE INVESTMENT PROCESS
See the sections Deal process, Deal Selection, and Deal Funnel. Walk the interviewer through the
process from sourcing to closing at a high level in ~2 minutes. No need to touch on every detail. If the
interviewer wants more details he/she will ask.
17. WOULD YOU RATHER ACHIEVE A HIGH IRR OR A HIGH MOM ON A DEAL? WHAT ARETHE
TRADEOFFS? WHAT FACTORS MIGHT INFLUENCE YOUR ANSWER?
PE firms try to achieve high IRRs and high MoMs on deals, but sometimes tradeoff choices between
these two common returns metrics do arise. For example, let’s say a PE firm bought a company for
$100 and, three years later, has a choice to either sell it immediately for $180 or wait another year
and sell it for $200. In this scenario the PE firm would achieve a 22% IRR and a 1.8x MoM by selling
after year three versus a 19% IRR and 2.0x MoM by selling after year four. This tradeoff exists
because a longer hold period counts against IRR but does not count against MoM.
Two common reasons to prefer a higher IRR are:
• IRR is the most important single metric by which many LPs judge the performance of PE firms
because LPs such as pension funds and endowments need to hit certain return rate thresholds in
order to meet their commitments to their constituents. An LP won’t be impressed with a 2.0x
MoM if it take 10 years to materialize, because the IRR on that return would be far below the LPs
requirements for the PE portion of its portfolio. Funds which achieve “top quartile” IRRs usually
have little trouble raising subsequent funds, whereas funds with low IRRs struggle to raise future
funds. Therefore, PE funds are careful not to let IRRs drift below the level their LPs expect.
• Most PE funds don’t get their carried interest unless their IRR exceeds a certain “hurdle rate”.
Hurdle rates and the mechanics of hurdle rate accounting are varied and complicated, but most
funds must clear a 6–17% IRR in order to receive their full carried interest percentage.
Therefore, if a fund’s IRR is below or near its hurdle rate, PE funds are especially financially
incentivized to boost IRR.
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Two common reasons to prefer a higher MoM are:
• Assuming the hurdle rate has been exceeded, GPs are paid carry dollars based on MoM, not IRR.
If a GP buys a company for $100 and sells it for $140 one year later, that translates to a terrific
40%IRR, but the GP would earn only ~20% * $40 = $8 in carried interest. On the other hand, if a
GP buys a company for $100 and sells it for $250 after four years, the IRR falls to 25% but the
carried interest earned is ~20% * $150 = $30.
• PE firms (and by proxy their LP investors) incur transaction costs when they buy and sell
companies. If a PE firm sells portfolio companies too quickly in order to juice IRR, then it has to
spend more money to find and close additional deals. In addition, once a PE firm fully invests its
existing fund, it must raise another fund, which also has fundraising costs associated with it.
As you can see, the choice between MoM and IRR can be complicated and involves several
considerations. As a general rule PE firms prefer to hold on to portfolio companies and grow MoM as
long as the annual rate of return the portfolio companies are generating meets or exceeds the rate
expected by the PE firm’s LPs.
18. WHICH VALUATION TECHNIQUES USUALLY PRODUCE THE HIGHEST VS. LOWEST
VALUES? WHY?
There is a great deal of variability among the outcomes of different valuation techniques for different
industries and companies. Some banker interview guides state that there is a commonly accepted
order of valuations with precedent transactions at the top and market valuation at the bottom.
However, the reality is that it is difficult to predict which techniques will yield higher or lower
valuations. The most I would say is as follows:
• The cost of PE equity is higher than nearly any other form of capital, so in an efficient market, PE-
backed LBO valuations should tend to be on the lower side on average. Of course there are times
when this is not the case, especially when a company is under-levered or poorly managed.
• Precedent transactions tend to be on the higher side, especially when the buyer is “strategic”
because such buyers frequently pay both a control premium and a synergy premium.
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• Public comps / market valuations tend to be roughly in the middle of the pack depending on
whether the market is hot or cold.
• DCF analyses are also middle of the pack on average, but there is a wild variability in DCF
analyses on both the high side and the low side because DCF analyses are extremely sensitive to
input assumptions.
19. HOW WOULD YOU ESTIMATE ROUGHLY HOW MUCH DEBT CAPACITY IS AVAILABLE
FOR AN LBO?
Debt capacity for an LBO is typically constrained by three primary ratios, total leverage ratio,
interest coverage ratio, and minimum equity ratio. Any one of these ratios could be the governing
constraint for a particular deal. To estimate debt capacity for an LBO, you could estimate debt
capacity under each of those ratios and take the lowest of the three. See the Debt coverage and
Leverage Ratios section for further details.
Total Leverage Ratio: The most common method for estimating this ratio is Total Debt / LTM
EBITDA. During normal times, Maximum Debt = ~5.0x(LTM EBITDA). During hot debt markets this
ratio can go up to ~6.0x, and during cold debt markets it can fall to ~4.0x. This ratio can also be higher
or lower based on the nature of the target’s business. Highly cyclical or risky businesses with few
tangible assets are on the lower end of the range, while stable business with a lot of tangible assets
(which can be liquidated to repay debt holders in the event of default) are on the higher end of the
range.
Interest Coverage Ratio: The most common method for estimating this ratio is LTM EBIT / Annual
Interest Expense. The floor for this ratio is usually around 1.5x. Therefore, the maximum debt this
ratio will allow is roughly:
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The blended interest rate depends on prevailing interest rates and how the overall LBO debt package
is structured, but roughly 8-9% is a safe assumption.
Minimum Equity Ratio: Long gone are the days when PE firms could routinely buy targets for 5–10%
Equity and 90–95% debt as a percentage of the total acquisition price. These days lenders demand
that about 20–30% of the total acquisition price be equity. As such, you could estimate:
20. WHAT CONSTITUTES A GOOD LBO TARGET?
See the Deal Selection section for the common boilerplate answer. The truth is that there have been
many good deals done with targets which failed most of the criteria in the section. They key is price.
Almost any target would make a good buyout candidate at a low enough price. Is there any company
you wouldn’t buy for a dollar? I caveat my answers to questions like these by asserting that “deals
which check all the boxes are usually very expensive” and “all problems may be overcome with price.”
21. WHAT IS AN ACQUISITION / CONTROL PREMIUM AND WHY IS IT PAID?
When a PE buyer (or any investor) acquires a majority share of a publicly traded company, it nearly
always pays more per share than the company was trading at prior to acquisition. The percentage by
which the acquisition price per share exceeds the pre-acquisition trading price per share is called a
control premium (aka acquisition premium). The trading price per share prior to acquisition is
commonly calculated as a 30 to 90-day trailing Volume Weighted Average Price (VWAP) prior to the
day news of the pending acquisition becomed public. For example, if the 30-day VWAP of a stock is
$20 on the day an acquisition is announced for $25 per share, then the acquisition premium
is$25/$20-1 = 25%. The size of control premiums varies, but they are usually between 10% and 50%.
There are several reasons why investors might be willing to pay acquisition premiums:
• Some buyers, especially strategic buyers, expect to realize synergies with the acquired asset
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which makes the asset more valuable to the acquirer than to previous shareholders.
• Majority control of a company allows the new owners to choose how to spend the company’s
capital, including how and when to take dividends or exit the investment. Unlike public
shareholders, PE owners have a great deal of influence over how and when they will get cash out
of their investment.
• Buyers of public assets frequently believe that the company will be worth more under their
control than its public valuation. They believe they can add value by getting better management,
setting a better strategic direction, fixing operating problems, etc. Majority control is what gives
buyers the power to execute such plans.
Another way to look at control premiums is from the perspective of the sellers. A public stock has a
very fragmented ownership base. Thousands or more individuals or entities may be owners of a
single stock, and the top ten largest owners frequently own less than 50% of outstanding shares. In
order to consummate an LBO, the buyer has to convince at least a majority of shareholders to
approve the transaction. Many of these owners own the stock precisely because they think it is
undervalued by the market. Such owners would not be willing to sell the stock at its market price.
There are of course zero (or nearly zero) owners who would sell the stock below its trading price.
Therefore, by virtue of pure math, a new buyer will need to pay more than the trading price to
acquire a majority of shares.
22. HOW WOULD YOU GAUGE HOW ATTRACTIVE AN INDUSTRY IS?
The three most important measures of an industry’s attractiveness are its growth rate, stability, and
profitability. The most attractive industries are predictable/stable, high growth, and high
profitability. However, keep in mind that attractive companies can exist in unattractive industries if
they have a strong competitive advantage. For example, the airline industry is low growth, cyclical,
and unprofitable, but Southwest Airlines has been successful for many decades due to their
differentiated business model. Even unattractive companies in unattractive industries might
sometimes make good investments if you can buy them at the right price and/or remedy some of
what ails them.
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Gauging stability
• The stability and predictability of an industry is usually easy to gauge by determining its growth
drivers and examining its performance over a few business cycles.
• If the growth drivers depend on entrenched secular trends (e.g. the healthcare industry in a
country with a demographically aging population) then the industry will be more predictable
than one which depends on taste/trends/fads (e.g. fashion brands).
• If the products the industry produces are “must haves” for customers (e.g. electricity or food
staples), then the industry will be more resistant to recessions than an industry which produces
luxuries (e.g. cruise lines or expensive cars).
• If the products the industry produces are commoditized, then its fortunes tend to oscillate with
the business cycles of its customers (e.g. mining or semiconductors), whereas industries with
strong intellectual capital/differentiation tend to be less cyclical (e.g. enterprise software or
medical devices).
Gauging growth rate
• Estimate the industry’s historical growth rate from industry reports or from the aggregate
revenue growth rates of participant companies.
• Discover the primary drivers of historical growth (e.g. technology improvement, untapped
market penetration, growing product/service adoption, price growth, etc.) from industry reports,
participant’s public disclosures, or calls with industry experts.
• Discover how growth drivers are trending and project future growth from educated assumptions
about the main drivers.
Gauging profitability
• Discover the historical profit margins of industry participants and then utilize the 5-forces
framework to gauge whether industry-wide profit margins are likely to shrink, grow, or remain
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steady. The 5-forces framework is as follows:
• Bargaining power of suppliers: The relative level of consolidation between industry
participants and the industry’s suppliers frequently determines which side is likely to
capture most of the profits. If industry participants are more consolidated than the
industry’s suppliers that is a good sign for future profitability. If not, the reverse may be true.
• Bargaining power of customer: Similar logic applies as Suppliers’ Bargaining power. If
industry participants are more consolidated than their customers it’s a good sign for
profitability.
• Threat from new entrants: How strong are the industry’s Barriers to Entry (BTEs)? Strong
BTEs include essential/exclusive intellectual property, high fixed capital investment
requirements, high minimum efficient scale thresholds, and high value placed on brand and
existing relationships. Highly profitable industries with low BTEs are likely to lose
profitability over time as new competitors pile in.
• Threat from substitute products: A good signal is when the industry’s products or services
meet essential customer needs which cannot be met other different ways.
• Existing competitive rivalry: It’s a good sign if the existing competitors have established a
pattern of competing on factors other than price and on focusing on growing the industry
rather than taking market share from each other.
23. WHICH INDUSTRY WOULD YOU INVEST IN AND WHY?
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This is another common way to ask the previous question about how attractive an industry is. The
trick to this question is that it’s not simply about identifying a good industry, but rather is about
identifying an industry which is improving. If an industry is already high-growth and profitable, the
valuations of acquisition targets are also likely sky high. Investing is about buying undervalued assets
rather than simply good assets. If you identify a bad/mediocre industry which is about to improve,
you could probably find a lot of undervalued acquisition targets in it. Therefore, look for industries
which are experiencing some of the following:
• Acceleration in long-term growth: Driven by new technology, an inflection point in adoption,
changing consumer preferences, etc.
• A shift in competitive rivalry: E.g. competitors are beginning to compete on brand, quality,
service, technology, etc. instead of price. E.g. a major competitor is exiting the industry.
• A shift in supply chain dynamics: E.g. the industry is consolidating. This could lead to both add-
on acquisition opportunities as well as better bargaining power relative to suppliers and
customers.
• Barriers to entry increasing: E.g. patents, proprietary technology, brand, minimum efficient
scale, etc. are becoming more important
• Threat from substitutes declining: E.g. the products and services the industry provides are
becoming more unique and essential to customers.
24. HOW WOULD YOU GAUGE A COMPANY’S COMPETITIVE POSITION?
Market share: High market share relative to competitors is usually a sign of competitive strength.
Firms with higher market share are more likely to enjoy brand awareness, close relationships with
key customers/suppliers, economies of scale, etc. Recent share trends also matter. Companies which
are gaining share tend to be better positioned competitively.
Profit margins: High profit margins (such as Gross Margin, EBIT Margin, Net Income %, etc.) are
frequently a sign of competitive strength. Companies with higher margins are usually more cost
efficient and/or able to charge premium prices due to a superior product offering. Recent expansion
of margins is also frequently a positive signal.
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Brand perception: Brand awareness can be a very important competitive strength indicator,
especially for consumer-facing businesses. Equally important is how customers perceive the brand
when they are aware of it. The best signal of competitive strength is high unaided customer
awareness, associations with positive attributes customers care about most, and a high willingness to
recommend the brand to friends and family.
Product breadth and quality: In many industries it is important for competitors to carry a full line-up
of products that can meet all or most of customers’ needs. For example, a farm equipment
manufacturer should probably manufacture not only tractors, but also tillers, harvesters, and many
other things a farm equipment wholesaler/retailer is likely to carry. It is equally important, of course,
that the products and services a company offers are well designed, well manufactured, and highly
regarded by customers.
Management team quality: A bad management team can ruin the best business. A good
management team can sometimes work miracles. Assessing management team strength is highly
subjective, but it’s something PE professionals spend a lot of time discussing.
Other signs of competitive strength:
• Lowest-cost product / service delivery model
• Strong intellectual property (IP) such as patents
• Low levels of customer “churn” (customers rarely stop being customers)
• Excellent physical locations (important for retail companies)
• Diversified customer and supplier base
• Diversified revenue sources
• High levels of recurring revenue
25. WHAT ARE SOME COMMON WAYS PE FIRMS INCREASE PORTFOLIO COMPANY VALUE?
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How much value PE firms actually add is an open question, but the following methods are frequently
mentioned:
• Recruit better management and board members
• Provide more aligned management incentives (usually via stock option pool)
• Identify and finance new organic growth opportunities (new geographies, new product lines,
adjacent market verticals, etc.)
• Find, finance, and execute add-on acquisitions
• Foster stronger relationships with key customers, suppliers, and Wall Street
• Support investment in better IT systems, financial reporting and control, research &
development, etc.
26. WHAT COMPANY WOULD BE A GOOD LBO CANDIDATE TODAY AND WHY?
You always want to have one or two good pitches in your back pocket in case you get asked this
question. Before selecting a candidate, refer back to the sections on the common attributes of LBO
candidates and how PE firms make money. Try to find candidates which fit at least some of the
following criteria:
• Has a lot of stable and predictable free cash flow to pay down debt relative to how much you
would have to pay to acquire it. A free cash flow yield (FCF / purchase price) of 10+% is a solid
benchmark
• Could benefit from a strategic overhaul which would be difficult to execute as a public company
• Is having significant operational difficulties which would require a lot of time, patience, and
capital to address
• Has a bad management team or governance structure which a PE firm could improve
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• Has a lot of room to grow either organically or via acquisition if backed with enough patient long-
term capital
27. IF I GAVE YOU $X, HOW WOULD YOU INVEST IT?
There is no right answer to this question, but a good answer demonstrates your passion for investing,
understanding of risk vs. reward, and understanding of investment time horizons. I usually answer
this question by following these steps:
• Discuss a few of the investment options available to you
• State what your investment goal, risk appetite, and time horizon is
• Compare and contrast the risks, rewards, and time horizons of these options
• Pick the investment options which best fits these criteria
SAMPLE ANSWER: "The investments options with which I am most familiar are private equity co-invest,
bonds, and equities, so I would limit my investments to those areas because I would not invest in something I
do not understand well. I have a long way to go before retirement, so my main investment goal is a high rate
of return. However, I would also like to purchase a home in about five years, so I will require liquidity around
that time. In order to meet my goals, I would invest 10% of my assets in PE co-invest because historically it
offers the highest long-run return. I would not invest more than 10% because co-invest is highly illiquid and
too correlated with the fortunes of my employer. I would invest 60% of my assets in passive equities funds,
split evenly between domestic and international stocks to take advantage of equity’s historically solid
returns while increasing diversification. I would then invest the final 30% of my assets in a low-cost mediummaturity bond fund because such bonds are relatively uncorrelated with equity investments and ensure I will
be able to buy a home in five years.”
28. WHAT ARE SOME DIFFERENT TYPES OF DEBT COVENANTS AND WHAT ARE THEY USED
FOR?
Debt covenants are contractual agreements between lenders and borrowers (such as companies
which have been bought via an LBO) that give lenders certain rights to help protect their investment.
Maintenance covenants require the borrower to maintain a certain equity cushion or debt service
coverage cushion to maintain their ability to repay its debt. Incurrence covenants prevent the
borrower from taking certain actions which could be detrimental to existing lenders such as taking
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on more debt or paying out cash dividends to equity holders. Strict covenants can make an
investment much riskier to a PE investor because a default on a covenant can result in the loss of the
entire equity investment even if the portfolio company remains solvent. See the section on covenants
for details.
29. WHAT IS FREE CASH FLOW, HOW DO YOU CALCULATE IT, AND WHY DOES IT MATTER IN
AN LBO?
See the Free Cash Flow (FCF) section for more details.
30. IF YOU HAD TO VALUE A COMPANY BASED ON A SINGLE NUMBER FROM ITS FINANCIAL
STATEMENTS, WHAT WOULD THAT NUMBER BE?
The single most important value determinant for most companies is its Free Cash Flow (FCF) because
FCF is how owners pay themselves dividends and pay down debt. If you could know a second fact
about the company before estimating its value you would want to know how quickly its FCF is
growing.
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Sample Deal Walk Through, One Good, One Bad
Sample Deal Walk Through, One Good, One Bad
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Bonus Webinar: How to Speak About Your Investment
Banking Deals In a Private Equity Interview
Bonus Webinar: How to Speak About Your Investment Banking Deals In a Private
Equity Interview
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module5-interview-questions/bonus-webinar-how-to-speak
Relevant Files:
pe_recruiting-_deal_exp_-_11.19.14_v2.pdf
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How to Prep for a PE Megafund Interview
How to Prep for a PE Megafund Interview
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Relevant Files:
pe_interview_june_8.pdf
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What if you can’t value a company using DCF or
multiples?
What if you can’t value a company using DCF or multiples?
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Why You Should Care About Changes in Net Working
Capital (Repeat)
Why You Should Care About Changes in Net Working Capital (Repeat)
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Bonus Webinar: PE Investment Case Presentation and
How The Deal Process Works
Bonus Webinar: PE Investment Case Presentation and How The Deal Process
Works
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DCF vs. Trading Multiples vs. Transaction Multiples…
Which provides the Highest Valuations?
DCF vs. Trading Multiples vs. Transaction Multiples… Which provides the Highest
Valuations?
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The 7 Traits of The Perfect Deal and… One That Is More
Important Than All of Them Combined (Repeat)
The 7 Traits of The Perfect Deal and… One That Is More Important Than All of
Them Combined (Repeat)
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Module 5: Interview Questions
Top 15 Fit Questions & Answers
Top 15 Fit Questions & Answers
Top 15 Fit Questions & Answers
Fit or “behavioral” questions are used to assess whether you have the right attitude, work ethic,
personality, and values to fit in with a PE firm’s culture. Most PE firms take fit extremely seriously
because most firms usually have only a handful of investment professionals who must collaborate
over long hours and under tight deadlines. This section discusses the personal traits PE firms
commonly look for in candidates so you can highlight these attributes when you answer fit questions.
This section also walks you through the most common types of fit questions and suggests approaches
for answering them. The suggested approaches and sample answers are meant to be illustrative. You
need to adapt your answers to be true to yourself and your own words. Don’t make the mistake of
reading from these samples because this course is read by a lot of people, and the PE universe is very
small.
Personal attributes PE firms look for
• CONFIDENCE: As an investment professional, you will be asked to form opinions about
potential investments. It will not be enough to simply execute perfect analyses and build flawless
models. You will need to make decisions about what matters most and how to interpret
ambiguous data. You must be able to form an opinion without having all of the facts. You must be
able to defend your opinions in the face of skepticism. Deal teams work best when members
challenge each other (respectfully) and push each other’s thinking. Therefore, interviewers are
looking for you to demonstrate that you believe in yourself and your abilities enough to take a
stand when appropriate.
• HUMILITY: The evil twin brother of confidence is arrogance. It can be hard to tell them apart. No
doubt there are quite a few successful, arrogant PE professionals. However, for the most part
they succeed in spite of their arrogance rather than because of it. Arrogant people are hard to
work with. Arrogant people tend to ignore good advice and disregard evidence that contradicts
their existing beliefs. These traits are corrosive to teamwork and lead to bad investment
decisions. Confidence is good, but only when quenched in a pool of deep humility. None of us
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have all the right answers. The markets will make fools of us all from time to time. It is important
that you demonstrate that you know your limits and respect the opinions and experiences of
others.
• WORK ETHIC: PE works hour are long, deadlines are tight, and stress can be high. Deal teams
are only as strong as their weakest link. A PE professional must be willing to put in long hours
without losing engagement or focus. A PE professional must also be willing to make some tradeoffs with respect to their life outside of work. Deal processes often work on deadlines set by
sellers and investment banks. In order to win a deal firms must be able to execute their diligence
process on time. Sometimes deal deadlines conflict with other commitments. A PE professional
has to accept that they won’t always be home for dinner and that weekend plans are written in
pencil rather than in pen.
• ATTENTION TO DETAIL: PE partners live in a world of numbers. Sometimes it feels like
numbers are the air they breathe. Numbers are their reality. PE partners see the world like the
Matrix, replete with ratios, multiples, margins, and growth rates. Partners are partners because
they can take numbers and turn them into decisions. When you screw up a number or a
calculation, you alter reality. If a partner can’t trust your numbers with 100% confidence then he
or she can’t make decisions. Therefore, you must demonstrate your ability avoid mistakes at all
costs.
• INTELLECTUAL HONESTY: PE professionals make a lot of judgment calls based on limited or
ambiguous information. Credit committee decisions may be swayed one way or another based
on which modeling assumptions you make and what information you choose to present or
exclude. When you make a recommendation, your team needs to trust that it’s based on a
balanced and thoughtful analysis of all sides of an issue. Therefore, PE firms looks for candidates
who demonstrate the ability to see issues from several points of view and avoid being influenced
by personal biases.
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• PASSION FOR INVESTING: PE is a difficult profession which requires long hours and a
commitment to ongoing learning. People who get into it for the wrong reasons tend to become
unmotivated and unhappy over time. Therefore, PE firms look for candidates who enjoy the
investment process and want to be in the industry for the long haul.
• CURIOSITY: As the PE industry matures, it’s getting harder and harder to make money by doing
what has been done before. Firms need to innovate and find new ways to source deals and value
to existing portfolio companies. The most successful agents of such innovation are those who
aren’t blinded by the status quo. PE firms want candidates who will ask unconventional
questions, pursue unexplored opportunities, and never stop pushing the envelope of what’s
possible.
• SELF-AWARENESS: Every PE professional has areas of strengths and weakness. We all have
certain domains of expertise and ignorance. A deal team functions best when each member
contributes where they are strong and asks for help where they are weak. No single person ever
has all of the answers, so it’s important to demonstrate both your expertise as well as your ability
understand and admit your limitations.
Fit Questions & Answer Approaches
1. WALK ME THROUGH YOUR RESUME
This is the most common fit question. It comes in other open-ended forms such as “tell me about
yourself.” This question is asked in practically every interview process, but it’s amazing how many
people don’t have a ready answer. If asked, this question almost always comes first because the
interviewer want to get comfortable with you and set the stage for more specific probing questions.
There are many creative ways to answer this question and we can’t discuss all of them here. What we
will focus on is how to give a good “standard” answer. A good standard answer is your professional
life story which highlights every major stop, explains the reasons for the transitions, and ends with
why you are now having the current interview. The entire answer should be three minutes or less.
You don’t need to give too many details. The interviewer will probe on anything you skipped over or
summarized. The most common error in answering this question is droning on too long. You answer
must be tight.
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I usually follow a structure like this:
• Where I grew up
• What personal interests led me to choose my undergrad college and major
• It’s good if you can already set the scene here for your ultimate interest in business,
investing, etc.
• What I learned in college which made me take my first job out of undergrad
• What skills I learned on my first job, what I liked about it, and what I didn’t like about it
• The what I learned section is a chance to highlight skills and attributes which PE recruiters
are looking for
• I try to pick my “likes” to be things which are still true in PE
• I try to pick my “dislikes” to be things which are less present in PE
• Why I’ve decided to move on from this job and switch to PE
SAMPLE ANSWER: “I was born and raised in XXX until my family moved to XXX at age XX. When I was in
high school I took a class in XXX which got me interested in studying XXX in college. I chose to go to XXX
University because I discovered that they have a particularly strong XXX program. While at school I
discovered that I have a real passion for XXX, which led me to pursue a career in [INDUSTRY]. I chose to
work at [OLD FIRM] because I knew I would learn XXX and gain exposure to XXX. I spent XXX years at [OLD
FIRM] and learned a lot while I was there. I think the most valuable skills I learned at [OLD FIRM] are XXX,
XXX, and XXX. I enjoyed my time at [OLD FIRM] very much because I really liked XXX. However, as time
passed I began to recognize that there are additional thing that I want to do and learn in my career.
Specifically, I’ve decided that I would really enjoy XXX, which is why I have decided to make the switch to PE.
I was really excited to have the chance to interview with [New FIRM] in particular because I know it has a
great reputation for XXX, so I’m glad to be here. I realize that was a pretty brief summary. Is there anything I
could tell you a bit more about?”
NOTE: In addition to a 3-minute version of this answer you should also have a 30-second version of
this answer. Sometimes interviewers ask this question as a total formality and don’t want your life
story. If the interviewer asks this question in a perfunctory way or if you notice they are getting
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impatient flip to your 30 second answer. The 30-second answer could be as simple as:
SAMPLE ANSWER 2: “I went into [Industry] after college because XXX. I enjoyed it very much and learned
a lot about XXX, but ultimately I’m interested in becoming an investor and feeling a real ownership stake in
my work so I have decided to transition to PE. I’m especially excited to be interviewing with [Your Fund]
because XXX.”
2. WHY DID YOU CHOOSE YOUR CURRENT INDUSTRY OR EMPLOYER?
Interviewers ask this question to get a sense for what drives you and to understand the path which
led you to PE. The goal of your answer should be to give clear and concise reasons that highlight your
personal attributes which PE firms like. Refer to the list of desirable personal attributes above and
brainstorm truthful answers that highlight those qualities.
Here are some sample answers that accomplish your mission:
• “I’ve been interested in business and investing since [high school / college / etc.] because I believe
smart investors allocate capital where it is needed and help grow our economy. I went into
investment banking in order to learn to be an investor and learn the skills I need to eventually
transition to the buy side.”
• “I’m the type of person who really enjoys working on teams to solve interesting problems. I went
into [Industry] because it offered the chance to work with really smart people and create a lot of
value by solving XXX.”
• “I have been planning to break into PE for a long time and I knew that in order to have that
opportunity I would need to learn [skills]. I went into [Industry] in order to learn those skills. Now
I am ready to apply these skills on the buy side.”
• “I’m the type of person who thrives when the stakes are high and my team is fighting against the
clock. When I was [member / captain / whatever] of my college [sports team], some of the most
exciting moments of my life were when I led my team from behind to victory. I went into
[Industry/Firm] because I knew I would have the opportunity to be on teams facing analogous
circumstances.”
There are many honest ways to answer this question. Find answers you really believe in because
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making things up is both risky and unethical. Almost as important as what you say is what you DO
NOT say. Avoid the following mistakes:
• Many people go into finance because it pays well. However, for whatever reason, mentioning
this as a motivator in an interview is a death sentence. Mention compensation and it’s curtains.
Thanks for stopping by, don’t let the door hit you on the way out. I have no idea why the industry
isn’t willing to be honest with itself on this point, but it’s just a fact. You can still give honest
answers without mentioning compensation. If you have no other honest answers … maybe look
for different work because you’ll eventually burn out and hate your day to day job.
• Don’t sound arrogant and don’t brag. I’ve seen candidates I’ve interviewed answer this question
by saying they are hyper competitive and went into banking because they knew they would beat
their competition. This type of response doesn’t make an interviewer want to work with you.
• Avoid obvious clichés that sound contrived and fail the smell test. “I love working 80hr weeks” is
not a good answer because nobody likes working 80hr weeks.
3. WHY DO YOU WANT TO TRANSITION TO PE?
Once again the interviewer is looking to understand what drives you and whether you’re getting into
PE for the right reasons. A good answer does the following:
• Describes what you like about your current job and what skills you’ve learned on your previous
job, especially if both are applicable to PE
• Describes what it is about your current job that isn’t satisfying or could be more satisfying in PE
• Makes the case for why a transition to PE makes sense now
Here are a couple of sample answers:
• “I have been working as a consultant for X years and for the most part I have enjoyed it very
much. Solving challenging problems alongside smart team members has been exciting. I’ve
learned a lot about analyzing the competitive position of a business and about figuring out ways
to improve its operations. However, now that I’ve completed several projects I find that I’m
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wishing for of an ownership stake in the outcome of my work. I’m also excited about the prospect
of seeing a company through from origination to closing to operational improvement. I feel that
PE would give me both an ownership stake as well as the chance to engage with companies for
the long run and witness the fruits of my labor rather than always transitioning to the next case.”
• “Investment banking has taught me a lot about how to value a company and how to think about
different types of deals and financings. However, I feel that at the higher levels of investment
banking my job would become more and more a salesmanship role. My true passion lies in
learning to apply my investor’s judgment and discovering ways to add value to companies. PE
offers the perfect blend of analysis and judgment that I want to continue to cultivate in my
career.”
Once again as above do not mention compensation as a motivator, don’t brag or over-sell yourself,
and keep your answers truthful.
4. WHY ARE YOU INTERESTED IN OUR FIRM IN PARTICULAR?
The interviewer wants to make sure that you are truly serious about their firm and that there is likely
to be a good fit between you and the firm. Your goal should be to demonstrate your clear interest by
showing you’ve spent time researching the firm and have specific reasons to be interested in it.
Before you go into an interview, dig up some of the basic information about it:
• Its origin, age, fund size, office locations, industry focus, investment criteria, etc.
• Bios of some of it investment professionals, especially those likely to interview you
• Existing and past deals / portfolio companies
• How they describe themselves / how they see themselves / what makes their investment
process or culture unique
Great resources for learning the above include:
• The firm’s website first and foremost. It frequently has an “about the firm” section, IP bios,
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investment criteria, existing portfolio and past deal examples or case studies
• CapIQ and other similar data providers also frequently have some of the above data
• Google the company’s name for news article, especially press releases on new investments and
exits
• Search for WSO threads about the company and read the WSO database entries on the company
• If you have friends who work there or have worked there they can of course be a great resource
It’s not enough to offer vague praise about brand name and prestige. Make your reasons as specific
as possible and tailor them to your own background where possible. Sample reasons for being
interested in a particular firm include but are not limited to:
• Focus or strong track record in a particular industry vertical, especially if you have demonstrable
personal interest or experience in that vertical (e.g. “I have a lot of interest and experience in the
healthcare vertical and I know that you have done several successful deals in that space such as
X, Y, Z)
• Affinity for a particular sourcing model (e.g. “I appreciate that many of your deals are proprietary
and I believe a great way to generate strong returns is to avoid competitive auctions”)
• Focus on a particular deal stage (e.g. I really enjoy investing in growth businesses rather than
trying to optimize capital structures so I’m excited by your focus on growth equity deals such as
X, Y, Z)
• Focus on how the firm drives returns (e.g. “I believe that PE firms should drive returns by adding
a lot of value to their portfolio companies. [Your firm] has a large portfolio group and several high
profile operating partners such as X,Y,Z, which reinforces your claims to being a value-added
sponsor”)
• Focus on a geography (e.g. “I know that [your firm] has done several deals in [geography] such as
X,Y,Z. As a native (or native speaker of) [geography / language], I am highly interested in looking
at deals in this region.
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5. WHAT DO YOU THINK THE JOB OF A PE ASSOCIATE IS / WHAT MAKES A GOOD PE
ASSOCIATE?
The interviewer is trying to assess whether you really understand the job you are interviewing for.
Make sure to read the portions of this guide relating to PE roles, the PE investment process, and
personal attributes PE firms look for. Your goal should be not only to answer the question, but also to
subtly make your case for why you would be good at it. You should tailor your answer to each
particular firm instead of giving one standard answer. If a firm like TA or Summit require a lot of
proactive sourcing work from associates you need to mention that and describe what makes
someone good at sourcing (positive attitude, a lot of energy, curiosity and gregariousness, ability to
handle rejection, creativity, etc.). If a firm requires associates to deeply engage with portfolio
companies and help with operations you need to mention the requisite consulting toolkit.
SAMPLE ANSWER 1: “The role of an associate can vary a lot from deal to deal, but I understand there are
some common elements. At various points in the deal process and associate may be called on to develop
investment themes, triage incoming deals, support deal diligence and execution, and engage with portfolio
companies. Some common tasks associates execute include reading incoming CIMs, building LBO models,
doing trading multiples analysis, competitive position analysis, and industry growth forecasting."
SAMPLE ANSWER 2: “A good associate is first and foremost highly diligent and detail oriented in order to
prevent having any mistakes in their numbers. In order to accomplish this good associates make it a habit to
double check their work and learn techniques for spotting error red flags. A great associate is someone who
doesn’t make mistakes and understands the purpose of their work so that they can use their initiative and
judgment to add more value to their deal team. In addition to delivering the product their manager
requested, a great associate will offer interpretations for what their product implies for an investment thesis,
appraise their manager of any uncertainties in the analysis, and suggest useful next steps."
6. WHAT IS YOUR LONG-TERM CAREER GOAL / WHERE WOULD YOU LIKE TO BE IN 5YEARS?
The interviewer is trying to make sure that you see PE as a meaningful phase of your career and that
you have reasonable expectations for what the role you’re interviewing can offer you.
PE requires a lot of hard work and dedication; it is not a job for someone to try out on a whim. PE
firms spend a lot of time interviewing candidates and make their decisions very carefully. They don’t
want to hire someone who might not be fully committed.
You do not need to pretend to know with certainty that you will be in PE for the rest of your life, but
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it helps if you think PE at least factors prominently in your future. On the other hand it’s also
important to have reasonable expectations. If you’re sure that you’re going to go from new associate
to full partner in five years you might end up disappointed by a longer climb up the ladder. Be honest
if you’re not 100% sure you will definitely stay in PE. That’s not a deal-breaker, especially at firms
with pre-MBA associate programs which don’t necessarily give offers to all “graduating” associates
for partner-track positions. It helps, however, if your alternate plans include options which will be
enhanced by your PE experience because then the PE firm remains comfortable you will remain
committed to your work for the duration of your employment. For example, a PE firm would be more
likely to hire someone who’s career alternatives include public markets investing, entrepreneurship,
or general management than they are to hire someone who’s real dream is to be an engineer, or
doctor, or journalist.
SAMPLE ANSWER: “I have been working toward a career in principal investing for many years and am
strongly committed to this path. Of course it’s hard to be 100% certain, but I expect that I will enjoy this job
very much and will look to turn it into my long-term career. If things go well I would love to either come back
here after an MBA or simply rise through the ranks if that is an option. If, for whatever reason, my career has
to go in another direction, I expect that I would remain involved with investing, if perhaps in a different role
or asset class.”
7. WHAT OTHER OPPORTUNITIES ARE YOU CONSIDERING / WHAT OTHER FIRMS ARE YOU
INTERVIEWING WITH?
This question is tricky because, as always, you want to be honest but you don’t want to necessarily
reveal your entire hand or have to answer even more awkward questions like “what is your first
choice if you had your pick”. I usually try to keep my answer to such questions vague in hopes that my
interviewer will drop the subject, and frequently they do. If I’m interviewing with some direct
competitors and I don’t want to go into details I usually say something like, “I’m involved with some
other processes, but I’m not under any time pressure and I’m most excited about seeing where the
process with [your firm] leads first.”
In the rare case that my interviewer presses me to reveal names, I try to just reveal a couple which I
suspect the firm will respect but won’t feel like they’ll definitely lose me if I get a competing offer. I
then try to give one or two credible reasons for why I am most interested in the firm with which I’m
interviewing. PE firms really hate it when their offers get turned down, so you’re less likely to get an
offer if the firm doesn’t think it has a great chance to sign you. Maybe this approach will strike some
as dishonest, and I respect that, but I find this question a little unfair so I’m not above playing games.
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It’s kind of like when you’re on a first date, your date asks for the names of other people you’ve gone
out with recently. Caveat: If you already have an offer with another firm (especially one which you
would strongly consider taking) don’t be shy about disclosing it. I have no numerical proof, but in my
experience PE firms get more serious about you when they know you’re already wanted by a
competitor they respect. If you already have a good offer then revealing it can sometimes get other
processes moving along quicker so that you don’t have to twist in the wind for too long. Any
downside is limited because you always have your good offer to fall back on. Just don’t be tempted to
make up phantom offers … the PE world is small. It’s rare that professionals have more than one or
two degrees of separation. I’ve seen candidates get caught lying, and it’s not pretty.
8. HOW WOULD YOUR PEERS, FRIENDS, OR MANAGER DESCRIBE YOU / HOW WOULD YOU
DESCRIBE YOURSELF / GIVE ME 3 ADJECTIVES THAT DESCRIBE YOU?
When faced with this question some candidates find it difficult to praise themselves and fail to
highlight their best qualities. Other candidates go overboard and describe themselves in absurdly
glowing terms. Remember that a PE firm is looking for confidence mixed with some humility. The
sweet spot for this question is to describe yourself in a few reasonable positive terms that you hope
are present in you or that others see in you.
Refer back to the attributes PE firms are looking for and select a few which you honestly feel apply to
you. You don’t need to feel pressure to balance positives with negatives with this question unless
explicitly asked to list weaknesses. Look at this question as an opportunity to sell yourself to the
interviewer. In order to drive the point home feel free to bring up stories or examples about some
praise you have received.
SAMPLE ANSWER: ”I would like to think my peers would describe me the same way I would describe
myself, which is an intelligent and honest person who is passionate about his work and loyal to his friends.
Honesty, loyalty, and hard work are common themes in the feedback I’ve gotten from friends and
supervisors. In my last review, my supervisor made special note of my readiness to work extra hours to help
newer members of my team and my willingness to state my direct and honest opinion whether popular or
not.”
9. WHAT ARE YOU BEST AND WORST AT / GIVE ME THREE STRENGTHS ANDWEAKNESSES?
This question is similar to the one above but you have to speak about weaknesses. For the strengths
feel free to choose similar ones as the ones for the previous question and the answer them in a similar
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way. The trick on weaknesses is to make them real and significant but not disqualifying. The
weaknesses you choose should also be ones which can be overcome with time and ones for which
have an improvement plan.
You can’t cheat and say things like “I work too hard” or “I’m too much of a perfectionist” because
those sound like blatant lies. On the other hand you can’t make disqualifying statements like “I’m not
sure I totally understand how an LBO model works”, or “a lot of people have found me difficult to
work with”, or “I get bored and unmotivated when I have to do a lot of repetitive work”. The
weaknesses you highlight need to be legitimate, but not scary.
I typically approach the weaknesses question by listing weaknesses which are real, but are also
common and expected for a professional in the position I am interviewing for. Nobody expects you to
be perfect. Some weaknesses happen to be very common for most junior IPs and PE firms are
comfortable they can be worked out over time because senior partners remember also having them
when they were younger.
SAMPLE ANSWER: "At various points in my life and career I have gotten some feedback on things I could
improve and there are a few themes which tend to recur.
• My first weakness is that sometimes I struggle to focus the bulk of my effort on the most critical tasks.
As a junior professional I have sometimes been so eager to leave no stone unturned that I’ve wasted
time on issues which don’t matter very much. I find that over time I am getting better at identifying
what matters up front, but it is proving to be a long process. One strategy which has been helping is
sitting down with my supervisor at the start of a project and jointly discussing which tasks are the most
mission critical.
• My second weakness is that I sometimes struggle to speak up when I know my opinion is different from
that of my supervisor. I know that my supervisors usually value my opinion, but sometimes I get stuck
assuming that if we disagree they’re probably right because they have more experience. The good news
is that I know my opinions have been generally well received when I’ve shared them. This knowledge is
helping me to gain more confidence expressing contradictory opinions.
• My third weakness is that sometimes I have a hard time delegating work or trusting the output of
others. I know that trust is essential for strong teams, but in the past I have tended to trust work only if I
have either done it or audited it extensively. There have been times when I have slowed down my teams,
wasted my own time, and possible reduced the morale of more junior colleagues by excessively checking
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new ways of auditing output faster at a higher level without diving into all the details."
10. HOW DO YOU FEEL ABOUT HAVING TO WORK ON WEEKENDS / DO YOU REGRET
MISSING OUT ON OTHER INTERESTS WHEN WORK GETS BUSY / HOW DO YOU MOTIVATE
YOURSELF WHEN A TASK BECOMES A CHORE, ETC.
It’s no secret that PE sometimes requires long hours of repetitive work, especially at junior levels.
Your interviewer wants to make sure that you know what you are getting into, are comfortable
making the required trade-offs, and don’t see yourself as “above” doing a bit of grunt work.
Thankfully PE isn’t banking, so you don’t have to pretend to be a borderline workaholic, but you do
need to show an awareness of what the job entails and signal a clear willingness to make sacrifices
when necessary. A simple approach to this question is to acknowledge the necessity of certain worklife sacrifices, affirm your willingness to make reasonable sacrifices, and cite an example which
demonstrates your previous experience doing so.
SAMPLE ANSWER: “I understand that associates here work long hours and sometimes have to be flexible
with personal plans in order to support their deal teams. This makes sense to me because I know that the
deadlines in deal processes are often tight and the stakes are high. I am comfortable making these trade-offs
because I see them as an investment in my future and the dues that I pay for the opportunity to learn the art
of PE. I have had to make similar trade-offs in the past, and I am glad that I did. In my previous job I
frequently had to [grunt work]. As a result of the long hours and diligent work I put in I learned X,Y,Z (or got
the opportunity to A,B,C). At this point in my career I am more than willing to do what it takes to support my
teams and to continue to learn.”
11. WHAT DO YOU DO FOR FUN / WHAT ARE SOME OF YOUR HOBBIES / TELL ME A
BITABOUT YOURSELF OUTSIDE OF WORK / TELL ME A BIT ABOUT YOURSELF AS A PERSON /
ETC.?
A question like this is a clear sign that the interviewer wants you to go off resume and reveal a bit of
your interests and personality. The interviewer is trying to gauge whether are a well-balanced person
who would fit in with the firm on a personal level and be fun to be around for long stretches of time.
Put the CV away and talk about the things that make you fun and interesting. This is your
opportunity to connect with your interviewer and demonstrate your likability in addition to your
professional competence. Pick something interesting and don’t be afraid to get a little personal (this
question practically begs you to get a little personal). You probably want to avoid highly controversial
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topics, but you have more leeway here than most candidates realize. Sports, hobbies, talents, funny
situations, unusual life stories, interesting achievements, outside passions, etc. are all fair game here.
The most important advice is: be interesting. Be a real life person your interviewer will remember.
12. DO YOU CONSIDER YOURSELF A RISK-TAKER / WHAT ARE SOME RISKS YOU
HAVETAKEN IN THE PAST AND WHAT DID YOU LEARN FROM THEM / HOW DO YOU FEEL
ABOUT RISKING OTHER PEOPLE’S MONEY?
Your attitude toward risk is important in a PE context. PE firms look for people who take the
responsibility of managing other people’s money very seriously, but who are willing to take prudent
risks to generate returns. Your interviewer is looking for a willingness to take risks tempered by a
careful and reasoned approach to balancing risks with rewards.
There are a couple of common ways to approach answering this type of question: You could tell a
story where you took a well calculated risk and it paid off, or you could tell a story about a bad risk
you took and how it taught you to be more careful. In either scenario you want to affirm your belief
that some risk is required for success, but that you’re the type of person who measures twice before
cutting once.
SAMPLE ANSWER: “I believe that taking risks is important not only in investing, but also in life because
taking risks is what lets us expand our capabilities. However, I am the type of person who feels comfortable
taking risks only when I’m certain the rewards are worth it and the downsides are well understood. This
attitude toward risk has helped me to take important leaps of faith in my life while largely avoiding any
catastrophic missteps. For example, I am currently taking a risk in refusing sponsorship from my old
company to pursue my MBA. I am sure that I would prefer to switch careers and pursue PE full time so my
upside is that I will land my dream job. The downside is that I am foregoing a lot of sponsorship support and
risking an unpredictable interview cycle. The reason I’m taking this risk is that it’s extremely important for
me to pursue the career which I feel suits me best, while going back to consulting is likely to always remain
open for me.”
13. DO YOU PREFER TO WORK INDEPENDENTLY OR AS A TEAM / DO YOU
CONSIDERYOURSELF A LEADER OR A FOLLOWER / TELL ME ABOUT A TIME YOU WORKED
AS PART OF A TEAM WHICH EXCEEDED EXPECTATIONS / ETC.
Teamwork is essential to the deal process because deadlines are tight and mistakes are expensive.
Your interviewer wants to make sure that you have teamwork experience, enjoy teamwork, are
effective as both a leader and a follower, and know when the time is right to take initiative vs. follow
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Top 15 Fit Questions & Answers
instructions. The impression you want to give is that you are comfortable as an individual contributor
but that you really enjoy teamwork and think that good teams are greater than the sum of their parts.
You should also highlight your understanding that the role of a junior professional is first and
foremost to diligently execute on the direction of senior staff, while looking for opportunities to take
initiative when the time is right.
SAMPLE ANSWER: “Although I am quite comfortable doing individual work, many of my most satisfying
work experiences have come as part of a team. The best part about teams, aside from the friendships they
help form, is that great teams achieve more than what the same group of individuals can achieve
independently. As a junior team member I have always realized that first and foremost I need to diligently
follow instructions from the team leaders because they have more responsibility and experience. My typical
approach is to first do what is asked of me and then to look for ways to add value based on personal
initiative. One illustrative example of my approach is that at my old job analysts spent a lot of time building
custom models for each new deal. After building several such models I noticed that many of our
customizations were repetitive and could be automated with a more flexible base model shell. I took some
personal time to build a new model shell which incorporated my observations. This improvement saved a lot
of time not only for myself but also for all of the other analysts in my class.”
14. WHAT DO YOU CONSIDER TO BE YOUR GREATEST ACCOMPLISHMENT / WHAT ISTHE
BIGGEST CHALLENGE YOU HAVE EVER OVERCOME / WHAT ARE YOU MOST PROUD OF?
This question is a polite way for the interviewer to tell you “ok kid, impress me.” Most people who
work in PE have accomplished some pretty impressive things before they broke into the industry.
The ranks of PE professionals are loaded with valedictorians, entrepreneurs, successful athletes,
philanthropists, innovators, etc. This question is an opportunity for you to show you belong in this
group. Some people advise answering this question in a humble way by pointing to a small but highly
meaningful accomplishment or focusing on personal accomplishments related to family and
relationships. I take the stance that such answers might make you seem likable, but that they duck
the central challenge of the question. On this question I say go big. Brag a little because that’s what
you’re being invited to do.
Imagine you had your own Wikipedia page (some of you probably do). What would be listed there as
the thing that makes you most noteworthy? Assuming you are not a Kardashian, pick that thing and
talk about it.
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15. WHAT IS THE BIGGEST MISTAKE YOU HAVE EVER MADE / WHAT IS YOU BIGGESTREGRET
/ WHAT IS AN EXAMPLE OF A DECISION YOU WISH YOU HAD MADE DIFFERENTLY?
Honest self-reflection is a hallmark of good PE investors. Everybody makes mistakes. What matters
is your ability to admit them and learn from them. Your interviewer wants to see that you’re not
afraid to own your mistakes and that you’re able to prevent them from recurring.
Much like the weaknesses question, you need to pick a real mistake, but not one so big that it will
disqualify you. If you’ve ever missed a deadline, messed up some analysis, damaged a relationship,
been suspended from school, or let a big opportunity pass you by, you’re probably on safe ground to
answer this question. Don’t be afraid to own it. On the other hand if you’ve been arrested or fired or
exhibited serious character flaws you’re playing with fire. Ditto if you’ve ever actually been accused
of lighting a squirrel on fire (you know who you are). Sometimes discretion is the better part of valor.
Choose which mistake to disclose wisely.
Whatever mistake you choose to discuss, do so without equivocation and in a way which makes clear
you take total responsibility. Then, spend the second half of your answer discussing what you learned
from your mistake and how you made sure it wouldn’t happen again.
SAMPLE ANSWER: “During my first few months at my current job I was asked to update a financial model
while simultaneously staffed on another deal. This update was difficult because of the model’s size and
complexity, but I did not ask for help out of fear of seeming incompetent. Whenever my manager checked in I
told him that it was a challenge but that I was on track. In reality I was struggling late into the night with
little progress. When my other deal became the priority I was asked to transfer my work to another analyst
and had to come clean. My manager was understandably upset that I had kept him in the dark. I also felt
guilty for leaving another analyst with a lot of work and little time to finish it. Had I flagged the issue earlier,
my manager would have understood the difficulties, and there would have been time to get help. My failure
to communicate honestly caused an unpleasant surprise and a scramble to finish the job. I now proactively
seek help and clarifications on new assignments. This approach helps me meet deadlines and avoid wasting
time wondering what to do or how to do it.”
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PE Firms Get Jealous Too: Here is Proof
PE Firms Get Jealous Too: Here is Proof
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Bonus Webinar: Transition from Investment Banking to
Private Equity
Bonus Webinar: Transition from Investment Banking to Private Equity
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Module 5: Interview Questions
Top 10 Brainteaser Questions & Answers
Top 10 Brainteaser Questions & Answers
Top 10 Brainteaser Questions & Answers
Brainteasers test your ability to think on your feet, apply simple logic, and do mental math. A
brainteaser can make even the smartest and best prepared candidate break down if he or she hasn’t
faced a similar question. Fortunately, some brainteasers and their variants appear frequently. The
most common are below:
1. WHAT IS THE ANGLE BETWEEN THE BIG HAND AND LITTLE HAND ON A CLOCKFACE
WHEN IT IS 3:15
This is a common question but the time changes. Just remember that a clock face is 360 degrees, split
into 12 hours of 360 / 12 = 30 degrees each. When it is 3:15, the long minutes hand is pointing
directly at the 3-hour mark, while the short hours hand is below it because the time is 15 minutes
past the 3-o’clock hour. The angle between the hands is equal to how far the short hours hand moves
in 15 minutes, which is a quarter of an hour. Since an hour equals 30 degrees, the angle between the
hands is 30 / 4 = 7.5 degrees.
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2. THERE ARE THREE BOXES. TWO BOXES ARE EMPTY AND THE THIRD CONTAINSA PRIZE.
YOU SELECT ONE OF THE BOXES AT RANDOM. THE BOX YOU SELECTED IS SET ASIDE,
LEAVING TWO REMAINING. ONE OF THE TWO REMAINING BOXES IS OPENED AND
REVEALED TO BE EMPTY. THERE ARE NOW ONLY TWO CLOSED BOXES REMAINING, THE
ONE YOU ORIGINALLY SELECTED AT RANDOM AND ANOTHER ONE WHICH WAS NOT
SUBSEQUENTLY OPENED. YOU MAY NOW CHOOSE ONE OF THE TWO REMAINING BOXES,
AND IF YOU CHOOSE CORRECTLY YOU WIN THE PRIZE. SHOULD YOU CHOOSE THE
ORIGINAL BOX YOU SELECTED, SWITCH YOUR CHOICE TO THE OTHER BOX, OR DOES IT
NOT MATTER? WHY?
You should always switch to the other box (i.e. don’t pick the box you originally selected). There is a
1/3 chance that the prize is in the original box and a 2/3 chance that the prize is in the other box. It’s
simple to see how this is so if you imagine that there are 1,000 boxes instead of three. Imagine you
picked one box at random out of 1,000 and it was set aside. Of the remaining 999 boxes, 998 were
then opened to reveal no prize. The odds that you initially picked the right box at random are 1/
1,000, but the box which remains unopened after 998 other boxes were revealed to be empty almost
certainly contains the prize.
3. WHAT IS THE SUM OF THE INTEGERS BETWEEN 0 AND 100 (INCLUSIVE OF 0 AND100)?
The trick to solving questions like this is making pairs which add up to something that is easy to
count. In this case, 0+100, 1+99=100, 2+98=100, 3+97=100, etc. There are 50 such pairs because
there 50 numbers between 0 and 49 (including the zero). 50 times 100 is 5,000. Don’t forget the final
50 which didn’t get paired up and you get 5,000 + 50 = 5,050.
4. IMAGINE I OFFER TO PLAY A COIN FLIPPING GAME WITH YOU WITH A FAIR COIN. IFTHE
FIRST FLIP IS HEADS I WILL GIVE YOU ONE DOLLAR. FOR EACH SUBSEQUENT HEADS FLIP I
WILL DOUBLE THE PAYOUT. THE GAME ENDS ONCE A SINGLE TAILS IS FLIPPED. WHAT IS
THE HIGHEST PRICE YOU WOULD PAY TO PLAY THIS GAME IF YOU ARE 100% SURE I WILL
PAY WHAT IS OWED TO YOU AND IF YOUR ONLY MOTIVATION IS TO MAKE AN EXPECTED
PROFIT?
This mathematical problem is referred to as the St. Petersburg Paradox. The strange solution is that
you would pay up to an infinite amount of money to play this game because the expected value of
playing it is also infinite. The trick to solving is realizing that the expected value of this game equals
the sum of all possible payoffs multiplied by the odds of that payoff occurring. You will win a dollar
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with a ½ probability, win 2 dollars with a ¼ probability, win 4 dollars with a 1/8 probability, etc.
Therefore, your expected value is:
Look up the St. Petersburg Paradox for more details. Note that some interviewers won’t stipulate
that expected value is the only thing you care about. In such cases you should caveat your answer by
saying that although the expected value is infinite, you wouldn’t pay an infinite amount of money to
play the game because the range of outcomes is highly risky and you are averse to risk. The odds of
making you money back are below 50% if you pay anything above a dollar. This insight is important
because PE firms are risk averse, and would rather avoid losing money than making an equal amount
of profit.
5. IMAGINE A TOWN WITH 100 MARRIED COUPLES. THE WIVES OF THIS TOWNARE
INSTANTLY INFORMED IF THE HUSBAND OF ANOTHER WIFE CHEATS, BUT THEY ARE NOT
INFORMED IF THEIR OWN HUSBAND CHEATS. ANY WIFE WHO HAS IRREFUTABLE PROOF
THAT HER HUSBAND CHEATED MUST DIVORCE HIM IMMEDIATELY. ALL DIVORCES ARE
MADE PUBLIC EACH MORNING. WHAT WOULD HAPPEN IF “N” HUSBANDS CHEAT, AND A
RELIABLE GOSSIP COLUMN REVEALS THAT AT LEAST 1 HUSBAND HAS CHEATED (N IS
BETWEEN 1 AND 100).
The way to approach this (and similar) problems is to apply recursive logic. If n = 1 then the cheater’s
wife can prove her husband cheated because she knows n is at least 1, and she knows none of the
other husbands cheated. Therefore, if n = 1, the cheating husband will be divorced on day one. If n = 2
then no woman is sure her husband cheated on day one. This is because each cheater’s wife knows
two facts: n is greater than or equal to 1, and at least one other woman’s husband cheated. As far as
each scorned wife knows, only one husband cheated. However, after the first day passes with no
divorces each wife knows that n is equal to or greater than 2 (since wives know an n of 1 would
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produce a divorce on the first day). Therefore, if n = 2, then both cheating husbands will be divorced
on the 2nd day. You can apply this logic over and over to extrapolate that all cheating husbands will
be divorced within “n” days after the publication of the gossip column. Also, don’t feel too badly for
the poor wives of this town … after all … who are these husbands cheating with?
6. THERE ARE 100 CLOSED LOCKERS IN A ROW. FIRST, YOU OPEN EVERY LOCKER.YOU THEN
CLOSE EVERY 2ND LOCKER STARTING WITH LOCKER #2. YOU THEN OPEN EVERY 3RD
LOCKER IF IT’S CLOSED OR CLOSE IT IF IT’S OPEN, STARTING WITH LOCKER #3. YOU THEN
CLOSE EVERY 4TH LOCKER IF IT’S OPEN OR OPEN IT IF IT’S CLOSED, STARTING WITH
LOCKER #4. YOU CONTINUE ON IN THIS FASHION UNTIL YOU COMPLETE 100 FULL
ITERATIONS BY OPENING (OR CLOSING) EVERY 100TH LOCKER BEGINNING WITH LOCKER
#100. OF THE 100 LOCKERS, HOW MANY ARE NOW OPEN?
The lockers begin in the closed position. Each locker which is touched (opened or closed) an odd
number of times by the end of the procedure will end up being open. The key insight is that a locker
will be touched (opened or closed) equal to the number of its factors. For example, locker number 20
has 6 factors (1, 2, 4, 5, 10, and 20), so it will be touched 6 times. Only numbers which are perfect
squares have an odd number of factors. Therefore only lockers whose numbers are perfect squares
remain open. There are 10 perfect squares between 1 and 100: 1, 4, 9, 16, 25, 36, 49, 64, 81, 100.
Therefore, 10 lockers are open.
7. YOU DROP A 10X10 RUBIK’S CUBE INTO A BUCKET OF PAINT. HOW MANYINDIVIDUAL
CUBES HAVE PAINT ON THEM?
The trick is to realize that cubes on the edge of any one of the 6 faces have a side on two faces (3
faces for corner cubes), so you can’t simply calculate the number of cubes on a single face and
multiply by the number of faces. The most intuitive way to solve this problem is to calculate the total
number of individual cubes in a 10x10x10 Rubik’s cube, and then subtract the number of cubes which
are all internal with no facings on the outside. There are 10 * 10 * 10 total individual cubes. On the
inside of a 10x10x10 cube, there is an 8x8x8 cube with no outside facings. The 8x8x8 cube contains
512 individual cubes. Therefore, there are 1,000–512 = 488 cubes on the outside of the Rubik’s cube
with paint on them.
8. HOW WOULD YOU ISOLATE EXACTLY THREE GALLONS OF WATER IF YOU ARESTANDING
IN A RIVER WITH A 5 GALLON JUG AND A 2 GALLON JUG?
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Top 10 Brainteaser Questions & Answers
Fill the 5 gallon jug to the top and pour water out of it into the 2 gallon jug until the 2 gallon jug is full.
You will have exactly 3 gallons of water in the 5 gallon jug.
9. YOU HAVE TEN BLACK MARBLES, TEN WHITE MARBLES, AND TWO BUCKETS. I AMGOING
TO SELECT ONE BUCKET AT RANDOM AND PULL OUT ONE MARBLE FROM IT AT RANDOM.
HOW WOULD YOU FILL EACH BUCKET WITH MARBLES TO MAXIMIZE THE ODDS THAT I
SELECT A WHITE MARBLE?
Put one white marble in one bucket and put the other 19 marbles in the other bucket. The bucket
with the lone white marble will be chosen 50% of the time. When the other bucket is selected, the
odds that a white marble is pulled are still nearly 50%. By allocating marbles this way you make the
overall odds of a white marble being selected nearly 75%.
10. A CAR DRIVES FROM POINT A TO POINT B AT 60MPH. IT THEN RETURNS FROMPOINT B
TO POINT A AT 30MPH. WHAT IS THE AVERAGE SPEED OF THE TOTAL ROUND TRIP?
A lot of people say 45mph, which is wrong. Average speed equals total distance over total time. In
this case let’s assume the distance between A and B is 60 miles. The first leg of the journey takes one
hour and the return trip takes 2 hours. The total distance traveled is 120 miles and the total time the
trip takes is 3 hours. Therefore, the average speed of the round trip is 120 miles / 3 hours = 40mph.
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Follow These 5 Steps if You Get Stuck on a
Brainteaser
Follow These 5 Steps if You Get Stuck on a Brainteaser
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Module 6: LBO Modeling
Introduction to LBO Modeling Tests
Introduction to LBO Modeling Tests
Introduction to LBO Modeling Tests
The final step in preparing for your PE interviews is to master the art of LBO modeling. There are
three main types of LBO modeling you should be able to do before you walk through the door of your
interview: the Paper LBO, the Basic (1-hour) LBO, and the Full (3-hour) LBO.
THE PAPER LBO: This is an exercise in mental math and paper calculation. This will often come up in
the middle of an interview, with an interviewer giving you assumptions and simply asking “how does
the deal look?” This is an opportunity for you to show off your understanding of how PE firms make
money, your ability to think on your feet, and your investment judgment.
THE BASIC (1-HOUR) LBO: This is where your Excel abilities come into play. Often the interviewer
will give you a computer, some assumptions, an empty office and a time limit. Your job is to model out
the deal and give a recommendation. The Basic LBO will usually require limited Balance Sheet
modeling (e.g., just a debt schedule), and assumptions that require less nuanced modeling than the
Full LBO.
THE FULL (3-HOUR) LBO: Here is the final test of your modeling capabilities. You will be given more
time, but be expected to churn out a full three-statement LBO model. You may also be asked to
model in some more complicated deal structures.
This chapter will walk you through how to do each type of model along with illustrative examples.
You should be following along and trying to build the models yourself, and then checking your work
against ours. At the end, we will also provide additional practice questions and modeling tests with
example answers so you can build your capabilities. The good news is that if you have made it to the
Excel modeling stage of the interview process, you are likely being considered seriously; nail the test
and you are in excellent position to land the job.
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The Paper LBO
The Paper LBO
The Paper LBO
The following example corresponds to the accompanying Excel file titled “WSO–PE Guide–Paper
LBO Example 1.xlsx”.
The Paper LBO is a simplified version of the LBO that is designed to test your understanding of the
logic and basic mechanics of buyouts. These questions can come in the middle of both first round and
later stage interviews. Your interviewer will give you some basic assumptions and deal details, and
ask whether this deal is attractive. You then can walk your interviewer through the rough
calculations of the Paper LBO, and after generating a deal IRR you can comment on the
attractiveness of the deal.
A few quick points before we jump into the mechanics. First, the interviewer may not give you all of
the assumptions you need up front. This is fine; they are looking to see whether you know what the
missing terms are to ask for or whether you can make reasonable assumptions about them (e.g., “Do
you know what the tax rate is here? Or should I just assume 40%?”). Second, this is always a simplified
version of the LBO and is designed to get you in the ballpark of the deal IRR; do not be afraid to round
numbers as necessary, because giving an IRR to the third decimal point is an exercise in false
precision. Third, if you are comfortable doing the math in your head that is great, but do not feel like
you absolutely have to. Finally, this is an exercise where you are trying to show your thought process
and understanding of the mechanics; as you are making your calculations, explain what you are doing
to the interviewer so they can follow along.
Paper LBO Example
Your interviewer opens with the following: “Let’s say we’re looking at a company that did $200M in
revenue last year and has a 25% EBITDA margin. We could buy it for 6x EBITDA with 75% debt, and
sell it for 5x EBITDA in 5 years. We expect EBITDA to grow at 10% during our hold period. Does this
look like a good deal?”
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The Paper LBO
You have gotten most of the information you will need to do the Paper LBO, but not all of it.
However, you have enough to do the first step of the Paper LBO: the Deal Entry Calculation.
• Deal Entry Calculation
• Multiplying revenues ($200M) by the EBITDA margin (25%) will give you LTM EBITDA at the
time of the deal ($50M).
• Multiplying LTM EBITDA ($50M) by the EBITDA multiple (6x) gives you the initial TEV ($300M).
• Multiplying the TEV ($300M) by the debt percentage (75%) gives you the implied debt ($225M).
The remainder ($75M) is the size of the equity check at entry.
An Excel version of how your paper may look when you have finished this step may look like this:
The next step is to project the financials and cash flow of the business during the hold period, or the
Forecasted Financials. This is important to understand both how much cash the business will
generate while you own it, as well as to understand the price you will get for the business at exit
(which here will be based on a multiple of EBITDA at exit). However, you do not have enough
information to complete this step yet. At this point you should ask your interviewer about the cost of
debt, the debt paydown policy, the tax rate, capex, D&A, and net working capital.
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The Paper LBO
Your interviewer responds with: “Let’s keep it simple. The cost of debt will be 10%, and we’ll assume
that we don’t pay down any debt during the hold period and instead take cash out at the end. The tax
rate is 40%, and capex and D&A are both $15M per year. Net working capital increases by $5M each
year.”
You now have the information to project the Forecasted Financials during the hold period.
Forecasted Financials
Income Statement
• We calculated above that LTM EBITDA was $50M. Given the 10% growth rate, we can calculate
EBITDA for years 1-5 by multiplying each prior year by 1.1. Doing this we calculate EBITDAs
of$55M, $60.5M, $66.6M, $73.2M, and $80.5M for years 1-5 respectively.
• D&A is steady at $15M per year, so we can populate that for each year.
• Subtracting D&A from EBITDA, we get EBITs of $40M, $45.5M, $51.6M, $58.2M, and $65.5M
for years 1-5.
• Calculating interest in this situation is as simple as multiplying the amount of debt (calculated
as$225M in the Deal Entry Calculation above) times the cost of debt (10%) to yield $22.5M.
Because we are not paying down debt during the hold period, it is the same each year.
• Subtracting interest from EBIT gives us EBTs of $17.5M, $23M, $29.1M, $35.7M, and $43M for
years 1- 5.
• Taxes are then calculated as 40% of EBT for each year. These will equal $7M, $9.2M,
$11.6M,$14.3M and $17.2M respectively.
• Subtracting taxes from EBT will give us our Net Income each year: $10.5M, $13.8M, $17.4M,
$21.4M and $25.8M.
This gives us our Income Statement. An Excel version of your paper may look like this:
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The Paper LBO
Cash Flow
• From here we can calculate cash flow. We will start with Net Income calculated above.
• To this we add back D&A of $15M each year.
• We then subtract capex of $15M each year.
• Finally, we subtract an increase in NWC of $5M each year.
• This will give us a Cash Flow line of $5.5M, $8.8M, $12.4M, $16.4M, and $20.8M in years 1-5
respectively.
• We can sum across the Cash Flow line to see that cumulatively the business will generate $64M
in cash during the hold period, which we will receive at exit.
An Excel version of your paper may look like this:
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The Paper LBO
We’re almost done. All we have left is the Deal Exit Calculation and your recommendation.
Deal Exit Calculation
• At Exit, we know LTM EBITDA will be $80.5M (Year 5 EBITDA from above).
• Multiplying LTM EBITDA at exit ($80.5M) by our Exit Multiple (5x) will give us our exit TEV
($402.5M).
• To this figure, we add our cumulative cash generated ($64M) and subtract our debt (still $225M)
to get an Exit Equity value of $241.5M.
• Next we must calculate our Multiple on Invested Capital (MOIC) / Multiple of Money (MoM). To
do this we divide the Exit Equity value by our Entry Equity ($241.5M / $75M) to yield 3.2x.
• Finally, to convert the 3.2x MOIC into IRR we can do one of two things:
• We can calculate it by using the typical CAGR formula. We take our MOIC ^ (1/Hold
Period)–1. In this case: 3.2 ^ (1/5)–1, giving us an IRR of 26.4%.
• Alternatively, we can rely on the rough heuristic table below:
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The Paper LBO
We see that a 3x deal over five years yields around a 25% IRR, while a 3.5x deal is almost 29%. Thus,
for a 3.2x deal we can assume an IRR around 26%. This level of precision should be fine for a Paper
LBO. (In fact, you should memorize the year 5 column of this grid for your own reference, regardless
of how you choose to calculate IRR during a Paper LBO. Knowing that a 2x deal is a 15% IRR, a 2.5x
deal is a 20% IRR, and a 3x deal is a 25% IRR is quite useful.)
An Excel version of your paper may look like this:
The final step is to provide a recommendation. This specific deal looks good, with a 3.2x MOIC and a
26% IRR. However, you may want to comment on whether this return adequately compensates you
for the risk you are carrying (e.g., if faced with a deal that has a 19% IRR, you may comment “This deal
looks to be decent, but it depends on how risky the business is. If this is a very safe business, I’d be
more comfortable pulling the trigger here and accepting a high-teens return.”) You may also want to
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The Paper LBO
comment on what is important to make the deal a success and how that would affect the way you
diligence the business (e.g., here you might say “This deal looks great with a 26% IRR, but we would
have to dig in during diligence to get conviction around the 10% EBITDA growth. Cash flow
generation provides some of the return here, but this is primarily an EBITDA growth story.”). This
kind of analysis is pretty basic, but it lets you to show some of your investment judgment rather than
just your math skills.
One final comment on the Paper LBO is to be aware that there are a number of twists that can be
thrown into these questions. For example, rather than asking you what the IRR of a given deal is, the
interviewer may ask you what the exit multiple must be given a set of assumptions to get a 20%
return on a deal, or what price you could pay at entry to receive a target return. They also may ask
you to include things that have been simplified away in this case, like including management options
or deal fees. Ultimately, the mechanics of the exercise will be the same, but you’ll be solving for a
different variable or adding a few additional line items. Don’t get caught off guard by these tweaks;
just calmly walk through the mechanics and show you can deal with anything they throw your way.
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Paper LBO Example 1
Paper LBO Example 1
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Module 6: LBO Modeling
The Basic (1-Hour) LBO
The Basic (1-Hour) LBO
The Basic (1-Hour) LBO
The following example corresponds to the accompanying Excel file titled “WSO–PE Guide–Basic
LBO Example 1.xlsx”.
Many Private Equity firms ask their candidates to do more than just an LBO on paper; they also want
to see your modeling capabilities. They will give you some information about a potential deal, a
computer, and a set amount of time and ask you to build an LBO model for them. The Basic (1-Hour)
LBO test is the simplest version of this test.
The model you will need to build in the Basic LBO test is akin to what many PE shops refer to
internally as a “mini-model” (rather than a “full model”). The mini-model has all of the major items
necessary to judge the attractiveness of a deal in the early-to-medium stages; as a deal heads toward
completion, however, firms will build a full model that includes all of the intricacies of the transaction.
Fundamentally, the steps to doing a Basic LBO model are the same as for the Paper LBO: Deal Entry,
Forecasted Financials, and Deal Exit. Each step along the way is just a bit more detailed.
Basic LBO Example
You receive the following prompt:
“Company ABC is a public company that is trading at $20 / share. They have 25 million fully diluted
shares outstanding, and $200M of net debt. Last year, the business realized the following operating
numbers:
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“The MD believes it can be taken private at a 20% premium. The MD believes the business has a
strong management team, and to retain and incentivize them he believes a 5% management option
pool would be necessary.
“ABC’s management has presented an operating plan that we believe they can hit. It calls for 4% top
line growth, and EBITDA margin expansion of 50 bps per year. They anticipate D&A, Capex, and
NWC to remain the same as a percentage of sales, and for the tax rate to remain at 35%. While the
business has $75M of cash on the balance sheet now, it only needs $20M to run its day-to-day
operations.
“The investment bankers advising you suggest that the deal could be funded with 3.0x Bank Debt
priced at L+300 bps and 2.0x Senior Notes with a 12% coupon. The five year LIBOR swap rate at the
moment is 3.0%. The equity analyst at the bank believes the long-run valuation of this business
should be 8.5x EBITDA. Between financing, legal, and accounting, fees and expenses should be
around $50M.
“What are the returns of this deal at the 20% take-out premium the MD anticipates being necessary
assuming management hits its operating plans? Would you recommend we do the deal?”
That seems like a lot to digest, but you can organize everything by creating an assumptions section at
the top of your model. Write down every number, and code it in blue to represent that it is hardcoded. This will allow you to keep track of and organize everything in the prompt, as well as
centralize the assumptions that you will link to for the rest of your model. Here is an example
assumptions section:
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Next, it is time to move onto calculating the details around Entry as well as create the Sources and
Uses table.
Deal Entry
Sources and Uses
• The Sources and Uses (S&U) table explains where the cash is coming from to do the LBO, and
where it is going to. The Sources must equal the Uses.
• S&U tables are often structured with a list of sources on one side, and a list of uses on the other
side (or one on top of the other). Each line item will have a dollar amount next to it, and many
times will have stats around the xEBITDA or the percentage of the total deal it represents (see
example below).
• Starting with the Uses side is usually easier. Here there are four uses of cash:
• Cash to buy the shares of existing equity holders: We’ve already calculated this figure above
in our assumptions example. This is done by taking the current stock price, multiplying it by
(1 + Takeout Premium) to get the price per share paid to shareholders, and multiplying that
by the number of shares outstanding. In this case, the math is $20 / share * (1+20%) * 25M
shares =$600M.
• Cash to retire / refinance the existing net debt: This figure was given to us in the prompt
as$200M. Note that we are using net debt here, which means we are netting the cash
currently on the balance sheet against the gross debt. It is possible to use gross debt on the
Uses side, and then use existing cash on the balance sheet as a source of cash on the Sources
side, but you must be consistent to make sure you do not double-count. Either use net debt
on the Uses and do not use existing cash as a Source, or use gross debt on the Uses and do
use existing cash as a Source.
• Cash to go to the balance sheet to run the business: This was given in the prompt. Use the
minimum cash required in the business ($20M) for this number. Note that because we are
netting all of the existing cash against net debt (and reducing that Use of cash), we need to
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include this line item to make sure we “put” enough cash into the business for it to run.
• Cash for fees and expenses: This was given in the prompt as $50M.
• Next is the Sources side. Here there are only three sources of cash for the deal:
• Bank Debt: The prompt said we anticipated being able to get 3.0x Bank Debt on this deal;
the question is: 3.0x what? In PE, when people give multiples for leverage purposes, it is safe
to assume they mean multiples of EBITDA unless they state otherwise. Here, 3.0x EBITDA
implies total bank debt of $300M.
• Senior Notes: The prompt indicated we could get 2.0x Senior Notes, which implies $200M.
• Sponsor Equity: Sponsor Equity is actually the ‘plug’ here. We know that the Sources and
Uses must sum to the same total, and we see the total uses are $870M ($600M to existing
equity holders + $200M to existing net debt + $20M to put on the balance sheet to run the
business +$50M of fees). We also know that we can finance $500M of the deal with debt
($300M of Bank Debt and $200M of Senior Notes). Thus, to do the deal the sponsor will
need to invest $370M ($870M–$500M).
An example Sources and Uses table may look like this:
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Now that we have all of the details around the Sources and Uses and the Deal Entry, we are ready to
start modeling out the finances of the business for the hold period. There are three main components
necessary in the Basic LBO model, and they are all interconnected: the Operating Model, the Levered
Cash Flow, and the Debt Schedule.
Forecasted Financials
Operating Model
• The operating model is where you will model out all of the details about how the business
performs. It will feed into Levered Cash Flow and the Debt Schedule, as well as pull from the
Debt Schedule.
• We know from the prompt that revenue in Year 0 is $500M, and that revenue is expected to
grow at 4% per year for the next five years. Thus, we can project revenues of $520M, $541M,
$562M,$585M, and $608M in years 1-5 respectively.
• We also know that EBITDA in Year 0 is $100M. This implies an EBITDA margin in Year 0 of 20%.
Management’s plan anticipates 50 bps of EBITDA margin expansion each year during the hold
period, so we can project margins going forward of 20.5% in Year 1 trending up to 22.5% in Year
5.
By multiplying our projected revenues and our projected EBITDA margins, we can get
expected EBITDAs of $107M, $114M, $121M, $129M, and $137M.
• We know D&A in Year 0 is $25M from the prompt, which is 5% of sales. Holding this percentage
constant per management’s expectations yields us D&A projections of $26M, $27M, $28M,
$29M, and $30M.
• Subtracting D&A from EBITDA gives us EBIT. The next step is to take out Interest to get to EBT.
However, Interest will come from the Debt Schedule, so let’s put in a placeholder line item for
now, and generate EBT by taking EBIT minus that placeholder.
• Management expects taxes to be 35% going forward, so we can multiply EBT by this figure to get
annual taxes.
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• Finally we can then take EBT minus taxes to get Net Income.
• Though everything else so far in the Operating Model has been part of an Income Statement, we
now need to add two other assumptions relevant for generating cash flow projections to the
operating model.
• Net Working Capital was $75M in Year 0, representing 15% of sales. Assuming this
percentage remains the same, we can project NWC going forward of $78M, $81M, $84M,
$88M, and $91M.
• Capex was $20M in Year 0, representing 4% of sales. Assuming this percentage remains the
same, we project Capex of $21M, $22M, $22M, $23M, and $24M.
• Note that we still have the Interest issue to sort out, but we are done with the Operating Model
for now. Because the Interest figure is incorrect, everything below that line is also incorrect and
will change later on.
Here is what the current version of your model may look like right now:
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Levered Cash Flow
• Next is the Levered Cash Flow section, which pulls directly from the Operating Model and feeds
into the Debt Schedule. In this section we calculate how much cash flow we will generate each
year.
• Levered Cash Flow can be calculated a number of ways, but the two main ways are a) starting
from EBITDA, and b) starting from Net Income.
• The “starting from EBITDA” methodology begins by pulling the EBITDA line from the
Operating Model, and subtracting from that the following line items: Capex, Interest, Taxes,
and any increases in NWC.
• The “starting from Net Income” methodology begins by pulling the Net Income line from the
Operating Model, then adding back D&A, then subtracting Capex and any increases in NWC.
• The sum of these calculations will provide you with the Levered Cash Flow for each year, which
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we will use in the Debt Schedule next. Note that because Interest (and consequently Taxes and
Net Income) are incorrect in the Operating Model still, LCF will be incorrect as well until this is
fixed.
An Excel version of your Levered Cash Flow section may look like this:
Debt Schedule
• The Debt Schedule is where we forecast the debt structure (and consequently the Interest
expenses) of ABC over time. We know that we are going to buy the business with $500M of debt,
but we also know that we are going to generate cash during the hold period with which we can
pay down debt. We are going to pull information from the S&U, Assumptions, and LCF sections,
and will end up feeding information into the Operating Model (which will flow back into the LCF
section and the Debt Schedule).
• It is important to understand what your debt payback policy will be during the hold period. Are
you going to keep cash generated on the balance sheet, or repay debt? If you are going to repay
debt, which tranche will you repay?
• The most common answer to this is to use all cash above the minimum cash on your balance
sheet to repay debt, and to start to repay any revolvers or bank debt first. This is because
revolvers and bank debt usually do not have prepayment penalties, while most notes and
other forms of junior debt have a no-call period or a call schedule that makes it expensive to
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prepay these debts early on.
• Here we will assume excess cash flow will go to repaying Bank Debt.
• Within the Debt Schedule, you should start by building a four-line infrastructure for each
tranche of debt separately that includes Beginning of Period (BOP) Balance, Interest, Paydown,
and End of Period (EOP) Balance. You should also create a similar structure for Cash, Total Gross
Debt, and Total Net Debt.
• Our Bank Debt uses a floating interest rate of L+300 bps, so we should also insert a LIBOR line in
our Debt Schedule that we can reference while calculating our Interest payments.
• When populating the LIBOR line, you can use:
• The expected LIBOR forward curve (meaning LIBOR changes over time based on current
expectations), or
• The 5-year LIBOR forward swap rate for every year (meaning LIBOR stays constant over
time; implies you hedge your floating rate position at the close of the deal).
• Here we do not have information about the LIBOR forward curve, so we are simply going to
use the swap rate.
• First, let’s fill in the BOP numbers for Year 1 for each tranche. Pulling from the S&U section
above, we get $300M for Bank Debt, $200M for Senior Notes, and $20M for Cash. The
mechanics of our Total Gross Debt and Total Net Debt should yield figures of $500M and
$480M respectively.
• Second, we need to calculate the Interest for each tranche.
• There are two ways of calculating Interest for each tranche. One is to multiply the interest
rate by the BOP figure, and the other is to multiply the interest rate by the average of the
BOP and EOP figures. This second methodology will typically be more accurate, but will
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create a circular reference. Circular references will slow down your model, and to use them
you must turn them on in Excel. Here we will use the first methodology.
• To turn on circular references in Excel: press Alt, then t, then o to open the Excel options
menu, then go down to the “Formula” submenu on the left, then check “Enable iterative
calculation” in the top right.
• To calculate the Interest for each tranche using the first methodology, we multiply the BOP
amount outstanding by the interest rate.
• For the Bank Debt, the rate will be the LIBOR in Year 1 (which we have swapped to the 5-
year rate of 3%) plus the spread (300 bps or 3%).
• For the Senior Notes, the interest rate will simply be the 12% we have in the Assumptions
section.
• For interest earned on cash, there are several things we can do here. We do not have
information in the prompt, so we should make a “reasonable” assumption and be prepared to
justify it. We could assume this cash is required to run the business so it is in use and will not
earn an interest rate (e.g., cash sitting in the register at retail locations). One could also
assume that this cash is in a bank account which earns some “reasonable” rate. In this case,
we are assuming that this cash will be invested and earn LIBOR.
• These calculations give us the Interest for each tranche in Year 1. For Bank Debt, this is $18M,
for the Senior Notes it is $24M, for Cash it is $1M, and the Total Gross Interest and Total Net
Interest equal $42M and $41M respectively.
• Third, we need to calculate the amount of debt Paydown in each tranche.
• The cash flow available to pay down debt is the output of the Levered Cash Flow section.
Note that this information is not 100% accurate yet because we have not linked the
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Operating Model to our Debt Schedule, but we can still set up the mechanics now.
• Our debt policy is to maintain a minimum cash level of $20M, and then with excess cash flow
repay Bank Debt first, then Sr. Notes. Thus, the mechanics of how to allocate the Levered
Cash Flow must follow this ‘waterfall’ structure.
• Crafting this ‘waterfall’ structure is a bit tricky if you have never done it before, and it requires a
lot of Excel logic.
• Cash logic: Our change in cash balance will simply be the sum of the Levered Cash Flow and
the Paydown of the Bank Debt and the Senior Notes. The complexity of the waterfall will
come through in our Bank Debt and Sr. Note Paydown calculations.
• The Excel manifestation of this: = LCF + Bank Debt Paydown + Sr. Notes Paydown
• Bank Debt logic: If cash flow is negative, pay down zero Bank Debt. If it is positive, use all LCF
above what is needed to make sure the Cash balance is in line with Min Cash to pay down the
Bank Debt until the balance is zero.
• The Excel manifestation of this logic: =MIN(MAX( -BOP Bank Debt, -LCF–(BOP Cash–Min
Cash)),0)
• The Excel logic here is such that if the Cash Balance is less than Min Cash, the Bank Debt
Paydown will “claim” less than the full amount of the LCF, thereby leaving some left to
increase the cash balance.
• Senior Notes logic: Pay down Sr. Notes after the Bank Debt is fully repaid with any LCF left over
(after maintaining Cash at Min Cash) until the balance is zero.
• The Excel manifestation of this logic: =MIN(MAX( -BOP Sr. Notes, -LCF–Bank Debt
Paydown–(BOP Cash–Min Cash)),0)
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• Be sure to double-check your signs here, as they can be tricky.
• Next, we need to calculate the End of Period balance for each tranche. This is simply the BOP
balance minus any paydowns (or plus any additions for Cash).
• We now have the mechanics for Year 1 of the Debt Schedule. To roll this forward, we then link
the Year 2 BOP balances for each tranche to the Year 1 EOP balance, and then copy the
remainder of the formulas to the right. Make sure references to static assumptions (e.g., Min.
Cash, Interest Rates, etc.) are locked when you copy your formulas over. Repeat until we have
the Debt Schedule mechanics built for Years 1-5.
Note that we now have the mechanics built correctly, but we do not have the right figures because
we have not linked the Interest to the Operating Model and LCF. Your Excel model may look like this:
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• The last step remaining is to build the final link between the three sections of our projections. So
far we have been excluding the Interest expense from our Operating Model (and thus our LCF)
because we did not have the correct numbers. Now, we can link the Interest expense line from
the Operating Model to the Total Net Debt Interest numbers. This will lower your EBT, Taxes,
Net Income, and Levered Cash Flow, which will also reduce your debt paydown.
An Excel output of your final Operating Model, Levered Cash Flow, and Debt Schedule may look like
the following:
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The Basic (1-Hour) LBO
We now have the Sources and Uses to understand the Deal Entry, as well as the important
Forecasted Financials during the hold period. The last step is to model the Deal Exit.
Deal Exit
• Modeling the Exit is similar to what was done in the Paper LBO, though this time there is an
additional wrinkle of management options to take into account.
• First, we know LTM EBITDA at exit will be $137M as we calculated in the Operating Model
above. We also know from our assumptions that we expect to exit at 8.5x LTM EBITDA.
Multiplying these together gives us a TEV of $1,163M at exit.
• At exit we have $287M of net debt (as per the EOP Net Debt balance in our Debt Schedule). We
can subtract this from the TEV for a total Equity value of $876M.
• At this point, we need to take into account management options, which are to be 5% of the
company. There will be two steps to this calculation: the cash management puts in to exercise its
options, and the equity value it receives for these options.
• Note that there are two ways to interpret the 5% figure. One is that management will own
5% of the company after they exercise the options. The second is that they are given options
that are equivalent to 5% of the pre-exercise shares outstanding (e.g., they have 5M in
options while the sponsor has 100M shares, so after they exercise management will own
5/105 of the company). Here we are using the second treatment, but simply be conscious of
which you are using.
• When management exercises its options, it will pay cash into the company of the strike price
times the number of options struck.
• This will only occur if the equity value is above the strike price, otherwise management
will not exercise its options
• Though option packages can vary, typically the strike price for management is equal to
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the price of equity at entry.
• To calculate this figure, we use the following logic: =IF(Exit Equity Value>Sponsor Entry
Equity in S&U, Management Options %*Sponsor Entry Equity in S&U, 0). This value
should be $19M in this case.
• Next we need to calculate the value management will get from the options it just exercised.
• The value of the equity after the options are exercised is the Equity from above
($876M) plus the cash management just put in ($19M).
• Because we are using the second methodology mentioned above, management’s share
of this value is just below 5% (equal to 5/105).
• To calculate this figure, we use the following logic: =IF(Cash from Management
Options>0,-(Management Options % /(1+Management Options %))*SUM(Exit Equity
Value Pre-Options, Cash from Management Options), 0). This value should be $43M
here.
• To calculate Sponsor Equity Value at Exit, we take total pre-options Equity value ($876M), add
Cash from Management Options ($19M), and subtract Equity Value to Management Options
($43M). This gives us an Exit Equity Value of $852M.
The Exit Calculation of your Excel model may look like this:
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Now that we have modeled the deal exit, we can calculate the MOIC and IRR of the deal, as well as
generate any necessary sensitivity tables that will be useful in helping us craft our recommendation.
• Calculating MOIC and IRR are the same as they were in the Paper LBO. Calculate MOIC by
dividing the Sponsor Equity at Exit by Sponsor Equity at Entry, yielding a 2.3x MOIC here. Then,
given the five-year time horizon, calculate IRR as MOIC ^ (1/5)–1. In this case, IRR is 18.2%.
• Before we make our recommendation, we may want to do a few sensitivity tables.
• Most sensitivity tables in LBO models use IRR as the dependent variable.
• There are many combinations of tables you can do, but the most common include:
• Entry Price / Multiple / Premium vs. Exit Multiple
• Entry Price / Multiple / Premium vs. Leverage
• Entry Price / Multiple / Premium vs. Key Operating Driver (e.g., Revenue Growth,
EBITDA margin, Synergies)
• Key Operating Driver 1 vs. Key Operating Driver 2 (e.g., Revenue Growth vs. EBITDA
margin)
Here we’ve included Entry Price vs. Exit Multiple and Entry Price vs. Revenue Growth:
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Finally, we have built our Basic LBO model and can make our recommendation. A response might be:
“The proposed buyout of ABC does not look particularly compelling at the moment, but it may be
worth spending more time understanding the opportunity. The preliminary figures suggest the deal
at a 20% premium to the current stock price would yield a 2.3x MOIC and an 18% IRR, which is not
terribly enticing. This includes giving management full credit for their plan, which could prove to be
optimistic. That said, if the stock drops another 10%, or we believe we could sell it for 9.5x EBITDA,
or that we could grow revenues at 5.5%, the IRR on this deal would reach the low-20% range which
would be interesting. We should also think about how risky this asset is, and what the potential is for
upsides and downsides to this base case. If ABC is particularly stable, a high-teens IRR would be more
palatable. Likewise, if we think there are big upsides with limited downsides, this may prove to be an
attractive opportunity yet. However, if further work does not improve the profile of this deal, I would
recommend that we pass on the opportunity.”
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Basic LBO Example 1
Basic LBO Example 1
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Final Thoughts on LBO Modeling Tests
Final Thoughts on LBO Modeling Tests
Final Thoughts on LBO Modeling Tests
Now that you’ve made it through these examples and understand how to do the Paper LBO, the Basic
LBO, and the Full LBO, you are almost ready for your PE interviews. We say almost because practice
truly makes perfect here and going through these just once is not enough. Ultimately interviews are
high-pressure situations, and you will want to be well-versed enough to have this be second nature to
you when you walk through that door. It is also important to have the basics down cold so that when
the interviewers throw in a new wrinkle (again, there are infinite variations of these) you will be able
to think on your feet and incorporate it accordingly.
To help you get to the point where the LBO models are second nature, we’ve also included Excel files
with several additional example prompts for each type of test, as well as sample answers. These will
include a few additional wrinkles that we have not covered here to give you more exposure to things
you could see in an interview. Here is a thorough (but by no means inclusive of everything that could
come your way) list of complexities you could see:
• Roll-over equity of prior shareholders / management (covered in Basic LBO Example 3)
• Roll-over debt
• Call premiums (covered in Basic LBO Example 2, Full LBO Example 2)
• Debt covenants and cushions (covered in Full Example 2)
• Seller notes (especially when interviewing with shops that do smaller deals)
• Net Operating Losses (covered in Basic LBO Example 3)
• Interest rate or commodity price hedges
• Modeling partial years
• Calculating exits using forward P/E multiples based on post-IPO capital structures
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Module 6: LBO Modeling
Final Thoughts on LBO Modeling Tests
• Dividend recapitalizations (covered in Basic LBO Example 2)
• Business unit divestitures
• Add-on acquisitions
• Opco / Propco structures
• Preferred equity investments or PIPEs
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Module 7: Private Equity Cases
Private Equity Case - Paysmart
Private Equity Case - Paysmart
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module7-private-equity-cases/private-equity-case-paysmart
Relevant Files:
private_equity_case_-_paysmart_aug_6.pdf
solution.xlsx
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Module 7: Private Equity Cases
Private Equity Case - Oilfield Services
Private Equity Case - Oilfield Services
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module7-private-equity-cases/private-equity-case-oilfield
Relevant Files:
special_sits_case_study_model.xlsx
special_situations_case_study_pres.pdf
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Module 7: Private Equity Cases
Private Equity Case - Transnational M&A
Private Equity Case - Transnational M&A
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module7-private-equity-cases/private-equity-case
Relevant Files:
lbo_model_weaver_2_23_16.xlsx
wall_street_oasis_lbo_deals_2_23_16.pdf
lbomodel_solution_2_3_16.xlsx
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Module 7: Private Equity Cases
Private Equity Case - Creating Value Through
Operational Change - Apparel Industry
Private Equity Case - Creating Value Through Operational Change - Apparel
Industry
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Module 8: Appendix
Paper LBO Example 2
Paper LBO Example 2
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module8-appendix/paper-lbo-example-2
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Module 8: Appendix
Paper LBO Example 3
Paper LBO Example 3
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Module 8: Appendix
Basic LBO Example 2
Basic LBO Example 2
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Module 8: Appendix
Basic LBO Example 3
Basic LBO Example 3
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module8-appendix/basic-lbo-example-3
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Module 8: Appendix
Full LBO Example 2
Full LBO Example 2
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module8-appendix/full-lbo-example-2
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Module 8: Appendix
Full LBO Example 3
Full LBO Example 3
Watch video at https://www.wallstreetoasis.com/courses/private-equity-interview-course/module8-appendix/full-lbo-example-3
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Module 8: Appendix
Common Terms Glossary
Common Terms Glossary
Common Terms Glossary
“A” round: a financing event whereby venture capitalists become involved in a fast growth company
that was previously financed by founders and/or angels.
Accredited investor: a person or legal entity, such as a company or trust fund, that meets certain net
worth and income qualifications and is considered to be sufficiently sophisticated to make
investment decisions in complex situations. Regulation D of the Securities Act of 1933 exempts
accredited investors from protection under the Securities Act. Typical qualifications for a person are:
$1 million net worth and annual income exceeding $200,000 individually or $300,000 with a spouse.
Directors and executive officers are considered to be accredited investors.
Alternative asset class: a class of investments that includes private equity, real estate, and oil and
gas, but excludes publicly traded securities. Pension plans, college endowments and other relatively
large institutional investors typically allocate a certain percentage of their investments to alternative
assets with an objective to diversify their portfolios.
Angel: a wealthy individual that invests in companies in relatively early stages of development.
Usually angels invest less than $1 million per startup. The typical angel financed startup is in concept
or product development phase.
Anti-dilution: a contract clause that protects an investor from a substantial reduction in percentage
ownership in a company due to the issuance by the company of additional shares to other entities.
The mechanism for making adjustments is called a Ratchet.
“B” round: a financing event whereby professional investors such as venture capitalists are
sufficiently interested in a company to provide additional funds after the “A” round of financing.
Subsequent rounds are called “C”, “D” and so on.
Best efforts offering: a commitment by a syndicate of investment banks to use best efforts to ensure
the sale to investors of a company’s offering of securities. In a best efforts offering, the syndicate
avoids any firm commitment for a specific number of shares or bonds.
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Beta Product: a product that is being tested by potential customers prior to being formally launched
into the marketplace.
Blow-out round: see Cram-down round.
Board of directors: a group of individuals, typically composed of managers, investors and experts,
which have a fiduciary responsibility for the wellbeing and proper guidance of a corporation. The
board is elected by the shareholders.
Boat anchor: a person, project or activity that hinders the growth of a company.
Book: see Private placement memorandum.
Bootstrapping: the actions of a startup to minimize expenses and build cash flow, thereby reducing
or eliminating the need for outside investors.
Bridge financing: temporary funding that will eventually be replaced by permanent capital from
equity investors or debt lenders. In venture capital, a bridge is usually a short term note (6 to 12
months) that converts to preferred stock. Typically, the bridge lender has the right to convert the
note to preferred stock at a price that is a 20% discount from the price of the preferred stock in the
next financing round. See Wipeout bridge and Hamburger Helper bridge.
Broad-based weighted average ratchet: a type of anti-dilution mechanism. A weighted average
ratch-et adjusts downward the price per share of the preferred stock of investor A due to the
issuance of new preferred shares to new investor B at a price lower than the price investor A
originally received. Inves-tor A’s preferred stock is repriced to a weighted average of investor A’s
price and investor B’s price. A broad-based ratchet uses all common stock outstanding on a fully
diluted basis (including all convertible securities, warrants and options) in the denominator of the
formula for determining the new weighed average price. See Narrow-based weighted average
ratchet.
Burn rate: the rate at which a startup with little or no revenue uses available cash to cover expenses.
Usually expressed on a monthly or weekly basis.
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Business plan: a document that describes a new concept for a business opportunity. A business plan
typically includes the following sections: executive summary, market need, solution, technology,
compe-tition, marketing, management, operations and financials.
Buyout: a sector of the private equity industry. Also, the purchase of a controlling interest of a
company by an outside investor (in a leveraged buyout) or a management team (in a management
buyout).
Buy-sell agreement: a contract that sets forth the conditions under which a shareholder must first
offer his or her shares for sale to the other shareholders before being allowed to sell to entities
outside the company.
C corporation: an ownership structure that allows any number of individuals or companies to own
shares. A C corporation is a stand-alone legal entity so it offers some protection to its owners,
managers and investors from liability resulting from its actions.
Capital call: when a private equity fund manager (usually a “general partner” in a partnership)
requests that an investor in the fund (a “limited partner”) provide additional capital. Usually a limited
partner will agree to a maximum investment amount and the general partner will make a series of
capital calls over time to the limited partner as opportunities arise to finance startups and buyouts.
Capitalization table: a table showing the owners of a company’s shares and their ownership percentages. It also lists the forms of ownership, such as common stock, preferred stock, warrants and
options.
Capital gains: a tax classification of investment earnings resulting from the purchase and sale of
assets. Typically, an investor prefers that investment earnings be classified as long term capital gains
(held for a year or longer), which are taxed at a lower rate than ordinary income.
Capital stock: a description of stock that applies when there is only one class of shares. This class is
known as “common stock”.
Capped participating preferred stock: preferred stock whose participating feature is limited so that
an investor cannot receive more than a specified amount. See Participating preferred stock.
Carried interest: a share in the profits of a private equity fund. Typically, a fund must return the
capital given to it by limited partners plus any preferential rate of return before the general partner
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Common Terms Glossary
can share in the profits of the fund. The general partner will then receive a 20% carried interest,
although some successful firms receive 25%-30%. Also known as “carry” or “promote.”
Catch-up: a clause in the agreement between the general partner and the limited partners of a
private equity fund. Once the limited partners have received a certain portion of their expected
return, the gen-eral partner can then receive a majority of profits until the previously agreed upon
profit split is reached.
Change of control bonus: a bonus of cash or stock given by private equity investors to members of a
management group if they successfully negotiate a sale of the company for a price greater than a
spec-ified amount.
Clawback: a clause in the agreement between the general partner and the limited partners of a
private equity fund. The clawback gives limited partners the right to reclaim a portion of
disbursements to a general partner for profitable investments based on significant losses from later
investments in a port-folio.
Closing: the conclusion of a financing round whereby all necessary legal documents are signed and
capital has been transferred.
Collateral: hard assets of the borrower, such as real estate or equipment, for which a lender has a
legal interest until a loan obligation is fully paid off.
Commitment: an obligation, typically the maximum amount that a limited partner agrees to invest in
a fund.
Common stock: a type of security representing ownership rights in a company. Usually, company
founders, management and employees own common stock while investors own preferred stock. In
the event of a liquidation of the company, the claims of secured and unsecured creditors,
bondholders and preferred stockholders take precedence over common stockholders. See Preferred
stock.
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Comparable: a publicly traded company with similar characteristics to a private company that is
being valued. For example, a telecommunications equipment manufacturer whose market value is 2
times revenues can be used to estimate the value of a similar and relatively new company with a new
product in the same industry. See Liquidity discount.
Control: the authority of an individual or entity that owns more than 50% of equity in a company or
owns the largest block of shares compared to other shareholders.
Consolidation: see Rollup.
Conversion: the right of an investor or lender to force a company to replace the investor’s preferred
shares or the lender’s debt with common shares at a preset conversion ratio. A conversion feature
was first used in railroad bonds in the 1800’s.
Convertible debt: a loan which allows the lender to exchange the debt for common shares in a
compa-ny at a preset conversion ratio
Convertible preferred stock: a type of stock that gives an owner the right to convert to common
shares of stock. Usually, preferred stock has certain rights that common stock doesn’t have, such as
decision-making management control, a promised return on investment (dividend), or senior priority
in receiving proceeds from a sale or liquidation of the company. Typically, convertible preferred
stock au-tomatically converts to common stock if the company makes an initial public offering (IPO).
Convertible preferred is the most common tool for private equity funds to invest in companies.
Convertible security: a security that gives its owner the right to exchange the security for common
shares in a company at a preset conversion ratio. The security is typically preferred stock, warrants
or debt.
Co-sale right: the right that gives the investor a contractual right to sell some of the investor’s stock
along with the founder’s stock if the founder elects to sell stock to a third-party.
Cost of revenue: the expenses generated by the core operations of a company.
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Covenant: a legal promise to do or not do a certain thing. For example, in a financing arrangement,
company management may agree to a negative covenant, whereby it promises not to incur additional
debt. The penalties for violation of a covenant may vary from repairing the mistake to losing control
of the company.
Cram down round: a financing event upon which new investors with substantial capital are able to
demand and receive contractual terms that effectively cause the issuance of sufficient new shares by
the startup company to significantly reduce (“dilute”) the ownership percentage of previous
investors.
Cumulative dividends: the owner of preferred stock with cumulative dividends has the right to
receive accrued (previously unpaid) dividends in full before dividends are paid to any other classes of
stock.
Current ratio: the ratio of current assets to current liabilities.
Deal flow: a measure of the number of potential investments that a fund reviews in any given period.
Debt service: the ratio of a loan payment amount to available cash flow earned during a specific
period. Typically lenders insist that a company maintain a certain debt service ratio or else risk
penalties such as having to pay off the loan immediately.
Default: a company’s failure to comply with the terms and conditions of a financing arrangement.
Defined benefit plan: a company retirement plan in which both the employee and the employer contribute to the plan. Typically the plan is based on the employee’s salary and number of years worked.
Fixed benefits are outlined when the employee retires. The employer bears the investment risk and
is committed to providing the benefits to the employee. Defined benefit plan managers can invest in
pri-vate equity funds.
Defined contribution plan: a company retirement plan in which the employee elects to contribute
some portion of his or her salary into a retirement plan, such as a 401(k) or 403(b). With this type of
plan, the employee bears the investment risk. The benefits depend solely on the amount of money
made from investing the employee’s contributions. Defined contribution plan capital cannot be
invested in private equity funds.
Demand rights: a type of registration right. Demand rights give an investor the right to force a
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startup to register its shares with the SEC and prepare for a public sale of stock (IPO).
Dilution: the reduction in the ownership percentage of current investors, founders and employees
caused by the issuance of new shares to new investors.
Dilution protection: see Anti-dilution and Ratchet.
Direct costs: see Cost of revenue.
Disbursement: an investment by a fund in a company.
Discount rate: the interest rate used to determine the present value of a series of future cash flows.
Discounted cash flow (DCF): a valuation methodology whereby the present value of all future cash
flows expected from a company is calculated.
Distribution: the transfer of cash or securities to a limited partner resulting from the sale, liquidation
or IPO of one or more portfolio companies in which a general partner chose to invest.
Dividends: regular payments made by a company to the owners of certain securities. Typically, dividends are paid quarterly, by approval of the board of directors, to owners of preferred stock.
Down round: a round of financing whereby the valuation of the company is lower than the value
deter-mined by investors in an earlier round.
Drag-along rights: the contractual right of an investor in a company to force all other investors to
agree to a specific action, such as the sale of the company.
Drive-by VC: a venture capitalist that only appears during board meetings of a portfolio company
and rarely offers advice to management.
Due diligence: the investigatory process performed by investors to assess the viability of a potential
investment and the accuracy of the information provided by the target company.
Early stage: the state of a company after the seed (formation) stage but before middle stage
(generating revenues). Typically, a company in early stage will have a core management team and a
proven concept or product, but no positive cash flow.
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Earnings before interest and taxes (EBIT): a measurement of the operating profit of a company. One
possible valuation methodology is based on a comparison of private and public companies’ value as a
multiple of EBIT.
Earnings before interest, taxes, depreciation and amortization (EBITDA): a measurement of the
cash flow of a company. One possible valuation methodology is based on a comparison of private and
public companies’ value as a multiple of EBITDA. Earn out- an arrangement in which sellers of a
business receive additional future payments, usually based on financial performance metrics such as
revenue or net income.
Elevator pitch: a concise presentation, lasting only a few minutes (an elevator ride), by an
entrepreneur to a potential investor about an investment opportunity.
Employee Stock Ownership Program (ESOP): a plan established by a company to reserve shares for
long-term incentive compensation for employees.
Equity: the ownership structure of a company represented by common shares, preferred shares or
unit interests. Equity = Assets - Liabilities.
ESOP: see Employee Stock Ownership Program.
Evergreen fund: a fund that reinvests its profits in order to ensure the availability of capital for
future investments.
Exit strategy: the plan for generating profits for owners and investors of a company. Typically, the
op-tions are to merge, be acquired or make an initial public offering (IPO).
Expansion stage: the stage of a company characterized by a complete management team and a substantial increase in revenues.
Fairness opinion: a letter issued by an investment bank that charges a fee to assess the fairness of a
negotiated price for a merger or acquisition.
Firm commitment: a commitment by a syndicate of investment banks to purchase all the shares
avail-able for sale in a public offering of a company. The shares will then be resold to investors by the
syndi-cate.
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Flipping: the act of selling shares immediately after an initial public offering. Investment banks that
un-derwrite new stock issues attempt to allocate shares to new investors that indicate they will
retain the shares for several months. Often management and venture investors are prohibited from
selling IPO shares until a “lock-up period” (usually 6 to 12 months) has expired.
Founder: a person who participates in the creation of a company. Typically, founders manage the
com-pany until it has enough capital to hire professional managers.
Founders stock: nominally priced common stock issued to founders, officers, employees, directors,
and consultants.
Friends and family financing: capital provided by the friends and family of founders of an early stage
company. Founders should be careful not to create an ownership structure that may hinder the
partici-pation of professional investors once the company begins to achieve success.
Full ratchet: an anti-dilution protection mechanism whereby the price per share of the preferred
stock of investor A is adjusted downward due to the issuance of new preferred shares to new
investor B at a price lower than the price investor A originally received. Investor A’s preferred stock
is repriced to match the price of investor B’s preferred stock. Usually as a result of the
implementation of a ratchet, company management and employees who own a fixed amount of
common shares suffer significant dilution. See Narrow-based weighted average ratchet and Broadbased weighted average ratchet.
Fully diluted basis: a methodology for calculating any per share ratios whereby the denominator is
the total number of shares issued by the company on the assumption that all warrants and options
are exercised and preferred stock.
Fund-of-funds: a fund created to invest in private equity funds. Typically, individual investors and
rela-tively small institutional investors participate in a fund-of-funds to minimize their portfolio
management efforts.
Gatekeepers: intermediaries which endowments, pension funds and other institutional investors use
as advisors regarding private equity investments.
General partner (GP): a class of partner in a partnership. The general partner retains liability for the
actions of the partnership. In the private equity world, the GP is the fund manager while the limited
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partners (LPs) are the institutional and high net worth investors in the partnership. The GP earns a
man-agement fee and a percentage of profits (see Carried interest).
GP: see General partner.
Grossing up: an adjustment of an option pool for management and employees of a company which
increases the number of shares available over time. This usually occurs after a financing round whereby one or more investors receive a relatively large percentage of the company. Without a grossing
up, managers and employees would suffer the financial and emotional consequences of dilution,
thereby potentially affecting the overall performance of the company.
Growth stage: the state of a company when it has received one or more rounds of financing and is
gen-erating revenue from its product or service. Also known as “middle stage.”
Hamburger helper: a colorful label for a traditional bridge loan that includes the right of the bridge
lender to convert the note to preferred stock at a price that is a 20% discount from the price of the
pre-ferred stock in the next financing round.
Hart-Scott-Rodino Act: a law requiring entities that acquire certain amounts of stock or assets of a
company to inform the Federal Trade Commission and the Department of Justice and to observe a
wait-ing period before completing the transaction.
Harvest: to generate cash or stock from the sale or IPO of companies in a private equity portfolio of
investments.
Hockey stick: the general shape and form of a chart showing revenue, customers, cash or some other
financial or operational measure that increases dramatically at some point in the future.
Entrepreneurs often develop business plans with hockey stick charts to impress potential investors.
Hot issue: stock in an initial public offering that is in high demand.
Hurdle rate: a minimum rate of return required before an investor will make an investment.
Incorporation: the process by which a business receives a state charter, allowing it to become a
corpo-ration. Many corporations choose Delaware because its laws are business friendly and up to
date.
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Incubator: a company or facility designed to host startup companies. Incubators help startups grow
while controlling costs by offering networks of contacts and shared backoffice resources.
Initial public offering (IPO): the first offering of stock by a company to the public. New public
offerings must be registered with the Securities and Exchange Commission. An IPO is one of the
methods that a startup that has achieved significant success can use to raise additional capital for
further growth. See Qualified IPO.
Inside round: a round of financing in which the investors are the same investors as the previous
round. An inside round raises liability issues since the valuation of the company has no third party
verification in the form of an outside investor. In addition, the terms of the inside round may be
considered self-dealing if they are onerous to any set of shareholders or if the investors give
themselves additional preferential rights.
Institutional investor: professional entities that invest capital on behalf of companies or individuals.
Examples are: pension plans, insurance companies and university endowments.
Internal rate of return (IRR): the interest rate at which a certain amount of capital today would have
to be invested in order to grow to a specific value at a specific time in the future.
Investment thesis / Investment philosophy: the fundamental ideas which determine the types of
investments that an investment fund will choose in order to achieve its financial goals.
IPO: see Initial public offering.
IRR: see Internal rate of return.
Issuer: the company that chooses to distribute a portion of its stock to the public.
Junior debt: a loan that has a lower priority than a senior loan in case of a liquidation of the asset or
borrowing company. Also known as “subordinated debt”.
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Later stage: the state of a company that has proven its concept, achieved significant revenues compared to its competition, and is approaching cash flow break even or positive net income. Typically, a
later stage company is about 6 to 12 months away from a liquidity event such as an IPO or buyout.
The rate of return for venture capitalists that invest in later stage, less risky ventures is lower than in
earlier stage ventures.
LBO: see Leveraged buyout.
Lead investor: the venture capital investor that makes the largest investment in a financing round
and manages the documentation and closing of that round. The lead investor sets the price per share
of the financing round, thereby determining the valuation of the company.
Letter of intent: a document confirming the intent of an investor to participate in a round of
financing for a company. By signing this document, the subject company agrees to begin the legal and
due dili-gence process prior to the closing of the transaction. Also known as a “Term Sheet”.
Leverage: the use of debt to acquire assets, build operations and increase revenues. By using debt, a
company is attempting to achieve results faster than if it only used its cash available from preleverage operations. The risk is that the increase in assets and revenues does not generate sufficient
net income and cash flow to pay the interest costs of the debt.
Leveraged buyout (LBO): the purchase of a company or a business unit of a company by an outside
investor using mostly borrowed capital.
Limited liability company (LLC): an ownership structure designed to limit the founders’ losses to the
amount of their investment. An LLC does not pay taxes, rather its owners pay taxes on their
proportion of the LLC profits at their individual tax rates.
Limited partnership: a legal entity composed of a general partner and various limited partners. The
general partner manages the investments and is liable for the actions of the partnership while the
limit-ed partners are generally protected from legal actions and any losses beyond their original
investment. The general partner receives a management fee and a percentage of profits (see Carried
interest), while the limited partners receive income, capital gains and tax benefits.
Limited partner (LP): an investor in a limited partnership. The general partner is liable for the actions
of the partnership while the limited partners are generally protected from legal actions and any
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losses beyond their original investment. The limited partner receives income, capital gains and tax
benefits.
Liquidation: the selling off of all assets of a company prior to the complete cessation of operations.
Corporations that choose to liquidate declare Chapter 7 bankruptcy. In a liquidation, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common stockholders.
Liquidation preference: the contractual right of an investor to priority in receiving the proceeds
from the liquidation of a company. For example, a venture capital investor with a “2x liquidation
preference” has the right to receive two times its original investment upon liquidation.
Liquidity discount: a decrease in the value of a private company compared to the value of a similar
but publicly traded company. Since an investor in a private company cannot readily sell his or her
invest-ment, the shares in the private company must be valued less than a comparable public
company.
Liquidity event: a transaction whereby owners of a significant portion of the shares of a private company sell their shares in exchange for cash or shares in another, usually larger company. For example,
an IPO is a liquidity event.
Lock-up agreement: investors, management and employees often agree not to sell their shares for a
specific time period after an IPO, usually 6 to 12 months. By avoiding large sales of its stock, the
company has time to build interest among potential buyers of its shares.
LP: see Limited partner.
Management buyout (MBO): a leveraged buyout controlled by the members of the management
team of a company or a division.
Management fee: a fee charged to the limited partners in a fund by the general partner.
Management fees in a private equity fund typically range from 0.75% to 3% of capital under
management, depending on the type and size of fund.
Management rights: the rights often required by a venture capitalist as part of the agreement to invest in a company. The venture capitalist has the right to consult with management on key
operational issues, attend board meetings and review information about the company’s financial
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situation.
Market capitalization: the value of a publicly traded company as determined by multiplying the number of shares outstanding by the current price per share.
MBO: see Management buyout.
Mezzanine: a layer of financing that has intermediate priority (seniority) in the capital structure of a
company. For example, mezzanine debt has lower priority than senior debt but usually has a higher
in-terest rate and often includes warrants. In venture capital, a mezzanine round is generally the
round of financing that is designed to help a company have enough resources to reach an IPO.
Middle stage: the state of a company when it has received one or more rounds of financing and is
gen-erating revenue from its product or service. Also known as “growth stage.”
Multiples: a valuation methodology that compares public and private companies in terms of a ratio
of value to an operations figure such as revenue or net income. For example, if several publicly traded
computer hardware companies are valued at approximately 2 times revenues, then it is reasonable to
assume that a startup computer hardware company that is growing fast has the potential to achieve a
valuation of 2 times its revenues. Before the startup issues its IPO, it will likely be valued at less than
2 times revenue because of the lack of liquidity of its shares. See Liquidity discount.
Narrow-based weighted average ratchet: a type of anti-dilution mechanism. A weighted average
ratchet adjusts downward the price per share of the preferred stock of investor A due to the issuance
of new preferred shares to new investor B at a price lower than the price investor A originally
received. Investor A’s preferred stock is repriced to a weighted average of investor A’s price and
investor B’s price. A narrow-based ratchet uses only common stock outstanding in the denominator
of the formula for determining the new weighed average price.
NDA: see Non-disclosure agreement.
Non-compete: an agreement often signed by employees and management whereby they agree not
to work for competitor companies or form a new competitor company within a certain time period
after termination of employment.
Non-cumulative dividends: dividends that are payable to owners of preferred stock at a specific
point in time only if there is sufficient cash flow available after all company expenses have been paid.
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If cash flow is insufficient, the owners of the preferred stock will not receive the dividends owed for
that time period and will have to wait until the board of directors declares another set of dividends.
Non-interference: an agreement often signed by employees and management whereby they agree
not to interfere with the company’s relationships with employees, clients, suppliers and subcontractors within a certain time period after termination of employment.
Non-solicitation: an agreement often signed by employees and management whereby they agree
not to solicit other employees of the company regarding job opportunities.
Non-disclosure agreement (NDA): an agreement issued by entrepreneurs to protect the privacy of
their ideas when disclosing those ideas to third parties.
Offering memorandum: a legal document that provides details of an investment to potential
investors. See Private placement memorandum.
OID: see Original issue discount.
Optics: the way a concept is presented. Sometimes entrepreneurs’ presentations are strong on
optics but weak in content.
Options: see Stock options.
Option pool: a group of options set aside for long term, phased compensation to management and
employees.
Original issue discount (OID): a discount from par value of a bond or debt-like instrument. In
structur-ing a private equity transaction, the use of a preferred stock with liquidation preference or
other clauses that guarantee a fixed payment in the future can potentially create adverse tax
consequences. The IRS views this cash flow stream as, in essence, a zero coupon bond upon which tax
payments are due yearly based on “phantom income” imputed from the difference between the
original investment and “guar-anteed” eventual payout. Although complex, the solution is to include
enough clauses in the investment agreements to create the possibility of a material change in the
cash flows of owners of the preferred stock under different scenarios of events such as a buyout,
dissolution or IPO.
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Orphan: a startup company that does not have a venture capitalist as an investor.
Outstanding shares: the total amount of common shares of a company, not including treasury stock,
convertible preferred stock, warrants and options.
Oversubscription: when demand exceeds supply for shares of an IPO or a private placement.
Pay or play: a clause in a financing agreement whereby any investor that does not participate in a
future round agrees to suffer significant dilution compared to other investors. The most onerous
version of “pay to play” is automatic conversion to common shares, which in essence ends any
preferential rights of an investor, such as the right to influence key management decisions.
Pari passu: a legal term referring to the equal treatment of two or more parties in an agreement. For
example, a venture capitalists may agree to have registration rights that are pari passu with the other
investors in a financing round.
Participating dividends: the right of holders of certain preferred stock to receive dividends and
partic-ipate in additional distributions of cash, stock or other assets.
Participating preferred stock: a unit of ownership composed of preferred stock and common stock.
The preferred stock entitles the owner to receive a predetermined sum of cash (usually the original
in-vestment plus accrued dividends) if the company is sold or has an IPO. The common stock
represents additional continued ownership in the company. Participating preferred stock has been
characterized as “having your cake and eating it too.”
PE ratio: see Price earnings ratio.
Piggyback rights: rights of an investor to have his or her shares included in a registration of a
startup’s shares in preparation for an IPO.
PIPEs: see Private investment in public equities.
Placement agent: a company that specializes in finding institutional investors that are willing and
able to invest in a private equity fund. Sometimes a private equity fund will hire a placement agent so
the fund partners can focus on making and managing investments in companies rather than on
raising capital.
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Portfolio company: a company that has received an investment from a private equity fund.
Post-money valuation: the valuation of a company including the capital provided by the current
round of financing. For example, a venture capitalist may invest $5 million in a company valued at $2
million “pre-money” (before the investment was made). As a result, the startup will have a postmoney valua-tion of $7 million.
PPM: see Private placement memorandum.
Preference: seniority, usually with respect to dividends and proceeds from a sale or dissolution of a
company.
Preferred stock: a type of stock that has certain rights that common stock does not have. These special rights may include dividends, participation, liquidity preference, antidilution protection and veto
provisions, among others. Private equity investors usually purchase preferred stock when they make
investments in companies.
Pre-money valuation: the valuation of a company prior to the current round of financing. For
example, a venture capitalist may invest $5 million in a company valued at $2 million pre-money. As a
result, the startup will have a “post-money” valuation of $7 million.
Price earnings ratio (PE ratio): the ratio of a public company’s price per share and its net income
after taxes on a per share basis.
Primary shares: shares sold by a corporation (not by individual shareholders).
Private equity: equity investments in non-public companies.
Private investment in public equities (PIPES): investments by a private equity fund in a publicly
trad-ed company, usually at a discount.
Private placement: the sale of a security directly to a limited number of institutional and qualified
indi-vidual investors. If structured correctly, a private placement avoids registration with the
Securities and Exchange Commission.
Private placement memorandum (PPM): a document explaining the details of an investment to
poten-tial investors. For example, a private equity fund will issue a PPM when it is raising capital
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from institu-tional investors. Also, a startup may issue a PPM when it needs growth capital. Also
known as “Offering Memorandum.”
Private securities: securities that are not registered with the Securities and Exchange Commission
and do not trade on any exchanges. The price per share is negotiated between the buyer and the
seller (the “issuer”).
Promote: see Carried interest.
Prospectus: a formal document that gives sufficient detail about a business opportunity for a
prospec-tive investor to make a decision. A prospectus must disclose any material risks and be filed
with the Securities and Exchange Commission.
Prudent man rule: a fundamental principle for professional money management which serves as a
basis for the Prudent Investor Act. The principle is based on a statement by Judge Samuel Putnum in
1830: “Those with the responsibility to invest money for others should act with prudence, discretion,
intelligence and regard for the safety of capital as well as income.”
Qualified IPO: a public offering of securities valued at or above a total amount specified in a
financing agreement. This amount is usually specified to be sufficiently large to guarantee that the
IPO shares will trade in a major exchange (NASDAQ or New York Stock Exchange).
Quartile: one fourth of the data points in a data set. Often, private equity investors are measured by
the results of their investments during a particular period of time. Institutional investors often prefer
to invest in private equity funds that demonstrate consistent results over time, placing in the upper
quar-tile of the investment results for all funds.
Ratchet: a mechanism to prevent dilution. An anti-dilution clause is a contract clause that protects
an investor from a reduction in percentage ownership in a company due tothe future issuance by the
com-pany of additional shares to other entities.
Realization ratio: the ratio of cumulative distributions to paid-in capital. The realization ratio is used
as a measure of the distributions from investment results of aprivate equity partnership compared to
the capital under management.
Recapitalization: the reorganization of a company’s capital structure.
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Red herring: a preliminary prospectus filed with the Securities and Exchange Commission and
contain-ing the details of an IPO offering. The name refers to the disclosure warning printed in red
letters on the cover of each preliminary prospectus advising potential investors of the risks involved.
Redeemable preferred: preferred stock that can be redeemed by the owner (usually a venture
capital investor) in exchange for a specific sum of money.
Redemption rights: the right of an investor to force the startup company to buy back the shares
issued as a result of the investment. In effect, the investor has the right to take back his/her
investment and may even negotiate a right to receive an additional sum in excess of the original
investment.
Registration: the process whereby shares of a company are registered with the Securities and
Exchange Commission under the Securities Act of 1933 in preparation for a sale of the shares to the
public.
Registration rights: the rights of an investor in a startup regarding the registration of a portion of
the startup’s shares for sale to the public. Piggyback rights give the shareholders the right to have
their shares included in a registration. Demand rights give the shareholders the option to force
management to register the company’s shares for a public offering. Often times registration rights
are hotly negotiat-ed among venture capitalists in multiple rounds of financing.
Regulation D: an SEC regulation that governs private placements. Private placements are
investment offerings for institutional and accredited individual investors but not for the general
public. There is an exception that 35 non-accredited investors can participate.
Restricted shares: shares that cannot be traded in the public markets.
Return on investment (ROI): the proceeds from an investment, during a specific time period,
calculat-ed as a percentage of the original investment. Also, net profit after taxes divided by average
total assets.
Rights offering: an offering of stock to current shareholders that entitles them to purchase the new
issue, usually at a discount.
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Rights of co-sale with founders: a clause in venture capital investment agreements that allows the
VC fund to sell shares at the same time that the founders of a startup chose to sell.
Right of first refusal: a contractual right to participate in a transaction. For example, a venture
capital-ist may participate in a first round of investment in a startup and request a right of first
refusal in any following rounds of investment.
Road show: presentations made in several cities to potential investors and other interested parties.
For example, a company will often make a road show to generate interest among institutional
investors prior to its IPO.
ROI: see Return on investment.
Rollup: the purchase of relatively smaller companies in a sector by a rapidly growing company in the
same sector. The strategy is to create economies of scale. For example, the movie theater industry
un-derwent significant consolidation in the 1960’s and 1970’s.
Round: a financing event usually involving several private equity investors.
Rule 144: a rule of the Securities and Exchange Commission that specifies the conditions under
which the holder of shares acquired in a private transaction may sell those shares in the public
markets.
S corporation: an ownership structure that limits its number of owners to 100. An S corporation
does not pay taxes, rather its owners pay taxes on their proportion of the corporation’s profits at
their indi-vidual tax rates.
Small Business Investment Company (SBIC): a company licensed by the Small Business Administration to receive government loans in order to raise capital to use in venture investing.
Scalability: a characteristic of a new business concept that entails the growth of sales and revenues
with a much slower growth of organizational complexity and expenses. Venture capitalists look for
scal-ability in the startups they select to finance.
Scale-down: a schedule for phased decreases in management fees for general partners in a limited
partnership as the fund reduces its investment activities toward the end of its term.
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Scale-up: the process of a company growing quickly while maintaining operational and financial controls in place. Also, a schedule for phased increases in management fees for general partners in a
limited partnership as the fund increases its investment activities over time.
SEC: see Securities and Exchange Commission.
Secondary market: a market for the sale of partnership interests in private equity funds. Sometimes
limited partners chose to sell their interest in a partnership, typically to raise cash or because they
can-not meet their obligation to invest more capital according to the takedown schedule. Certain
investment companies specialize in buying these partnership interests at a discount.
Secondary shares: shares sold by a shareholder (not by the corporation).
Security: a document that represents an interest in a company. Shares of stock, notes and bonds are
examples of securities.
Securities and Exchange Commission (SEC): the regulatory body that enforces federal securities
laws such as the Securities Act of 1933 and the Securities Exchange Act of 1934.
Seed capital: investment provided by angels, friends and family to the founders of a startup in seed
stage.
Seed stage: the state of a company when it has just been incorporated and its founders are
developing their product or service.
Senior debt: a loan that has a higher priority in case of a liquidation of the asset or company.
Seniority: higher priority.
Series A preferred stock: preferred stock issued by a fast growth company in exchange for capital
from investors in the “A” round of financing. This preferred stock is usually convertible to common
shares upon the IPO or sale of the company.
Spin out: a division of an established company that becomes an independent entity.
Stock: a share of ownership in a corporation.
Stock option: a right to purchase or sell a share of stock at a specific price within a specific period of
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time. Stock purchase options are commonly used as long term incentive compensation for employees
and management of fast growth companies.
Strategic investor: a relatively large corporation that agrees to invest in a young company in order
to have access to a proprietary technology, product or service. By having this access, the corporation
can potentially achieve its strategic goals.
Subordinated debt: a loan that has a lower priority than a senior loan in case of a liquidation of the
asset or company. Also known as “junior debt”.
Sweat equity: ownership of shares in a company resulting from work rather than investment of
capital.
Syndicate: a group of investors that agree to participate in a round of funding for a company. Alternatively, a syndicate can refer to a group of investment banks that agree to participate in the sale of
stock to the public as part of an IPO.
Syndication: the process of arranging a syndicate.
Tag-along rights: the right of an investor to receive the same
Takedown: a schedule of the transfer of capital in phases in order to complete a commitment of
funds. Typically, a takedown is used by a general partner of a private equity fund to plan the transfer
of capital from the limited partners.
Takeover: the transfer of control of a company.
Ten bagger: an investment that returns 10 times the initial capital.
Term sheet: a document confirming the intent of an investor to participate in a round of financing for
a company. By signing this document, the subject company agrees to begin the legal and due
diligence process prior to the closing of the transaction. Also known as “Letter of Intent”.
Trade secret: something that is not generally known, is kept in secrecy and gives its owners a
competi-tive business advantage.
Turnaround: a process resulting in a substantial increase in a company’s revenues, profits and
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reputation.
Two x: an expression referring to 2 times the original amount. For example, a preferred stock may
have a “two x” liquidation preference, so in case of liquidation of the company, the preferred stock
investor would receive twice his or her original investment.
Under water option: an option is said to be under water if the current fair market value of a stock is
less than the option exercise price.
Underwriter: an investment bank that chooses to be responsible for the process of selling new
securi-ties to the public. An underwriter usually chooses to work with a syndicate of investment
banks in order to maximize the distribution of the securities.
Venture capital: a segment of the private equity industry which focuses on investing in new
companies with high growth rates.
Venture capital method: a valuation method whereby an estimate of the future value of a company
is discounted by a certain interest rate and adjusted for future anticipated dilution in order to
determine the current value. Usually, discount rates for the venture capital method are considerably
higher than public stock return rates, representing the fact that venture capitalists must achieve
significant returns on investment in order to compensate for the risks they take in funding unproven
companies.
Vintage: the year that a private equity fund stops accepting new investors and begins to make investments on behalf of those investors.
Voting rights: the rights of holders of preferred and common stock in a company to vote on certain
acts affecting the company. These matters may include payment of dividends, issuance of a new class
of stock, merger or liquidation.
Warrant: a security which gives the holder the right to purchase shares in a company at a pre-determined price. A warrant is a long term option, usually valid for several years or indefinitely. Typically,
warrants are issued concurrently with preferred stocks or bonds in order to increase the appeal of
the stocks or bonds to potential investors.
Washout round: a financing round whereby previous investors, the founders and management
suffer significant dilution. Usually as a result of a washout round, the new investor gains majority
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ownership and control of the company.
Weighted average ratchet: an anti-dilution protection mechanism whereby the conversion rate of
pre-ferred stock is adjusted in order to reduce an investor’s loss due to an increase in the number of
shares in a company. Without a ratchet, an investor would suffer from a dilution of his or her
percentage own-ership. Usually as a result of the implementation of a weighted average ratchet,
company management and employees who own a fixed amount of common shares suffer significant
dilution, but not as badly as in the case of a full ratchet.
Wipeout round: see Washout round.
Wipeout bridge: a short term financing that has onerous features whereby if the company does not
secure additional long term financing within a certain time frame, the bridge investor gains
ownership control of the company. See Bridge financing.
Write-down: a decrease in the reported value of an asset or a company.
Write-off: a decrease in the reported value of an asset or a company to zero.
Write-up: an increase in the reported value of an asset or a company.
Zombie: a company that has received capital from investors but has only generated sufficient
revenues and cash flow to maintain its operations without significant growth. Typically, a venture
capitalist has to make a difficult decision as to whether to kill off a zombie or continue to invest funds
in the hopes that the zombie will become a winner.
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