Introduction: Private Equity Training Program
This Street of Walls Private Equity training program is designed to help candidates like you land the Private Equity
jobs you seek. The program offers you the tools you need to gain a necessary edge over other private equity candidates
in the recruiting process.
Most would agree that, compared with a typical investment-banking interview, an interview for a private equity preMBA associate position is the equivalent of an investment banking interview “on steroids.” Private equity positions can
be among the most intense, highly rewarding jobs you can have, but the expectations in terms of your work output are
just as extreme, and the recruiting landscape is highly competitive.
For individuals seeking private equity jobs, there is quite simply a lack of quality interview preparation material
available. Online sources and books are both too general and too wordy. They discuss how to get an interview and how
to secure an offer at a very high level, without much necessary detail on the numerous steps in between.
This training guide is intended to fix that. These details—especially on technical skills and how to ace the private equity
case studies and modeling tests—are a key factor in receiving an offer, and that’s the inside information you’ll receive in
this guide. Read and study this entire training guide. Learn the ins and outs of the industry. You’ll be set apart by your
knowledge and ability to thoroughly analyze an investment opportunity. We offer specific case studies and walk you
through the crucial facts and tips about the industry and job. In addition, there are more practice case studies available
on the website.
Good luck and we wish you the best in your private equity interviewing efforts!
Table of Contents:
1. Private Equity Industry Overview
2. Private Equity Investment Criteria
3. Private Equity New Investment Process
4. Monitoring & Exiting Private Equity Investments
5. Private Equity Firm Hierarchy and Associate Role
6. Private Equity Resume
7. Private Equity Interview
8. Basics of an LBO Model
9. Paper LBO Model Example
10. LBO Modeling Test Example
1 ©2013 Street of Walls
Chapter 1: Private Equity Industry Overview
Private equity (PE) is an asset class for investing in public and non-public companies or physical assets, such as real
estate. These investments typically result in either a majority or substantial minority ownership stake in a company.
The investments can offer very strong return streams that are frequently much less correlated with indices than the
returns available in classic public market investment opportunities.
However, the tradeoff is that these investments are much less liquid and require a longer investment period.
Depending on the fund size and investment strategy, a private equity firm may seek to exit its investments in 3-5 years
in order to generate a multiple on invested capital of 2.0-4.0x and an internal rate of return (IRR) of around 20-30%.
In order to amplify returns, private equity firms typically raise a significant amount of debt to purchase the assets they
invest in, in order to minimize their initial equity requirement (i.e. they use leverage). This investment strategy has
helped coin the term “Leveraged Buyout” (LBO). LBOs are the primary investment strategy type of most Private Equity
firms.
History of Private Equity and Leveraged Buyouts
J.P. Morgan was considered to have made the first leveraged buyout in history with his purchase of Carnegie Steel
Company in 1901 from Andrew Carnegie and Henry Phipps for $480 million. Morgan employed a substantial amount
of debt to assist with this purchase. Later, in 1946, the first two ongoing private-equity firms were established: the
American Research and Development Corporation, and J.H. Whitney & Company.
After laying fairly dormant on Wall Street for a while, private equity became explosively popular during the 1980s, with
famous large buyouts being attributed to equally famous PE investors. Two examples are Jerome Kohlberg, Jr. and
Henry Kravis, who formed Kohlberg Kravis Roberts (KKR), and famously purchased RJR Nabisco in a leveraged
buyout by beating the CEO in a bidding war over the company. This transaction is immortalized in the book (and later
made-for-TV movie), Barbarians at the Gate, which details the famous transaction. This transaction is but one of the
many famous LBOs and hostile takeovers that were part of the merger and acquisition mania of the late 1970s and
1980s.
Between 1979 and 1989, it is estimated that more than 2,000 leveraged buyouts occurred, with a total transaction value
of over $250 billion. As mentioned earlier, the most notorious of these deals was KKR’s $31.1 billion RJR Nabisco
buyout. Although this was the largest leveraged buyout ever at the time, many people believed at the time that the RJR
Nabisco deal represented the end of the private equity boom of the 1980s, because KKR’s investment, however famous,
was ultimately a substantial failure for the KKR investors who bought the company. Other major firms created during
this decade include Bain Capital, Hellman & Friedman, The Blackstone Group and The Carlyle Group.
More recently, the history of private equity is often regarded as having two eras: pre-2008 and post-2008. In the early
2000s and especially 2005-2007, private equity firms were able to complete blockbuster buyouts due to liberal US
monetary policy and strong credit markets, which resulted in historically low interest rates, lax lending policies, and
large amounts of debt financing available. Large-scale buyouts were becoming ever more prevalent, as seen by LBOs of
Toys “R” Us ($7 billion), Hertz Corporation ($15 billion), Energy Future Holdings ($44 billion), Harrah’s
Entertainment ($27 billion), and Hilton Hotels ($26 billion). These deals were among the largest ever in size, but
similar to RJR Nabisco, they did not produce strong returns for their investors.
2008, however, marked an entirely new investing environment for PE firms due to the beginning of the credit crunch
and global economic crisis. PE firms had difficulty finding attractive investments and an even harder time obtaining
debt financing, as investors remained on the sidelines and investment banks (firms that typically underwrite debt
financings) were struggling with their own balance sheet problems. This resulted in fewer buyouts and a return to the
norm of smaller deals. To compare: the PE industry in the U.S. alone made 7,590 deals in the period 2005-2007,
accounting for nearly $1.1 trillion in value, but during 2008-2010, there were 5,056 deals worth only $408 billion,
showing a 62% drop in capital employed.
As the recession lifted, however, private equity buyouts gradually began to return, and in 2012, the deals were again in
the billions (though still nowhere near the levels of the 2005-2007 boom years). Fundraising for PE investments in
general has been much more difficult since 2008, because of both investors having less capital to invest in private
equity, and private equity funds having difficulty generating consistent returns for its investors. In addition, a lot of the
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money that was raised in the boom years (2005-2007) still has yet to be used for buyouts. This overhang of committed
capital prevents many investors from committing to invest in new PE funds. Overall, it is estimated that PE firms
manage over $2 trillion in assets worldwide today, with close to $1 trillion in committed capital available to make new
PE investments (this capital is sometimes called “dry powder” in the industry).
The PE industry has become much more socially acceptable over the last decade. The public perception of private
equity firms has improved for three primary reasons:
PE firms are making a conscious effort to invest in more socially responsible companies.
Many prominent PE deals in decades past, such as KKR’s acquisition of RJR Nabisco, are seen as displays of
greed and exercises in hubris, while today, practically all PE deals are executed with the sole intention of
creating economic value for shareholders and the economy at large.
The general public has begun to see how buyouts can play a beneficial role in improving companies and
sustaining economic growth. Instead of being seen as an industry that focuses on making operations leaner
through layoffs and restructuring, PE firms are starting to be seen as being able to help sustain and build
companies, as well as increase employment levels.
Types of Private Equity Investments
PE firms can invest in a wide mix of private investment strategies, with the mix varying greatly from firm to firm
depending on the firm’s size, stated investment strategy, and industry and transaction expertise.
Type of PE
Company Stage
(early > late)
Size of Typical
Investment
Type
of PE Firm
Description
Example Industry
Focus
Life sciences;
Technology;
Software
Venture
Capital
$50,000 to
$5 million
VC
Typically investments in companies that are early
stage of development and are cash flow negative.
Requires convincing market potential since not
proven.
Growth
Capital
$5 million to
$50 million
Small - Mid
Tier
Typically investments in equity and/or debt
instruments as these companies are growing and
require increasing amounts of working capital, capital
expenditures or an acquisition.
Most types
Mezzanine
Financing
$5 million to
$50 million
Small - Mid
Tier
Typically subordinated debt or preferred equity
investment into a company that falls between equity
and senior debt on the balance sheet.
Manfuacturing;
Consumer products;
Real estate
Leveraged
Buyout
$2 million to
$200+ million
Buyout
(all sizes)
Acquisition of an operating company with a significant
amount of borrowed funds to create value by realizing
opportunities and improving efficiencies, etc.(use debt
as financial leverage)
Consumer products;
Food manufacturing
Distressed
Buyout
$2 million to
$200+ million
Buyout
(all sizes)
Typically investments in equity or debt securities of
financially stressed companies. Investor can look for a
corporate restructuring or turnaround of business, for
example.
Paper & pulp
manufacturing
Venture Capital: A venture capital (VC) investment typically involves a minority investment in a high-growth
company with minimal revenue. These investments are made at an early stage in the company’s life cycle. VC deals
usually result in equity stakes in these startup businesses, and are usually characterized as high-risk/high-return
(“boom or bust”) opportunities. This method of investing is popular among newer companies because they generally do
not have access to debt markets to raise capital.
Typically, VC investments have the possibility of blockbuster returns for the investor. For instance, an initial
investment could be seed funding for the company to start building its operations. Later on, if the company proves that
it has a viable product, it can obtain Series A financing for further growth. A start-up company can complete several
rounds of series financing prior to going public or being acquired by a financial sponsor or strategic buyer. It is not
uncommon for VC deals to return 10x multiples of invested capital to investors (or potentially even more).
Growth Capital (also referred to as Growth Equity): Growth capital investments typically consist of a private
equity firm making a majority or minority ownership stake in an early-stage company. These investment opportunities
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typically involve companies that are more developed than classic VC investment companies, making them less risky
than VC investments, but with less upside potential.
Growth equity firms extensively research various industries and market trends in order to identify attractive
investment opportunities. They are looking for companies where they can add significant value in order to help
companies realize their market potential and become market leaders in their respective industries. This expertise can
come in a variety of forms including strategic guidance, operational support, management expertise and efficient
capital allocation. A successful growth equity investment will typically return at least a 3x multiple of invested capital
to investors. A few notable growth equity firms include General Atlantic, Golden Gate Capital, TA Associates, and
Warburg Pincus.
Mezzanine Financing: A private equity firm may offer mezzanine financing in the form of subordinated debt
(junior to senior debt) or preferred equity, where return expectations are typically around 15%-20% per year.
Mezzanine financing, in general, usually involves investor compensation in the form of interest combined with upside
participation (i.e., equity or options/warrants on equity). Companies will often search for other sources of capital
before turning to mezzanine capital, because it is expensive. However, this type of capital can help fill the gap between
senior debt and equity when a private equity firm considers a leveraged buyout—mezzanine financing effectively lowers
the required amount of equity capital invested in a leveraged buyout, and the equity capital has a higher required rate
of return. Therefore, mezzanine financing, while expensive, can help reduce the overall required rate of return on the
capital used to execute the LBO, by lowering the required equity investment, and thereby make some LBO deals
feasible that otherwise were not.
Leveraged Buyout (“LBO”): A leveraged buyout is the acquisition of a publicly or privately-held company,
typically characterized by the significant amount of debt financing used for the acquisition relative to the equity
financing used. LBOs are the bread-and-butter investment strategy for most Private Equity firms. In an LBO
transaction, a PE firm (also called a financial sponsor) or a group of firms (called a consortium or investor group)
acquire the target company using debt instruments for the majority of the purchase price (debt typically represents
about 60-75% of the total price). The leveraged buyout relies heavily on the future cash flows of the acquired business
to service the interest expense on the debt and, additionally, pay down the outstanding debt as quickly as possible.
(This pay-down is usually small at first, because the initial interest expense burden is substantial, but typically the paydown amount grows each year as the company’s cash flow grows and as the outstanding debt balance decreases from
previous pay-downs.) As the debt balance is lowered and the company’s value increases, the equity very quickly grows
as a proportion of the company’s capital structure. It is this deleveraging process that can help lead to substantial gains
for the equity holders in a successful LBO investment.
Top LBO PE firms are characterized by their large fund size; they are able to make the largest buyouts and take on the
most debt. However, LBO transactions come in all shapes and sizes. Total transaction sizes can range from tens of
millions to tens of billions of dollars, and can occur on target companies in a wide variety of industries and sectors.
Due to their reliance on high leverage, LBO firms must be adept at creating optimal capital structures for their target
companies (a process sometimes referred to as “financial engineering”). LBO firms rely on financial engineering as a
skill that is core to their investment strategy—much more so than growth equity firms, who focus almost exclusively on
company value creation. Well-known LBO firms include KKR, Blackstone, The Carlyle Group, TPG Capital, Goldman
Sachs Private Equity, and Bain Capital.
Distressed Buyout: In a typical distressed buyout, a private equity firm purchases a financially distressed company
below market value with the intention of divesting the company in the future for a higher value. The two main causes of
distress for a company include excessive financial leverage and operational volatility, such as a cyclical business. Prior
to executing a distressed buyout opportunity, a distressed buyout firm has to make judgments about the target
company’s value, the survivability, the legal and restructuring issues that may arise (should the company’s distressed
assets need to be restructured), and whether or not the creditors of the target company will become equity holders. If
the creditors are likely to become equity holders, they will acquire many rights as full or partial owners of the business,
and this can lead to very important issues regarding control of the business.
Private Equity Fund Structure
A private equity fund, also known as a general partner, consists of an investment team that raises committed capital
from outside passive investors known as limited partners. Limited partners typically are made up of endowments,
pensions, high net worth individuals, and institutional capital. The general partner invests the capital in public and
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private companies, manages the portfolio of investments, and seeks to exit the investments in the future for sizeable
returns. A typical fund for a private equity firm has a total lifespan of approximately 10 years. The PE firm is required
to invest each respective fund’s capital within a period of about 5-7 years and then usually has another 5-7 years to sell
(exit) the investments. PE firms typically use about 90% of the balance of their funds for new investments, and reserve
about 10% for capital to be used by their portfolio companies (bolt-on acquisitions, additional available capital, etc.).
Funds can span different sectors, risk appetites, investment horizons, or any other investment style, but firms often
specialize in one area (or a couple of related areas) and focus on growing their expertise and returns there.
A PE firm sustains itself through a continuous cycle of raising capital. As PE firms grow their capital base from funds,
they are able to grow the firms, as a result of the increased fees received for managing the investments in the various
funds they are managing. Conversely, if a PE firm does not have a strong investment track record, it may be forced to
unwind its operations if it is unable to raise additional capital by raising new investment funds.
Here’s an example: a private equity firm may raise its first fund, which it could call Fund 1. Fund 1’s committed capital
is being invested over time, and being returned to the limited partners as the portfolio companies in that fund are
being exited/sold. Therefore, as a PE firm nears the end of Fund 1, it will need to raise a new fund from new and
existing limited partners to sustain its operations.
Once 50% of Fund 1 has been invested to acquire companies, the PE firm will most likely need to make preparations to
start fundraising for Fund 2. If the PE firm is able to show an impressive track record of returns from Fund 1, it should
be able to raise larger sequential funds (starting with Fund 2). But if Fund 1 is not doing very well, it may struggle to
raise capital for Fund 2, which will possibly jeopardize the firm’s ability to continue operations.
Private Equity Firm
Limited Partners
2% annual mgmt fee*
General Partner
commited capital
Fund 1
Deals or Investment Portfolio
Deal 1
Deal 2
Deal 3
20% return on investments (profit)*
80% return on investments (profit)*
Consist of pension funds, insurance
companies, fund of funds, high networth investors, family offices,
endowments, foundations, sovereign
wealth funds, etc.
*Average fees on private equity funds is 2% annual management fee and 20% performance fee on committed capital and profit, respectively.
Typical Fees
Due to the specialized expertise of private equity firms, they are able to charge fees to their limited partners when
managing their investments. They do so through two primary sets of fees: annual management fees across total assets
under management (AUM), and a performance incentive fee based on a hurdle rate. While this varies by firm and
possibly by fund, typical management fees consist of 2% of the total assets under management annually, and
performance fees of 20%, which are taken from exited (“realized”) investments.
A PE firm’s performance fees are also called incentive fees, carried interest or carry. There is typically a hurdle rate
(an annual required return of 7-10%) that general partners must achieve before performance fees are allowed to be
taken. The structure of these performance fees motivates the partners of private equity firms to generate large returns;
they are intended to align the interests of the general partner with the limited partners. Hurdle rates force PE firms to
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strive for generating above-market returns, since they stand to earn a large amount of money from the share of profits
made on successful investments beyond the hurdle rate of return.
PE Firm Focus
There are many different types and sizes of private equity firms and funds. A private equity firm could have multiple
funds that can specialize in either a specific industry or a specific geography. Private equity firms create funds to focus
on areas where they think that can create value for companies. The figure below illustrates the types of investment
strategy, geography and industry focuses a PE fund can specialize in.
Investment Strategy
Venture Capital
Geography
Industry / Sector
Global
Generalist
United States
Healthcare
Growth Equity
South America
Mezzanine Fund
Technology, Media,
Telecom (TMT)
Europe & Eastern Europe
China & India
Leveraged Buyout
Financial Institutions
Real Estate
Industrials
Aerospace & Defense
Middle East & Africa
Infrastructure
Distressed Buyout
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Southeast Asia
Consumer & Retail
Chapter 2: Private Equity Investment Criteria
A PE investor must evaluate several factors in order to determine whether any given investment opportunity is a good
one (and is appropriate for the PE firm). Research is needed in order to understand a company’s financials, market
position, industry trends, and debt financing available. In the following pages, we’ll discuss how to assess an
investment opportunity and conduct due diligence for all types of investments. While every company has its different
nuances, this chapter will give you a general framework of how to analyze an investment opportunity and the various
considerations involved.
Criteria for Good LBO Candidates
A good LBO candidate typically has the following characteristics:
1. Strong market position and sustainable competitive advantages: This may seem obvious, but
strong LBO candidates include companies that are market leaders with sustainable business models. This can
be characterized by high barriers to entry, high switching costs, and strong customer relationships.
2. Multiple avenues of growth: It is always helpful to have a balanced and diverse growth strategy, so that a
company’s success is not completely reliant on one driver. This could include growth through the introduction
of new products, increasing in the number of locations, new customers, increasing the penetration of current
customers (upselling products), exploring adjacent industries, and expanding into new geographies, among
other possibilities.
3. Stable, recurring cash flows: Due to the reliance on high leverage, PE firms must find companies with
stable and recurring cash flows in order to have sufficient cash flow to service all of its debt requirements. This
requires to have relatively low exposure to seasonal fluctuations in cash flows, as well as low sensitivity to
cyclical fluctuations (i.e., relatively immune to economic downturns and/or commodity prices).
4. Low capital expenditure requirements: Companies with low maintenance capital expenditure
requirements provide management more flexibility in terms of how it can allocate the company’s capital and
run its operations: investing in growth capital expenditures, making bolt-on acquisitions, growth in its core
operations, or give back capital to its shareholders in the form of a dividend. Capital-intensive businesses will
typically generate lower valuations from private equity firms since there is less available capital (after interest
expense), and there is increased financial risk in the deal.
5. Favourable industry trends: Private equity firms are continually searching for companies that are wellpositioned to benefit from attractive industry trends, since it results in above market growth and provides
stronger equity return potential as well as stronger downside protection for the investment. Examples include
increasing automation, changing customer habits, adoption of a disruptive technology, digitalization, changing
demographics, increasing regulation, etc.
6. Strong management team: A strong management team is crucial to success as private equity firms will
provide strategic guidance but will almost exclusively rely on management to execute their operating strategy.
If a company does not have a strong management team, the private equity firm must have a replacement ready
before even seriously contemplating the investment.
7. Multiple areas to create value: In addition to the characteristics above, a good LBO target candidate will
also have multiple areas where the PE firm can create additional value. Examples include selling
underperforming assets, increasing the efficiency of operations, pricing optimization, organizational structure,
and diversifying the customer base.
Areas of Due Diligence
A crucial part of the investment process is the due diligence performed on the company. Think of it like an
investigation process for a potential investment: PE firms will perform very detailed due diligence in order to ensure
that they are making a sound investment. This process is crucial to the success of the investment, and the financial
sponsor must look at all critical aspects of the target company: commercial, financial, and legal. The vast majority of
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the time is spent on commercial due diligence while the financial and legal areas are more confirmatory in nature. PE
firms rely on consultants for their expertise and advice for portions of the due diligence process, but ultimately the
investment decision is the firm’s responsibility. This section provides questions and topics that are often evaluated
while looking at an investment opportunity.
Commercial due diligence includes understanding the company’s value proposition, market position, historical
performance, and industry trends in order to assess the target’s ability to achieve its forecasted projections.
Sample due diligence questions include:
Competitive Landscape and Market Position: It is important to understand how sustainable the target’s business
model is and where it is positioned relative to its competitors.
What is your competitive advantage (e.g. product offering, technology, price, premium brand, distribution
capabilities, geographic presence, fully-integrated solution, etc.)? Is this a disruptive business model (i.e., one
that changes the landscape of how business is done in this space in some way)?
What are the barriers to entry into the business? What are the costs of switching to a competitor’s product?
Where does the company fit in the industry value chain? How has the industry changed over the last 5 years?
How do you expect that to change over the next 5 years?
Who are your main competitors? From whom have you been gaining/losing market share? What firm is the
biggest threat to your company? What is the biggest share gain opportunity?
What is the market landscape (e.g. oligopoly, fragmented market, first-mover, etc.)? How saturated is the
market?
Industry Growth/Addressable Market: When evaluating the industry, it is crucial to understand the market
environment and the external factors affecting the business.
What is the historical growth of the market? What is the projected growth of the market over the next 5 years?
How mature is the industry?
What is the total addressable market? What segments of the industry are growing faster than others?
Describe the key macroeconomic drivers of the business. What are the trends?
Have there been any significant changes to the industry landscape (e.g. disruptive new entrants, consolidation,
vertical/horizontal integration, demand/supply imbalance, etc.)?
What are the regulatory concerns and how can it adversely affect the business?
Customer Base/Suppliers: This entails understanding the “stickiness” of customers and the company’s reliance on
suppliers.
How many customers do you have? What is the concentration of your top 50 customers?
What is the typical contract length of a customer relationship? What is a typical renewal rate? What percentage
of customers have multiple products?
Who are the key decision makers for the customers? What are the buying dynamics? How long is the entire
sales process?
Please describe your most recent customer wins and losses. What were the main reasons?
How many suppliers do you have? What is the concentration of your top suppliers? How large of a customer
are you to them? What is the average length of the relationship? How often are your supply contracts
renegotiated?
If you receive price increases from your suppliers, are you able to pass it through to your customers?
Capital Requirements of the Business: A good understanding of the total capital needed to run the operations of a
business is needed, especially during difficult times.
How capital intensive is the business? What percentage of capital expenditures is growth capital vs.
replacement/maintenance capital? How has that trended over the last 5 years? What kind of lead-time is
needed (i.e. time from purchase order to delivery) when making a purchase order? How large of a deposit is
customary for new purchases?
How cyclical is the business? Are there any severe seasonal changes in demand? What are the factors? How
much visibility do you have in expected sales?
What percentage of the COGS cost structure is fixed vs. variable? What is the breakdown of operating
expenses?
What is the normal working level of cash to run the business for a year?
At what manufacturing capacity is the company running right now? How quickly and to what extent can it be
reduced if demand falls?
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What would be your biggest concern in a downside scenario?
Financial Performance (Historical & Projected): This analysis provides a deeper look into the company’s historical
performance in order to understand how realistic the company’s forecasted projections are.
Provide a comparison of the historical performance to the management budgets for the last 5 years. Describe
the methodology behind the budget and the reasons for beating/missing the budget.
What are the key performance indicators (KPIs) the management uses to monitor the business? Describe the
trends in these indicators.
Break out your organic growth over the last 5 years (not including the impact from acquisitions).
Provide your 5-year financial model and describe the key drivers in your projections.
o Growth: Please describe key assumptions. How does it compare to expected market growth? Where will it
come from (increase in price, increase in volume, increase in market share, new products, acquisitions,
etc.)?
o Margins: Please describe key assumptions. Why (for example) do you expect margins to increase so
significantly compared to historical performance? Where will it come from (operating leverage, cost
efficiencies, higher margins on products, revenue/cost mix, etc.)?
o KPIs: Describe key assumptions. How do they compare to the industry average and/or your main
competitors?
o What are the primary risks to this forecast (new product introduction, successful expansion into new
geography, customer concentration, sufficient hiring of employees, R&D resources, etc.)?
Financial due diligence confirms that all the financial information provided is accurate and helps PE firms
understand some of the unique dynamics of the company from a financial reporting perspective. The firms typically
hire accountants and/or auditors to review the financials, operations, customers, markets, and tax issues in detail. This
is usually referred to as “transaction advisory services.”
The main areas of financial due diligence include:
Quality of earnings: The PE firms need to confirm the historical earnings of the company excluding non-recurring
costs/expenses, as this will affect the valuation of the company. Consequently, they hire accountants to ensure that the
information the company provides is accurate. Accountants review the company’s historical performance to
understand the target’s actual EBITDA, adjusted for non-recurring costs. Adjusted EBITDA is critical because that is
what will drive the company’s valuation (Adjusted EBITDA × EBITDA multiple = Purchase Price). These adjustment
types include management adjustments, business-related adjustments, and pro forma adjustments.
Management adjustments are common when purchasing family-founded businesses where compensation is
very flexible. Adjustments include one-time or excess owner/executive compensation, transaction costs, legal
settlements, and personal expenses (like a private jet, accounting fees, etc.).
Business-related adjustments include accounting-related issues, such as accounting true-ups for bonuses and
reserves, inventory valuation, revenue recognition, accrual/reserve reversals, etc. These adjustments also
include lost customers and unsustainable margins or cost cuts.
Pro-forma adjustments occur when the company has made recent acquisitions or divestitures. They are
attempting to answer the following question: given the current business structure, what would historical
earnings have been, pro forma for the acquisitions/divestitures? This review includes synergies (eliminated
positions & facilities, scaled pricing, major customers, audit/tax fees, open positions, known cost increases,
etc.).
Debt and debt-like items: During the review, firms need to calculate the company’s total debt-like items outstanding,
because it will impact the total amount given to the sellers (Total purchase price less debt = cash given to sellers). All
liabilities will be categorized as either working capital or debt, not both. Sellers have an incentive to have lower debt &
debt-like items, but buyers need to ensure that the amount of debt owed isn’t misrepresented. For example, capital
expenditures may not be accurate because the company could have ordered a lot of equipment but have yet to pay for
the purchase, which results in a payment post-acquisition, thus affecting the total cash available after the deal. In
addition, debt-like items are often buried in accounts payable and accrued expenses. Other common debt-like items
can be found in deferred compensation, termed accounts payable, shareholder payables, legal settlements, tax related
liabilities, and liabilities associated with certain cash transactions.
Normal working level of capital: The PE firm assumes that the company needs a normal level of working capital to
remain in business, and thus removes it from the purchase price. The accountant must identify adjustments to
reported working capital (this involves determining and reporting on the Quality of Operating Working Capital), and
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assist with setting an operating working capital target. Beyond setting a working capital target for the purchase price,
the accountant must perform due diligence to understand the other unique dynamics of the business model to optimize
the operations during various economic cycles. This would require looking at the characteristics of the company’s cash
flow, deferred revenue, orders, revenue recognition, and seasonality of the business.
Tax structure: This process entails looking at the tax structure of the company and providing a detailed analysis of the
federal, state, local, and international tax situation (both historical and anticipated). Federal taxation occurs at the
national level and includes a review of tax assets, structure the company, step-up calculations, compliance procedures,
and identification of the potential tax liabilities. State and local taxation are based on the location of the company. This
entails a review of the payroll, use tax, and sales compliance procedures as well as a high level assessment of potential
tax liabilities. International taxation deals with the transfer pricing as the company conducts business globally. This
also refers to the tax structure of the company after the acquisition. By looking closely at a company’s tax structure, the
analysis can provide insight into the best methods and locations for tax compliance so that the company may maximize
its net profit and minimize its tax liabilities.
Information technology: IT issues can cause a significant block in a smooth transition if the systems are not reviewed
correctly and comprehensively. The smooth process of IT systems is crucial to conducting accurate reviews of tax
liabilities and accounting as well as maintaining historical financial records.
Human resources: HR plays an important role in due diligence because it affects payroll and that in turn affects the
taxes for which the company is responsible. State filing requirements and income regulations are based partly on the
location of the payroll.
Legal due diligence is mainly confirmatory. It is focused on confirming that the target company is not subject to any
future liabilities including regulatory issues, threatened or ongoing lawsuits, and unusual or onerous contract
provisions.
Corporate filings: This component of the legal due diligence process is to confirm that all corporate filings have been
filed correctly (corporate organization and documents) and to understand the legal organization of the company, such
as whether there are any strange corporate structures.
Material contracts: Prior to acquiring a company, it is important to look at past and current material contracts. This
includes the debt structure, acquisitions and other liabilities, and it may include key customer, partner or supplier
agreements.
Property, plant and equipment: It is important to consider the company’s property, plant and equipment to study its
assets and liabilities. One example of this is a detailed review of key operating or capital leases.
Human resources: HR due diligence is another important area in legal due diligence, and it refers to the target
company’s management team and employees. Any HR risks need to be captured in the valuation model. The firm will
look at employment terms/agreements, individual contracts, collectively bargained agreements, and
retention/severance agreements. In conjunction, a review of the management and employees are necessary. The
compensation structure is crucial to understanding the organizational and operational structure of the company. This
includes compensation for executives, and the possible severance required if they are to be terminated during the deal.
This also includes other salary and stock option plans to key employees.
Health and welfare plans: The target company will have various benefit plans set up, which must be evaluated as the
acquisition is taking place. The firm reviews the health benefit plans, retiree health plans, and retirement plans to
understand any regulations or legal issues surrounding the benefits.
Information technology: Reviewing the company’s IT structure during legal due diligence is very important. Assessing
the company’s information technology and related agreements can provide further insight into the company’s
weaknesses and strengths. The review includes looking at software or hardware agreements with external parties,
contractually obligated product features or service level agreements, license agreements, and other technology
agreements.
Lawsuits/litigation/patents: A look at the company’s lawsuits/litigation provides a summary of any pending litigation,
history of past litigations, and what may arise in the company, such as environmental, employment, customer or
worker compensation issues. Similarly, a careful review of the intellectual property (IP) will be useful because the
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company’s proprietary information can help raise its value. Valuable IP can include patents/trademarks, domain
names, trade secrets, and design rights that are exclusive to the company and help drive its business. Regulatory issues
can also come into play here. On example of this is the need to review the possibility of asbestos liability for certain
companies in some industries.
Environmental: Another crucial aspect of operations is to understand any potential liabilities the business is exposed
to in its environment while conducting the day-to-day processes, such as hazardous material or toxic waste. Each
business has specific types of environmental issues, and they will vary based on the industry.
Capital Structure Considerations
Capital structure considerations are important for all private equity deals, but this is most relevant for LBOs, because
they rely heavily on leverage to produce attractive returns to equity investors. Leverage creates investment risk,
however, and choosing the optimal capital structure is therefore extremely important. The optimal capital structure
will also heavily influence how the target company runs its operations. Firms need to weigh the pros and cons of the
cost of the debt and the capital structure’s flexibility as well as how much debt is suitable for the company.
The figure below illustrates a typical capital structure for an LBO transaction, and some of the key characteristics and
considerations for each tranche (slice) of the capital structure.
Assets
Liabilities &
Shareholders'
Equity
Expected
Returns
Senior
Bank Debt
(30-60%)
4% - 8%
- Low financing costs
- Lowest default risk in cap structure
- Floating rate, callable instrument
- Restrictive maintenance covenants
- Ability to increase line of credit / additional debt
High Yield
Debt
(0-15%)
8% - 14%
- Typically fixed rate loan
- Prepayable penalties for first few years
- Limited flexibility in raising additional debt
Quasi Equity
(0-15%)
15% - 20%
- Has debt and equity characteristics
- Downside protection (like debt) with upside
potential (like pure equity)
20% - 40%
- Riskiest security in capital structure
- No downside protection with unlimited upside
potential
- Private Market Equity - Financial Sponsor
- Public Market Equity - Common Shareholders
Common
Equity
(20-50%)
Junior
1.
Key Characterstics
Senior debt: The largest component of an LBO company’s capital structure typically is the senior debt or
bank debt (otherwise referred to as “first lien” or “second lien”). Senior debt has the lowest financial cost and is
the first in line in the capital structure to receive its money during the liquidation of the company. In addition,
senior debt is sometimes secured by the company’s assets. However, the tradeoff is that the company is
typically burdened with strict maintenance covenants to protect the senior/bank debt investors. Such
covenants can include total leverage covenants and interest coverage covenants. Also, senior debt typically
requires annual principal payments (referred to as amortization payments), which creates a burden on the
company to generate sufficient cash flow from its operations. Senior debt typically matures after 5-7 years and
has a floating coupon (i.e., the interest rate fluctuates based on an index such as LIBOR).
2. High yield debt or subordinated debt: This kind of debt typically represents 20% to 30% of the LBO
capital structure and has higher financial costs than senior debt. In contrast, high yield debt usually has less
restrictive covenants or limitations, a longer time to maturity, and no required amortization payments.
Subordinated debt typically matures after 6-8 years and has a fixed coupon or interest rate. One restrictive
characteristic of high yield debt is that it is often not pre-payable by the company for a few years, so that high
11 ©2013 Street of Walls
yield debt investors can lock-in their high interest rate for at least a couple years. If a private equity firm is
looking to raise additional debt within the first few years of investment (e.g. for a bolt-on acquisition), it will
typically avoid a high yield debt structure, because it would then likely incur high prepayment penalties. This
portion of the capital structure can also include some combination of bridge financing, mezzanine financing, or
“quasi equity”.
3. Equity: This represents 20%-50% of the total capital of an LBO investment and is the most junior portion of
the capital structure. In other words, common equity shareholders are paid last during a liquidation of a
company. Equity holders require the highest rate of return on investment (approximately 20% to 40%) due to
the high level of risk being taken by equity investors. For example, the equity holders often will receive no
value if the company defaults on its debt payments (i.e., the entire equity investment will become worthless).
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Chapter 3: Private Equity New Investment Process
The typical process for evaluating and completing a new private equity investment opportunity has many different and
structured steps that can vary widely by PE firm, and can differ greatly due to specifics of the target company or the
transaction process. The initial investment evaluation can happen very quickly, but the entire process may take several
months or even a year or more. The discovery and assessment of the opportunity at the beginning of the process is
called “sourcing”—in this phase, the firm locates potential targets and looks at the viability of the investment and the
potential returns available. Then, as more information is gathered, the firm conducts due diligence, creates and
develops very detailed financial models, and evaluates the pros and cons of the opportunity prior to final approval and
execution of the transaction.
Sourcing of an Investment Opportunity
Sourcing for investment opportunities can be difficult and grueling, but it is an essential skill one needs if aspiring to
have a successful career in the PE industry. Depending on the PE firm’s preference, a deal may be sourced through a
variety of channels: internal analysis, networking, detailed research, and cold-calling executives at attractive
companies, for example. Other sources include meeting with various companies, company screens through databases
for specific criteria, industry conferences, and conversations with industry consultants and experts. Opportunities
sourced through any of these means is referred to as proprietary sourcing—i.e., internally sourced.
Another common way to receive potential investment opportunities is through a financial intermediary, such as an
investment banker. Companies often hire investment banks to sell businesses via Confidential Information
Memorandums (CIMs), which are distributed to potential acquirers, possibly including both financial sponsors
(private equity firms) and strategic buyers. This is typically characterized as a public auction. While searching for
potential opportunities, an associate would need to ensure that the investment opportunity fits into the firm’s
investment strategy, such as a minimum EBITDA, industry, potential value creation strategy, or a minimum (or
maximum) equity check.
Below we demonstrate the “sourcing funnel” of potential investment opportunities at an illustrative private equity firm:
Investment Process up to Signing
This section will look at how a typical PE investment process works. Even though the general aspects of the process are
the same across various firms, the details can vary widely depending on how the investment opportunity was sourced
(proprietary sourced vs. public auction) and each firm’s investment committee process. The larger the firm, the more
formalized the investment committee process will be and the higher the probability that public auctions will be used.
Conversely, growth equity firms tend to work on more proprietary-sourced deals where they have less competition and
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are dealing more directly with management. Growth equity firms also have less formalized investment committee
processes because there are typically fewer partners in the firm, thereby requiring less work to build consensus among
the partners before the investment can be made.
1. Signing a Non-Disclosure Agreement (NDA): In a public auction, investment bankers will often send out
teasers, which are 1-2 page summaries about the company up for sale. If the investment team finds the teaser
interesting, they will negotiate and sign an NDA to receive the company’s CIM prepared by the investment
bankers. In a proprietary-sourced opportunity, investment teams will often sign an NDA directly with the
target company in order to receive some confidential information regarding the company from management.
2. Initial due diligence & Management Presentation: At this stage, the investment teams will perform some
initial due diligence to better understand the company. This generally includes research on the industry,
talking to advisors about the specific company and the industry, and a building and enhancing a preliminary
financial/LBO model using the management’s projections to understand the potential returns of making the
investment. At the same time, the investment team may start reaching out to investment banks to hear their
thoughts on the company and understand how much debt financing (and what type) would be available for an
acquisition of this company. In a public auction, investment bankers will also offer a select group of potential
buyers an opportunity to meet with the management team (referred to as a “Management Presentation”). The
management team will present an overview of the company while the deal team is allowed to ask them
questions about their business. In order to prepare for the management presentation, the investment team will
create an initial due diligence question list (similar to questions discussed in the Commercial Due Diligence
section).
3. Deal Alert (first review with Investment Committee): After reviewing the management’s presentation and
having initial discussions, the investment team will prepare a brief (2-3 page) investment proposal and present
it to the PE firm’s Investment Committee. The first Investment Committee meeting can have a variety of
different purposes, depending on the PE firm. The meeting can be a deal update where no approval is needed,
or it can be the beginning of a formal approval process, whereby a deal team will be given permission to submit
a First Round Bid (discussed below) and/or a budget to spend a specified amount of money (referred to as
“cost cover”) on consultants or other deal-related expenses. If approved, the investment would proceed into
further diligence and discussions with the target company and its investment bankers.
4. Non-Binding Letter of Intent (LOI) or First Round Bid: At this point, the investment team may present the
target company with a non-binding LOI for the transaction on certain criteria that have been shared with the
investment team. The offer will detail a proposed purchase price (often a valuation range is given, rather than a
specified amount), a proposed capital structure post-acquisition, key assumptions made, key due diligence
areas, approximate timing needed to submit a binding offer, the PE firm’s relevant expertise and experience,
and the necessary authorizations & approvals required by the PE firm’s Investment Committee in order to
complete the transaction. At this point, the target company and its investment banking advisors will generally
choose a few bidders to move on to the next round in the auction process. The seller will base its decision on
key considerations, including total purchase price, credibility of the offer, the submitting firm’s experience and
value creation strategy, and the submitting firm’s compatibility with the current management team.
5.
Further due diligence with management: The target company will begin providing more detailed confidential
information in what is typically referred to as a virtual dataroom to the bidders that proceed beyond the first
round. Some example dataroom files are the corporation’s organization and legal entities, board minutes and
reports, detailed operations records, owned and leased property agreements, intellectual property
documentation, employee lists and employment agreements, detailed segment financial information, and
historical audited financials. At this point, private equity firms will begin reviewing all of the relevant
dataroom files and start to get more specific, detailed questions to the management team. Follow-up due
diligence calls will be held (through the supervision of the investment bankers) with specific members of the
executive and non-executive management team. Also, based on the dataroom files, the deal team will start
brainstorming the critical issues that they will often hire third-party consultants to help investigate.
6. Building an Internal Operating Model: After having detailed conversations with the management team on all
of the main drivers behind the business, the investment team will start building a detailed operating model for
the business based on reasonable forecast assumptions. An operating model is a very detailed revenue and cost
breakdown that is based on specific drivers and assumptions (e.g. price, volume, raw material costs, number of
branches, number of customers, renewal rates, fixed vs. variable cost structure, etc.). All of these breakdowns
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combine into one model to describe the expected financial performance of the company in great detail. This
gives the PE investors more detail on the drivers of potential return for the acquisition.
7.
Preliminary Investment Memorandum: Once the team has completed a more detailed investment model, and
a comprehensive investment thesis (reason for investing) and strategy (plan to carry out the investment
thesis), a Preliminary Investment Memorandum (PIM, typically 30-40 pages) is compiled to summarize
the investment opportunity to the Investment Committee. Sections in the PIM typically include:
a. Executive Summary: Details of the proposed transaction, background, and overall deal team
recommendation and investment thesis.
b. Company Overview: History, description, products & applications, customers, suppliers, competitors,
organizational structure, management team biographies, etc.
c. Market and Industry Overview: Key market growth rates, trends, etc.
d. Financial Overview: Historical and projected income statement, balance sheet, and cash flow statement
analysis.
e. Risks and Key Areas of Due Diligence: Potential risks to the industry/business and key areas of completed
and ongoing due diligence.
f. Valuation Overview: Comparable company analysis, precedent M&A transactions analysis, DCF analysis,
LBO analysis, etc.
g. Exit: Initial thoughts on investment exit options and anticipated timing of exit.
h. Recommendations and Proposed Project Plan: The deal team will recommend proceeding with their
proposed project plan based on a specific valuation range and budget approved by the Investment
Committee. The project plan will include the hiring of third-party consultants to perform commercial,
financial, and legal due diligence, and the team will hold further discussions with potential debt and
mezzanine financing providers. Deal teams will typically perform only initial legal due diligence at this
stage, since it is the most costly, and will typically hold off on it as long as possible (usually until the final
stages of the bidding process).
8. Final Due Diligence and process up to submit a binding bid: Provided that the PIM has been accepted by the
PE firm’s Investment Committee, the investment deal team and its consultants will perform any and all final
and confirmatory due diligence in order to provide a Final Binding Bid for the target company (discussed
later). At this stage, the deal team is now working exclusively on this investment opportunity (other potential
investments that the PE professionals on the deal team were working on will be put aside or farmed out to
other PE professionals at the firm) and is having daily interactions with the seller’s investment bankers and
management team. The bidder will send specific requests to the company based on all key outstanding issues.
These could include site visit requests, calls with specific salespeople/non-executive management, or calls with
customers and suppliers. In addition, the deal team will be managing its consultants on other due diligence
work streams, including portions of the commercial, financial, and legal due diligence process (detailed in
“Areas of Due Diligence”). For example, management consultants (McKinsey, Bain, BCG, etc.) are typically
hired to perform commercial due diligence on the addressable market, trends, and customer relationships.
Accountants (KPMG, PricewaterhouseCoopers, Ernst & Young, Deloitte, etc.), specifically within the
Transaction Services group of the accounting firm, are hired to perform confirmatory financial due diligence to
ensure that all the financial information provided is accurate. M&A lawyers (Wachtell Lipton Rosen & Katz,
Skadden, Sullivan & Cromwell, Simpson Thacher, etc.) are hired to perform legal due diligence and to handle
the initial drafting of acquisition documents. At the same time, the investment deal team will be negotiating
with the financing banks on the debt financing terms. When negotiating, the deal team’s objective is to obtain
the best debt financing execution (i.e. choosing the right group of banks) at the most favorable debt terms. The
deal team will also assist the financing banks with their own due diligence by fielding their specific questions
and concerns in order to get them more comfortable with underwriting their debt commitment. The average
time for this entire confirmatory due diligence process (occurring between the First Round Bid and the Final
Binding Bid) is approximately 3 to 6 weeks.
9. Update and Final Investment Committee Approval: Depending upon the exact investment process of the
private equity firm, an investment deal team must update the Investment Committee on key deal issues in a
number of potential ways. Once all due diligence items are completed and the investment team is comfortable
moving forward, a Final Investment Memorandum (FIM) is completed. A FIM is essentially the
equivalent of a PIM (which was completed before the First Round Bid) that also includes further due diligence
from the deal team and third-party consultants, and specifically addresses the key issues introduced by the
Investment Committee from the PIM. At this stage, the deal team will recommend acquiring the target
company at a specific valuation, which the Investment Committee will either reject or approve. It is very
15 ©2013 Street of Walls
common for private equity firms to proceed beyond the first round without submitting a final binding bid or
being restricted to a maximum price by the Investment Committee (i.e., they will not able to raise their price or
indicative valuation range, or may even fall short of the range specified in the First Round Bid).
10. Final Binding Bid and Signing: If it receives approval, the investment deal team will submit a Final Round Bid
(or Final Binding Bid) for the target company. This final bid is almost always binding (i.e. all due diligence has
been completed) and includes a final purchase price, fully-committed financing documents from investment
banks, and marked-up preliminary merger agreements to be discussed with the seller’s lawyers. The seller and
its investment bankers will spend a few days discussing the various final bids and will choose a winner. They
will then work exclusively (and often exhaustingly!) with that bidder in order to sign the transaction. Once a
winner has been chosen, negotiations between the lawyers of the seller and the lawyers of the buyer will
continue to finalize the Merger Agreement (also referred to as the Purchase Agreement) and other related
transaction documents. Several key points in the Merger Agreement will be negotiated, and the most
important of those is the Purchase Price Consideration (i.e., the definition of what is to be subtracted from the
Purchase Price to calculate the total amount wired to the Seller’s stakeholders). Additionally, the Merger
Agreement will spell out logistics of the wire transfers to equity (and other) stakeholders, and how much is to
be withheld for post-transaction adjustments.
Investment Process from Signing to Closing
Once a private equity firm has officially signed a deal with the target company, both parties will jointly issue a press
release announcing the transaction. From there, both parties will work toward closing the transaction, which can take
from a few months to a year to complete, depending on the size and complexity of the transaction. At this point, the
seller’s investment bankers will become less involved, and the main interactions will be between the lawyers
representing the buyer and seller.
Here are a few examples of items that will need to be finalized before closing:
1.
Management Equity Roll-Over and Incentive Option Pool: Depending on whether the private equity firm
wants to keep the current management team, it will start negotiating with the executives on their equity rollover commitment and their incentive option pool. PE firms will work hard to ensure that the management’s
interests are well aligned with theirs. Note that if the deal consists of the acquisition of a publicly-traded
company, the private equity firm is prohibited from having any discussions with the management team about
compensation before the deal is actually signed.
2. Execute Debt Financing: Once a deal is signed, all parties involved will start working on marketing materials
to present to prospective debt investors. In particular, if the debt markets are active and financing is available
at attractive rates, the financial sponsor will try to finalize the debt financing as quickly as possible. The
financial sponsor will have negotiated specific debt amounts and interest rates with the financing banks, but
the banks will have “flex terms” negotiated into their commitment letters which allow them to adjust the debt
terms if the financing markets turn sour (i.e., if the proposed financing terms cease to be viable due to adverse
changes in financial market conditions). The transaction closing and the debt financing execution are
coordinated with each other, as the debt is a vital part of the transaction funding.
3. Closing Funds Flow: Once all the necessary documentation is completed, the private equity firm must ensure
that everyone is properly paid on time, including selling equityholders, existing debtors, target and acquirer
advisors, and the escrow agent. Since transactions can reach billions of dollars in size, this part of the process
can be very difficult to navigate, given the numerous parties involved, various ownership structures, multiple
funding sources, and complicated funding timelines.
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Chapter 4: Monitoring & Exiting Private Equity Investments
Managing a Portfolio Company and Creating Value
In this section we’ll look more in-depth at how PE firms interact with their portfolio companies, and what the benefits
are for both the PE firm and the company itself.
Private equity firms provide their portfolio companies with expertise that they may otherwise not have. A majority of
PE firms create a close working relationship with the management teams of their respective portfolio companies. For
the most part, PE firms do not involve themselves directly in the day-to-day operations of their portfolio companies.
Rather, the firms typically seek to create value by collaborating with management in identifying and executing financial,
operating, and strategic priorities, and providing expertise in these tasks that the management team may not have. In
addition, a PE firm typically will have a few seats on the company’s Board of Directors or Advisory Board. Through
these seats, the PE firm can actively and directly influence the operational and strategic decision making of the
company.
Here are examples of some of the key methods by which PE firms can help create value for the portfolio company:
1.
Relationships in the industry: Portfolio companies can benefit from PE firm relationships, both in the
finance and corporate community. PE firms have relationships with investment bankers, are able to make
introductions to other key players on Wall Street and in the general business community, offer exposure at
industry conferences, and provide access to expert corporate advisors to portfolio company management
teams.
2. Experience running companies: Due to their experience operating many companies, often across various
industries, financial sponsors can educate management teams and help implement the industry’s best
practices for portfolio companies. Sponsors can mold entrepreneurs into professional management teams,
taking current teams “to the next level” by knowing the best strategies for sales optimization, pricing, cost
efficiencies, and other vital management techniques. Additionally, a financial sponsor may decide to replace all
or part of the current management team with a highly experienced executive or team within the sector. Other
times, the PE firm will decide to retain the current management team, and incentivize its members to reach
growth targets effectively. In either case, the PE firm can help the portfolio company attain superior results by
improving the management team and its ability to run the business effectively. In addition, the firm will help to
ensure that appropriate members are selected for the Board of Directors.
3. Transformation of businesses: The firm could help change and improve the company through new
products or helping the company to expand in various industries or countries. For example, a company may
have to change its business orientation from a business-to-business (“B2B”) model to a business-to-consumer
(“B2C”) model in order to navigate its changing industry landscape. Through these transformations, inefficient
processes can be improved, supply chains and distribution channels can be streamlined, the number of
required employees can be reduced to increase productivity, and margins and new products can be introduced.
4. Bolt-on acquisitions and creation of platforms: PE firms have a lot of experience acquiring companies
and typically have had success integrating acquisitions. Both of these factors can be extremely valuable to
portfolio companies pursuing an acquisition-oriented growth strategy. The right acquisitions can help improve
a company’s market position, can create strong partnerships in the industry, and can provide cost and/or
revenue synergies, which ultimately increase the value of the company.
5.
Experienced sellers of businesses: The PE firms know how to maximize a company’s value. They are
experts at how to pitch companies up for sale, and can provide invaluable expertise and resources when it
comes time to sell (exit) an investment.
6. Financial engineering: Financial sponsors help create value by optimizing a target company’s capital
structure where they are able to attain more leverage so that less equity is needed to purchase the company
originally. By understanding what the optimal capital structure is for a firm, private equity firms can maximize
the returns for themselves and all other stakeholders.
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Potential Exit Alternatives and Returns Analysis
PE firms acquire businesses with the intent to exit at a higher equity value than was initially invested. A typical
timeframe of an exit ranges between five and seven years. Most private equity investors require an expected IRR in
excess of 25% before considering undertaking an LBO of a potential target company. Typically, senior members of the
investment team will be required to make critical assumptions on the potential exit multiple (EBITDA and P/E) and
the maximum amount of debt load the target company can handle to achieve such high returns without taking on
excessive risk. The focus is typically on the multiple of invested capital rather than the IRR, because the focus is on
obtaining a higher total equity return more so than on receiving the investment back in a shorter time period (and
thereby “juicing” the IRR of the investment).
There are three primary methods used to increase the exit value realized by the equity holders in an LBO:
1.
EBITDA/Earnings Growth: Increasing EBITDA or earnings is the most effective way to increase the equity
value. Typical ways of increasing EBITDA or earnings include increasing sales, lowering overhead, and
increasing gross margin. Even if the EBITDA multiple paid at entry does not change at exit, a higher EBITDA
will increase the company’s value, and all of that value will accrue to equity holders. For example, if you
purchase a company at 5.0x LTM EBITDA and exit at the same multiple, then the EBITDA will directly affect
the exit price. If EBITDA grows from $110 million to $130 million, then the exit valuation is $650 million
compared with an entry valuation of $550 million—and all $100 million of the increased value will accrue to
the equity holders.
2. Multiple Expansion: Valuation multiples are linked to a company’s growth prospects, operating
performance, and competitive landscape, and can dramatically fluctuate depending on the market
environment. Therefore, a PE firm may try to time the macro-environment and the growth trajectory of its
portfolio company to sell at a higher multiple than what was paid at the initial investment. Multiples are
generally very reliant on market conditions, so an ideal situation would be to purchase companies at a time
when market multiples are lower than usual, and sell when multiples are higher than usual. Additionally, a PE
firm may try to enhance a company’s exit multiple by shifting the company to a more attractive mix of business
lines (potentially by targeted acquisitions) during the investment period, thereby allowing the company to be
potentially sold for a higher EBITDA/earnings multiple than it was acquired for.
3. Free Cash Flow Generation: All free cash flow can be used to pay down existing debt, which was used as
part of the purchase price at the time of the initial investment. As the debt is paid down, the equity value will
correspondingly increase. For this reason, a PE firm will attempt to increase growth and margins, which will
increase the free cash flow generated by the respective portfolio company—thereby further accelerating the
rate of growth in the equity’s value.
When initially evaluating an investment opportunity, PE investors must always keep in mind that the prospective exit
strategy is crucial to the overall success of the investment. Therefore they must assess the likely scenarios for the
common types of exits: typically, a trade sale (selling to a strategic buyer), an initial public offering, or a secondary
buyout. The most desirable option typically is to sell to a strategic buyer, because strategic buyers can typically pay
higher multiples for a business than financial buyers, and the investor would receive a return right away (upon closing
of the sale), rather than waiting for a public offering to complete (and the subsequent “lock-up” period to expire—more
on this later). Other exit options include refinancing, partial sales, and liquidations.
In deciding upon which exit strategy to pursue, the investor must consider the macroeconomic, legal, tax, and
regulatory environment. Macroeconomic risks include the conditions of the public capital markets and the current
trends in bank lending, such as interest rates and willingness to lend out capital. For example, if there is a period of
tight credit, a bank might not be willing to lend financing to a potential buyer, thereby reducing exit opportunities for
the company.
Trade (Strategic) Sale
A financial sponsor may realize gains in a portfolio company investment via a sale to a strategic acquirer. This allows
for an immediate liquidity event for the financial sponsor. Strategic buyers typically intend to hold the acquisition over
the long-term and thereby gain a greater competitive advantage and market share in its respective industry. A strategic
buyer is usually a non-PE firm, and the acquisition is in the buyer’s strategic interest (whether it’s for market growth,
trade secrets, new products, synergies, or other business improvements). Therefore the trade sale will usually
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command the highest sale price. For these reasons, the sale to a strategic buyer is generally the preferred exit option for
an LBO investor.
Initial Public Offering (IPO)
The primary benefit of an IPO exit for a portfolio company is the potential for a high valuation, provided that there is
investor demand for equity in the company and stable, favorable public market conditions. That being said, an IPO
involves high transaction costs. Additionally, if the financial sponsor is looking to fully exit the portfolio company,
potential public investors might view a full exit as a lack of confidence in the future prospects of the business.
Furthermore, the terms of the IPO may prohibit the financial sponsor from exiting some or all of its position for a
period of time (called a “lock-up” period). Other potential problems with an IPO exit include the risk of the quality of
the overall public equity market environment, and the likelihood of a discounted price for the IPO. (An IPO generally is
priced at a discount to the expected trading price of the stock once the IPO is completed—typically about 15%-20% of
the equity’s expected market value. This discount is designed to help drum up demand for the new issuance, but it
results in value left on the table by the issuer of the IPO, which directly impacts the achievable value for the PE firm’s
equity holders.)
Secondary Buyout
A financial sponsor can often sell a portfolio company to another financial sponsor in a leveraged buyout transaction
known as a secondary buyout. This name derives from the fact that the LBO is being sold to the next buyer in another,
separate LBO.
One possible rationale for this type of exit can be that the financial sponsor and current management team believe a
larger financial sponsor can add value to the portfolio company as it moves into the next stage of its development.
Alternatively, a financial sponsor may decide to sell the company to another financial sponsor if it has reached its
minimum investment time period and has already created a high rate of return on its initial investment. Other
potential benefits of selling to another PE firm include increased flexibility in the structure of the sale (where, for
example, the seller could potentially maintain a partial ownership stake and enable the company to continue
conducting its business with the intent of growth in the long term).
However, a financial sponsor is almost always a sophisticated buyer, and thus will try to purchase the asset at a
minimal valuation, typically at a much lower price than would a strategic buyer. In addition, the attainable sale price
could be highly dependent upon debt market conditions.
19 ©2013 Street of Walls
Chapter 5: Private Equity Firm Hierarchy and Associate Role
Private Equity Investment Professionals
Like investment banks, Private Equity firms typically have a fairly rigid seniority structure with big differences in
experience level and responsibilities from top to bottom. In general the senior-most professionals are responsible for
deal sourcing, relationship management, and investment decision making, while the junior-most professionals carry
the brunt of the analytical workload. However, unlike investment banks, Private Equity firms tend to employ a fairly
flat hierarchy structure with fewer layers. This is, at least in part, because Private Equity firms tend to be much smaller
than investment banking divisions at major banks. As a result, junior professionals will tend to have much more
interaction with senior professionals, fostering much more opportunity to work directly with and learn directly from
the most seasoned professionals in the firm.
Here is a brief description of the primary roles in the Private Equity firm hierarchy:
ASSOCIATE: Pre-MBA associates are typically the most junior professionals at the majority of PE firms. The
associate handles most of the financial modeling and initial due diligence for investment opportunities, while assisting
with the management and monitoring of portfolio companies as well as sourcing deals and supporting transactions.
More day-to-day details on the associate’s role are provided later in this guide.
A majority of Pre-MBA associates (especially in the US) are hired for a two-year to three-year program. At the
completion of the program, associates are typically expected to attend a top-tier MBA program. Smaller firms will often
promote associates to senior associates, and those firms in general tend to provide more opportunities for internal
promotions to more senior roles. Such firms include TA Associates and Summit Partners. On the flip side, large LBO
firms generally have a more regimented hierarchy and firm structure where the roles are more defined for associates,
and where there are limited internal promotion opportunities and limited opportunities to get involved in deal
sourcing. Some private equity firms do recruit for private equity analysts out of undergraduate school, although this is
uncommon. Most PE hierarchies start at the Pre-MBA associate level, and associates will usually have 2-3 years of
prior experience in investment banking or (sometimes) strategy consulting. Firms that do hire analysts straight out of
college will offer those analysts roles similar to those of the associates, but the analysts will tend to focus more on
logistical tasks, such as participating in conference calls, reviewing data and legal documents, and supporting the
associate and vice president with internal investment materials.
VICE PRESIDENT/PRINCIPAL: Vice presidents and principals typically manage the daily responsibilities of the
deal teams and work closely with the senior partners of the firm on strategy and negotiations. Professionals in these
roles are also expected to generate investment opportunities and potential acquisition ideas. Compensation for a VP or
principal varies depending on the size of the PE firm. PE firms will almost always offer some amount of carried interest
in the fund to employees at this level.
VPs/Principals manage internal due diligence streams by themselves and have a large role in negotiations. They
typically have an MBA degree from a top-tier business school, and one of their main responsibilities is to source
investment opportunities by cultivating and maintaining relationships with investment bankers, consultants, and
others. VPs/Principals also usually manage the pre-MBA associates and often play a large role in the negotiation aspect
of the transaction process.
MANAGING DIRECTOR/PARTNER: Managing directors and partners are the most senior members of the firm
and are the ultimate decision makers. They interact directly with the management of portfolio companies, target
companies, and investment banks, they conduct negotiations, they source deals, and they deal routinely with the PE
firm’s Investment Committee. A typical managing director receives significant compensation in terms of carried
interest in the PE fund(s).
20 ©2013 Street of Walls
Typical Private Equity Career Path
A typical career path for pre-MBA and post-MBA Private Equity professionals is illustrated below.
Undergraduate School (Pre-MBA Candidates)
Graduate School (Post-MBA Candidates)
Summer Analyst in a top-tier investment banking or consulting program
Summer Associate in a top-tier investment banking,
private equity or consulting program
Full-time Analyst program in investment banking or consulting
(2-3 yr)
Post-MBA Senior Associate
(2-3 yrs)
Graduate School (MBA)
Pre-MBA Associate
(2-3 yrs)
Vice President
(3-4 yrs)
PE or Investment Banking
Summer Associate
Direct promote to Senior Associate
(2-3 yrs)
Director / Partner
Post-MBA Associate
(2-3 yrs)
Vice President
(3-4 yrs)
Vice President
(3-4 yrs)
Director / Partner
Director / Partner
Typical Day of a Pre-MBA Investment Associate
Private equity is an extremely complex business, and an associate’s daily responsibilities vary tremendously depending
upon the firm the associate works for as well as what stage of the deal process the associate is currently working on.
That said, one can paint a fairly broad picture about what an associate’s responsibilities look like overall. Here is a
timeline for a “typical workday” for you as a private equity associate:
8:00 a.m.: On the way into the office, you read various news sources, such as the Wall Street Journal or Investor’s
Business Daily, and check emails that you received the previous night and this morning to make sure you are prepared
to take care of any pressing tasks as early as possible.
8:30 a.m.: You arrive at the office and go through any unaddressed emails. For example, you might see that you have
received an investment teaser from a boutique investment bank on a potential sale of a retail chain. Given that you
focus on consumer products and that this opportunity fits your fund’s investment criteria, you decide to share the idea
with a vice president in your investment area to discuss whether the opportunity is attractive and worth pursuing for
further consideration.
9:00 a.m.: You pull up an LBO model template for a different investment opportunity and input a new base-case
scenario that a senior member of the investment team would like to review this morning. You have been working on
this investment opportunity for the last several weeks and are getting ready to submit a Letter of Intent (First Round
Bid) to possibly acquire the relevant business.
11:00 a.m.: You make phone calls to various contacts on the buy-side and on the sell-side to catch up on any news
that came out that morning and discuss any new events occurring in the industry or sector you cover.
12:00 p.m.: You catch up over lunch with a former colleague that works at a private equity firm where your firm
occasionally co-invests.
21 ©2013 Street of Walls
1:00 p.m.: You send the updated LBO model to the senior member and meet in his office to discuss your assumptions
and the feasibility of the scenario. You notice that the IRR could be optimized using a different debt instrument, and
you go back to your office to update.
3:00 p.m.: Given that you received that investment teaser in the morning, you decide to look for relevant sector and
comparable company research reports to get a better sense of the available opportunity according to market conditions
and research conducted by others.
4:00 p.m.: You receive an email containing the monthly profit & loss (“P&L”) of a portfolio company you are partly
responsible for monitoring. You open up the financial model for the company and update the numbers in the model to
reflect the actual results you just received and then send the model to the senior member of your investment team who
also is responsible for the monitoring of that company.
6:00 p.m.: At the end of the business day, you receive a financial due diligence report for a potential investment that
has been approved by your Investment Committee to pursue further into the diligence process. You go through the
report and then summarize the findings in an internal memorandum that you have been putting together in
preparation for final Investment Committee approval process.
8:30 p.m.: You complete the memorandum and decide to call it a day, have dinner, and go to the gym for a quick
workout before heading home.
22 ©2013 Street of Walls
Chapter 6: Private Equity Resume
Most people believe they have a good private equity resume and many do. However, PE firms in general are looking for
very particular content, format, and style. In the following pages, the Street of Walls team will provide tips on how to
build the perfect resume for applying to positions with buy-side firms.
In general, PE employers are looking for people who can deliver a superior final product, handle the stress associated
with the job, maintain complete attention to detail, and be able to formulate a cogent investment thesis all at the same
time. In order to convey this, you must be sure that your resume is as crisp and as sharp as you are. Recruiters and
employers will spend about 30 seconds or less reviewing your resume, so first impressions is crucial and the correct
format is critical.
For starters, a good PE resume is similar to an investment banking resume. Thus anyone who has applied to and
obtained an investment banking position can use his or her resume from that interview process as a solid starting point.
The resume should look professional and clean without typos. It needs to be formatted well and include strong
credentials and, where possible, a glimpse into your personality. Making the slightest grammatical error or missing any
aspect of the correct format is a fairly likely way to get your resume rejected at the outset. In the discussion that follows,
we will provide guidance on what to include in terms of the behavioral and technical aspects of your resume.
Behavioral Aspects of your Resume
In order to build the perfect private equity resume, you must first understand what characteristics private equity firms
are looking for. Below we list a few traits that must stand out from your resume in order for you to be well positioned
to receive PE interviews. Ideal PE candidates will have the following characteristics:
Strong quantitative/analytical skills: This is a critical component of a PE resume and fundamental to success. Expect
to get tested for analytics in your interview. Have you:
Filtered through data and assumptions, and identified reasonable responses to complex problems?
Synthesized large amounts of information and identified issues?
Identified an important problem and taken a proactive approach to solving it?
Done well in academic courses and previous experience, demonstrating skill with heavy analytical and
quantitative content?
Performed experiments that required the formulation of a hypothesis and collection of evidence to prove or
disprove it?
Drive for exceptional results: Firms want to know whether you have the initiative, motivation, attention to detail, and
energy to deliver strong results. Start tracking and measuring your achievements. When you interview, you’ll need to
discuss your accomplishments in detail. Have you:
Brought new customers and revenue into your company?
Proven yourself as a self-starter who goes above and beyond requirements?
Shown the ability to switch priorities and move quickly among different tasks?
Set a challenging goal and achieved it?
Attended to the important details across multiple tasks while juggling them (that is, you prioritized effectively
and didn’t let important things fall through the cracks)?
Taken an innovative and efficient approach to get something done?
Strong communication skills: The ability to write and speak well suggests that you’ll be successful working with clients
and colleagues. Have you:
Interacted with clients and/or senior investment bankers during a live deal?
Written successful papers, memos, and/or speeches?
Worked effectively with clients to understand their needs?
Articulated ideas in a clear and coherent manner?
Presented in front of classes, teams, and/or organizations?
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Seasoned teamwork skills: Teaming up with clients and peers is a crucial task. PE professionals work in teams and it
will be critical that you can work effectively among teams of all types of professionals, both internally and externally.
Have you:
Been a member of a sports team, study group, or committee?
Worked effectively with people/teams in past work experience?
Inspired others to take action in an unstructured situation?
Technical Aspects of your Resume
Since Pre-MBA private equity associate candidates have limited work experience (most likely only a few years after
college), one major differentiator in resumes is how one highlights his or her work experience on his or her resume.
Recruiters and employers want to understand what kind of relevant experience you’ve obtained, and why you are
qualified to become a private equity associate. Cater your experiences to what you might do as a private equity
investment associate. Insert key details about your in-depth research, modeling experience, responsibilities within deal
teams, and type of material you presented to your company or clients. Include the details of the transactions you
worked on and what kind of results you helped with, in specific detail. Give examples of what you learned and what you
accomplished. If you had any special networking experiences or interactions with management, include that as well.
In addition, be very clear and concise regarding the type of experience you have had—product type and/or industry
focus in particular. (“Product type” refers to the type of financial instruments you have experience working with during
investment banking transactions or other financial services job responsibilities. Main categories include M&A, Debt,
Equity, Fixed Income, and Derivatives. “Industry focus” refers to the types of companies/industries that you are
familiar with.) Thus, for example, if you are applying to a healthcare private equity position, it will increase your
chances of landing an interview if you illustrate that you have prior experience working at a research lab in college or
interning at a healthcare-focused consulting group during the academic school year. Obviously, healthcare investment
banking is going to be a huge plus for your candidacy at that firm, so be sure to highlight the experience you’ve
garnered in that role thoroughly and clearly.
We have provided below some example descriptions that current private equity associates have used on their resume.
Note that many of these examples are specific to experience gained in investment banking roles. For applicants coming
from a different background, such as management/strategy consulting, try to tailor your description of your
experiences to convey your aptitude for the private equity role you are seeking. In other words, strive to make it clear
how your experience can be beneficial to you as a private equity associate.
Example investment banking analyst role descriptions on successful resumes include:
Performed pro forma merger consequences, public and acquisition comparables, discounted cash flow
analysis, and accretion/dilution analysis
Performed strategic financial alternatives analyses through merger consequences (accretion/dilution),
leveraged buyout, discounted cash-flow, sum-of-parts and public trading and acquisition comparables
Completed quantitative and qualitative analyses across the industrials sector
Explored optimal capital structure considerations involving equity-linked, high grade and high yield debt
products
Designed comprehensive financial models to evaluate strategic options for clients including leveraged buyouts,
mergers and acquisitions, initial public offerings, restructurings, and other financing alternatives
Performed financial valuation analysis through the use of discounted cash flow, trading comparables,
precedent transaction comparables, and leveraged buyout methodologies
Exposure to multiple product areas, including M&A, Fixed Income and Equity, as well as various industries,
including Biotechnology, Medical Technology, Specialty Pharmaceuticals, Healthcare Services and Consumer
Products
Performed in-depth financial and operational due diligence on client companies. Analyzed market trends,
competition, and potential strategic partners using information obtained from multiple data sources
Prepared materials for equity offering and financial advisory presentations, confidential selling
memorandums, and internal presentations. Analyzed comparable company and M&A transactions for
valuation purposes
Constructed detailed merger valuation models for both public and private consumer companies
Received top-tier ranking in first-year analyst class
24 ©2013 Street of Walls
Develop financial models for leveraged buyouts, mergers/acquisitions, initial public offerings, purchase price
ratio analysis, credit analysis and debt/equity financings
Conduct financial analysis using discounted cash flow, precedent transactions and comparable companies
analyses
Relevant transaction experience across the retail, consumer, industrial and communications/media sectors
Maintained comprehensive internal databases of current auction processes and precedent transactions in the
market
Helped lead and coordinate Harvard College undergraduate recruiting for the bank as a recruiting team
captain
Participate in all stages of equity, debt and mergers & acquisitions transactions, including the development of
financial models, due diligence sessions, the drafting of committee memos and sales memos, and board
presentations
Examples of effective, detailed transaction experience descriptions include:
Authored an internal marketing memorandum, assisted with the development of a roadshow presentation, and
participated in the roadshow for a $77 million IPO for a consumer retail company
Performed an equity valuation by analyzing comparable public companies and building a pro forma financial
model for a $500 million IPO pitch in the cloud-computing industry
Advised Company X on $2.5 billion acquisition of Company Y (Closed December 2010)
Constructed a financial model assessing the pro forma merger effects and potential returns on invested capital
from a proposed acquisition
Attended client meetings to help determine modeling assumptions and synergy potential
Conducted detailed due diligence sessions for business, financial, and accounting areas of the target company
Lead advisor to client for evaluating strategic alternatives in its division
Interacted directly with client’s corporate development team and actuaries to determine modeling assumptions
Conducted due diligence sessions detailing business, financial, and accounting considerations across the PBM
industry
Constructed model providing the company pro forma analysis for four potential acquirers with detailed
sensitivity tables and charts
Developed financial model providing pro forma merger analysis after immediate divestiture of a segment of
target’s business
Conducted due diligence on potential litigation liability and its implications on valuation
Determined appropriate value of target’s pipeline product assets by analyzing possible market opportunities,
peak sales scenarios, possible clinical trial outcomes and pro forma revenue and operating synergies
Lead advisor to Welsh, Carson, Anderson & Stowe evaluating timing of its IPO, size of secondary share offering
and other strategic alternatives (including outright sale of the company)
Developed bid strategy to best accommodate client’s message and needs
Worked directly with client’s CFO and Treasurer to develop accretion/dilution model, determine value drivers
in merger model, and display pro forma impact of acquisitions in board and investor presentations
Prepared extensive due diligence materials and assisted with drafting of credit approval memos, rating agency
presentations, roadshow presentation, fairness opinion, and prospectus supplement
Prepared due diligence materials, client presentations, and comparison of sponsor and management model
assumptions
Developed recapitalization model and performed in-depth analysis of company’s operating model drivers
Drafted rating agency presentation, Confidential Information Memorandum, and due diligence organization
materials
Created dynamic stand-alone operating model and company teaser for socialization process with potential
buyers
Performed benchmarking sales force analysis and precedent transactions analysis
Created a dynamic LBO financial model with various financing scenario optionality and valuation methods
Arranged lender’s presentations to market key investment highlights and coordinated bank meeting for
investors
Provided marketing and execution advisory services for financial sponsors and company management
Lead analyst on the largest-ever oilfield services transaction, working directly with the Head of Business
Development for the acquiring company
Delivered fairness opinion to X: Performed discounted cash flows and comparable companies analyses
Modeled “put” and “call” scenarios where X would sell or purchase the remainder of its joint venture with
Partner Y
25 ©2013 Street of Walls
Performed ability-to-pay, precedent transactions, future stock price and detailed synergies analyses
Negotiated a collar purchase mechanism that eliminated downside price risk but allowed the seller to share in
some potential upside
Drafted the Confidential Information Memorandum and management presentation for prospective buyers
Coordinated due diligence process with management, prepared materials with company CFO, and managed a
virtual dataroom
Designed a fully-integrated 3-statement model to analyze restructuring scenarios including delayed
equitization constructs, amend & extend scenarios, various capital raise possibilities, divestitures of select
business operations, and potential joint ventures
Analyzed dynamics of physical media replication and distribution industry and its effects on sell-side
opportunities
Drafted materials for Fairness Opinion including an extensive debt and equity valuation for presentation to X's
Board of Directors and bank’s internal Fairness Committee in advance of potential CBCA Plan of Arrangement
Created operating model and detailed valuation model for 1) target's print and digital business components
and 2) buyout of minority stake and equity control option in target's ownership of an online dealer
Conducted due diligence to adapt model assumptions and validate performance outlook and transaction
rationale for a potential acquirer
Analyzed and recommended two transformative strategic alternatives for a client including partial stake sale in
its $25bn+ cable business and ~$4bn LBO of its auction business, both in potential conjunction with a
proposed dividend recapitalization
Modeled various capitalization structures based on lender negotiations to recommend optimal financing
alternatives
Positioned resiliency of radio and growth prospects of outdoor businesses in lender and rating agency
presentations
Articulated the company’s ability to navigate a capital structure with ~8.0x secured leverage, 11.5x total
leverage, and $1.8bn of Adjusted EBITDA by crafting detailed client presentations and coordinating a
nationwide, 7-day roadshow
Private Equity Resume Template
You might have seen thousands of investment banking resume examples and dozens (or more) of private equity
applicant resumes, but only one will work consistently for major players in the Private Equity space. This point cannot
be emphasized enough. Private Equity has a strongly conservative cultural and professional heritage, and if you want to
work in that field, you should adapt your resume accordingly. Whether you are an investment banking analyst, a
management consultant, an employee in industry, or an MBA student, it is critical that your private equity resume
matches the expected format. Below is an example of the formatting style you should use—try to match it on your
resume as closely as you can.
26 ©2013 Street of Walls
In addition to formatting, keep in mind that your resume must absolutely be error-free, as we have discussed. You can
also go wrong by providing insufficient explanations of your experience thus far—inaccurate descriptions, vague
phrasing, too much boilerplate text and not enough substance. In our experience, poor resumes for qualified private
equity job candidates will typically fall into one of two categories:
Poor Resume Template: Candidate possesses relevant work experience and describes his or her experience
well, but the resume is not formatted according to basic, boilerplate formatting guidelines.
Poor Resume Writing: Candidate follows a proper formatting template but does a poor job of communicating
important details effectively, or lacks enthusiasm, or has made grammatical or typographical errors.
Hopefully these tips will help you! If you feel you still need more help, feel free to check out Street of Walls’ Private
Equity Resume Builder, where we will work with you to build a resume that you will be proud of and will help get you
in the door to your new career in private equity.
Final Edits
Investment bankers and private equity professionals are known to be able to spot errors in the Wall Street Journal or
advertisements in seconds. That is because they are trained to spot any grammatical or formatting error quickly in any
document they create—they spend countless hours creating materials for pitch books, and those materials must be
error-free! A careless mistake can significantly change the viability of an investment, which can dramatically change
estimated IRR calculations. Private equity professionals could spend days or weeks putting together an operating
model with IRR returns analyses, and one mistake in the revenue growth can significantly affect the expected returns.
Once you have finished and are sure it is perfect, put it in a drawer for a day or two and then take a fresh look. Then
have two or three other people look it over as well. Of course, check for grammar, spelling, and punctuation, but also
look carefully for formatting. Be sure that headings are in the same type of font. If you bold print one date, bold print
them all. Check for random indentations and auto-corrected errors, especially incorrect capital letters after periods
following abbreviations. It seems like such a little thing, but you want to prove you are someone who pays attention to
detail. You won’t get a second chance if your resume has careless errors.
Once you have perfected your resume, you are ready to start applying for private equity opportunities. Good luck!
27 ©2013 Street of Walls
Chapter 7: Private Equity Interview
Private Equity Recruiting Process
The lion’s share of the recruiting process for pre-MBA private equity associates truly begins in the first year of standard
investment banking and consulting analyst programs. This may surprise some people, but the recruiting cycle is very
structured, even though it can start at a moment’s notice (depending upon when the leading firms in the space begin
their process). Prospective private equity candidates must be ready for the process early in their investment banking
analyst programs in order to be successful in landing a private equity job. That said, recruiting for some other PE jobs
will take place year-round. Thus if you happen to miss the main recruiting process for PE jobs, you’re a leg down, but
not out. You may still be able to find available opportunities. This chapter will detail this timeline more thoroughly.
The pre-MBA recruiting process for PE positions is truly unique. After banking, exiting to a position as a private equity
associate is very prestigious, and PE firms want to make sure that they don’t miss the most qualified applicants. You’ll
need to be prepared for the process to start at any time. Once one of the leading PE firms begins its search for the
incoming associate class for its firm, the rest of the firms will generally start recruiting directly afterward. For the
majority of the firms, the entire recruiting process will be finished within several months once the leading firms start
recruiting.
This “leader and followers” pre-MBA recruiting process is primarily driven by the “megafunds” (KKR, TPG, Blackstone,
etc.). When they decide to start the recruiting process, most of the other large PE firms, with associate classes ranging
from 8-15 professionals per year, will then launch their processes right away. The middle market/smaller PE firms will
typically follow shortly after that.
Note that venture capital firms and smaller private equity firms will typically recruit outside of this standard recruiting
cycle, and thus the notes above about the process tend not to apply to them. That said, overall most hiring for next
year’s summer start dates will be completed by July or August—nearly a full year in advance!
The competition for these jobs is very tough. You’re going to be up against a large pool of talented, driven investment
bankers, and will be working against a tight timeline. Therefore it’s very important that you plan out your process well
ahead of time.
Even before the official private equity process begins, the initial step for pre-MBA recruits is to meet with headhunters.
They are essentially the “gatekeepers” for the interviews with most firms. Headhunters will contact a pre-MBA
candidate in the first year of his/her analyst program (up to three months in advance of the start of the recruiting
season).
For post-MBA candidates, note that the recruiting process is a bit different. These candidates can rely a bit more
heavily on their graduate schools’ career centers, since most PE firms will go directly to MBA program candidates to
begin recruiting them. In this respect, post-MBA recruiting is more predictable and standard, as it conforms to the
overall MBA student recruiting timeline.
The typical recruiting cycles for pre-MBA and post-MBA associate positions are illustrated below:
28 ©2013 Street of Walls
PE Firm
Pre-MBA
Associate
Position
Post-MBA
Associate
Position
Recruiting Process
Size
Stage
Begin Interviewing
Give Offer
Large
Established successful
track record
Winter of 1st Yr or
Early July of 2nd Yr
Few months after
beginning process
Mid
Early-mid successful
track record
Winter of 1st Yr or
Early July of 2nd Yr
Few months after
beginning process
Small
Early stage; Proving
track record
January - April
April - June
Large
Established successful
track record
September
October - November
Mid
Early-mid successful
track record
November - December
February - March
Small
Early stage; Proving
track record
November - December
February - May
Other Comments
Depending on need,
may hire year round;
Start date is July timeframe
Start date for full-time and
summer position starts in
June-July timeframe.
For pre-MBA candidates, after the headhunter interview the candidates go on to meet with the private equity firms
directly. The overall process is a lot faster and more intense than investment banking. Candidates in this process truly
need to be prepared for anything and everything. The recruiting process can be over very rapidly! A specific firm’s
interview process can range from days to weeks, depending on the market conditions, how many firms are recruiting at
the same time, and how quickly the firm in question finds prospective associates it wants to hire and who want to work
for them.
Some investment banking analysts recruiting for PE firm jobs have encountered first-round interviews called “superdays,” where they meet with 8-10 people in one day and receive full-time offers at the end of the day. If this occurs, the
PE firm will expect the candidate to accept (or reject) the offer within a few days! In other cases, the process is a bit
slower, with several rounds of interviews spread out over a couple of weeks.
The traditional components of a private equity recruiting process include the standard behavioral and technical
interviews conducted by junior PE associates—this part of the process is similar to investment banking recruiting.
Where the process differs is in two primary places: the testing for investing acumen, and the testing for superior and
LBO-specific technical ability.
Testing for investing acumen can come in the form of a broad 20-minute, consulting-like case study, or a detailed 3-5
hour investing exercise wherein the candidate has to research a company, go through the company’s filings, and write
an investment memo on the sample target company. Unlike in a hedge fund recruiting process, PE associate candidates
will very rarely be asked to pitch an investment idea. Instead, they may be asked what characteristics they would look
for in a good LBO candidate.
LBO-specific technical ability screenings can come in the form of a financial modeling test, such as a paper LBO (in
which the candidate must do LBO math in his/her head or on a piece of paper), or in a several-hour modeling test
wherein the candidate has access to a computer and Microsoft Excel. Different firms like to administer this portion of
the interview process differently, so for example, some will have modeling tests at the beginning of their process, while
others may have it as the last stage of the process.
Therefore, you need to be prepared for every possibility if you hope to maximize your chance of landing a private equity
associate position successfully. That said, don’t be afraid. The following sections and chapters in this guide will help
you navigate the recruiting cycle and also help to prepare you for the modeling tests.
Initial Preparations: Before Headhunter Recruiting Starts
Given the short timeframe of the recruiting process, investment banking and consulting analysts need to be as
prepared as possible for the process to start. In addition, no one knows exactly when the recruiting process is going to
start until it does!
29 ©2013 Street of Walls
The first thing to do, then, is to make sure you’re interested in private equity. If so, make sure you understand the
industry thoroughly, and know what the firms in the industry are going to be looking for in a good candidate.
The key thing that private equity firms look for is that the candidate is skilled at thinking like an investor rather than
just being capable of performing the tasks needed for deal execution, which would mean being skilled at operating like
an investment banker. Remember, private equity involves making successful investments rather than cranking out
many transaction closings. For the banker, the firm’s revenue and profit are not affected by the post-transaction
performance of the clients. In private equity, the firm’s success is heavily dependent upon how the client/target
performs after the transaction is completed. Therefore, a successful PE associate will need to be able to help his
colleagues make successful transaction decisions.
If this does not sound like something you’re interested in doing, then PE is probably not the right destination for you. If
it is, then you will need to know how to best position yourself and market yourself to the interviewer with all of this in
mind. Start thinking like an investor now, if you’re not already doing so—it will pay huge dividends for you when the
PE recruiting process begins.
The technical and behavioral preparation for the interviews is very similar to the preparation for investment banking
interviews, so the preparation process may seem familiar, but remember that the PE recruiting process is much more
intense, and the PE firm is looking for something slightly different than the investment bank is (as discussed above).
To prepare, candidates should follow these simple steps:
Prepare and know your resume inside and out.
Think about the type of private equity fund you plan to target:
o Mega/large fund or middle market fund?
o Investment style (buyout, growth capital, etc.)?
o Culture and lifestyle: Do you prefer small or larger deal teams?
o Geographic location of PE firm or fund: What are your top three preferred city locations?
Think about the focus of the position offered: Generalist vs. industry-focused? Do you prefer to concentrate on
many industries or specifically on one industry?
Use head-hunters/recruiters: Many firms hire exclusively through recruiters even if you have personal
contacts at a particular firm. Schedule screening interviews early with the top recruiters as their capacity for
candidates is limited. Make a good first impression.
Prepare to interview extensively by practicing with others. A typical interview process will last 3 to 5 rounds
(including the headhunter) with most rounds consisting of numerous individual interviews. Because the
competition will be very strong, intense preparation in this phase of the recruiting process will be crucial.
Prepare for detailed analytical questions as well as brainteasers.
o Be able to talk through the stages and return drivers of an LBO model.
o Prepare by reading up on the relevant industry/industries and learning about what opportunities may be
available there, or what transactions are taking place there.
o Modeling tests range from 4-hour computer based tests to “LBO on paper” exams. Be prepared to excel at
all of them.
Private Equity Headhunter Interview
Now that you know how to prepare for the early stages of the PE recruiting process, we’ll discuss what the headhunter
interview entails. Recruiters, or headhunters, play a large role in private equity searches. These recruiting firms source
top candidates for private equity interviews. Traditionally, headhunting recruiters seek out and work with top-ranking
first-year analysts at investment banks and top-tier consulting firms. Recruiters are essentially the “gatekeepers” into
the private equity industry, so candidates need to take these relationships very seriously.
A good headhunter interview can make a tremendous difference in the number of PE interview opportunities a
candidate will be presented with. It is very important for candidates to realize that headhunters are working for their
private equity clients, and will therefore only show candidates that they believe are sufficiently qualified for the client
and fit the firm’s criteria. If you do not come across as highly qualified and a good fit for the client, the number of
opportunities you will be given will certainly suffer as a result.
Headhunters will often reach out to prospective candidates in their first year as analysts, often within 4-6 months of
being on the job, so bankers need to make sure they’re ready early on in their analyst position if they want to do well in
PE recruiting. For those who do not receive phone calls from headhunters, it doesn’t mean you are not desirable; it
30 ©2013 Street of Walls
simply means you may have to reach out to the recruiters yourself. Well-known private equity headhunters that you
can reach out to include SG Partners, GloCap, CPI, Amity Search Partners, Oxbridge Group, and Search One.
With headhunters, you will be put through a mini-interview, which is very important. Most of these headhunter
interviews will consist primarily of behavioral questions, such as:
Walk me through your resume and past deal experience.
What type of investment banking transactions or consulting projects have you worked on?
Do you have excellent financial modeling skills?
Why did you choose your particular college and major?
Why do you want to work at a private equity firm?
What type of private equity investing are you interested in?
What size of fund are you seeking?
Are there any particular firms you are interested in? In terms of geography, what are the three top locations
(cities) in the U.S. to which you would be willing to relocate?
Important! Headhunter Interview Tip: Make sure not to give the recruiter/headhunter any attitude. You are one of
many candidates with whom headhunting firms will be working, and headhunters will have no problem never working
with you again. They need to feel confident about you being a strong candidate, and just as importantly, being
presentable to their own clients. Displaying an attitude of “you will make money off of me” is just not a good way to get
the attention you want. Your attitude should be confident, yet humble, thoughtful and gracious.
Here are a few other important tips:
Know your story: You need to be able to communicate effectively with headhunters. Realistically, you’ll be
giving the same pitch to them as you will give during your private equity interviews. You’ll have to explain
where you’re from, why you chose your college, and why you chose your current job.
Know exactly what you’re looking for: The last thing headhunters want to do is figure out what positions you
fit into. If you’re really interested in private equity, you need to have a reason why, and be able to effectively
communicate your rationale. You need to display your passion for private equity and why they should put you
in front of their clients.
Show your personality: Headhunters meet with dozens of investment bankers every day, so you need to be
able to stand out with your own unique personality. Beyond the actual interview, create small talk with all of
the people you meet at the headhunting firm and be able to talk about more than just finance. They want to
know that you’re personable and someone with whom they could have a casual conversation.
Be prepared to pitch your transaction/work experience inside and out:
o Financials, growth rates, multiples paid, investment theses, and alternative transaction and strategic
opportunities are all things to have a firm grasp on as they relate to transactions you’ve worked on.
o Focus on M&A experience where available, but also know all types of transactions on your resume.
o Headhunters will want to know that you’ve been given a lot of responsibility by your banking superiors.
Practice superior communication: All the headhunters have had experience in some sort of finance, but in
reality they’re more removed from that part of their careers. They are most focused on whether you are
presentable to the client and less focused on the content. So you need to be professional, concise and confident.
Private Equity Interviews
The Behavioral Part of the Interview Process: If the headhunter is comfortable putting you in front of his/her
private equity clients, your resume will be submitted to the PE firm for selection. If selected, you will begin a typical
interview process that will most likely consist of 2 to 4 rounds of interviews. On the first round, the private equity firm
will host numerous 30-minute behavioral interviews to make sure you have the right background, strong
communication skills (for example, to make sure you are capable of engaging appropriately with investment target
companies, portfolio companies, bankers, and consultants), and that you have thoughtful, genuine reasons for
pursuing a private equity career. Make sure at this stage to describe what sets you apart from the other candidates.
That’s how you’ll stick in their memory and stand out from the dozens of other applicants.
Here are some typical, private equity-specific behavioral interview questions:
Why did you choose investment banking/consulting?
31 ©2013 Street of Walls
Why do you want to pursue a career in private equity?
What characteristics do you think are needed to be a successful private equity professional?
How does your experience translate into success in private equity?
Do you currently invest, perhaps via non-work-related investing?
What is the most recent book you have read?
What happened when you worked in a team and one member wasn’t contributing appropriately? How did you
respond?
What do you feel are your greatest strengths? Greatest weaknesses?
Are you risk-averse or risk-seeing? Under what conditions do you seek risk the most and why?
If I asked your senior manager, what would he or she say about you?
Are you interested in [add private equity firm’s industry expertise]?
Where do you see yourself in five years?
Give an example of a time when you demonstrated that you were very driven/committed?
What motivates you?
Why should we hire you?
What is the biggest risk you took in your life?
Firm Structure: You need to be prepared for these firm-specific questions before you interview. These can be generally
answered by viewing publicly available information on the PE firm’s website or through talking with the headhunter.
What is the firm’s or fund’s investment strategy? (e.g. size, geography, industry, type of control,
primary/secondary, minimum operating results, timing)
What would be the potential responsibilities for an associate at the firm? Is sourcing involved? How so?
What is the firm’s hierarchy? Fund investment structure? Investment committee structure?
Is there a path to direct promotion within the firm, or an expectation that associates will pursue an MBA?
Where have past associates gone?
How have the firm’s funds performed historically? What was the typical IRR on previous funds?
What is the firm’s history and what are some key past portfolio experiences for the firm?
The Technical Part of the Interview Process: If you receive a second-round interview, you can expect to reach
the more technical part of the process. Typical private equity firms look to hire pre-MBA and post-MBA associates who
have very strong financial accounting and modeling skills, and an appetite for quantitative analysis and data-driven
decision making. Be prepared for technical questions similar to ones you received in the investment banking interview
process. One major distinction in private equity interviews, though, is that candidates will often have to complete a
financial modeling case study that illustrates his or her proficiency in financing modeling and accounting concepts.
Candidates could be tested on this in a variety of ways, including analyzing a full LBO model, a growth capital case
study, a paper LBO, or a consulting-like case study. A candidate may be handed one sheet of paper that consists of
various assumptions and/or a laptop computer that has a blank excel sheet to build out an investment scenario. These
modeling tests will be detailed later in the guide.
Some sample technical questions include:
Private Equity or LBO-specific questions
What is an LBO?
Walk me through the mechanics of an LBO model.
How do you assess credit risk?
What are the different types of PE firms?
What makes a good LBO investment candidate?
What are the different ways to find the valuation of a company?
How would you spend a million dollars if it were given to you?
Company A has a potential IRR of 23% and Company B has a potential IRR of 30%. What 2 questions would
you ask before you decide which one to invest in?
What are the 4 main drivers of the change in IRR for an LBO scenario?
How do you model in PIK notes?
Walk me through the calculation of Free Cash Flow.
Why would a private equity firm use a convertible preferred note?
How do you calculate amortization of intangible assets?
What are the uses of excess cash flow?
What makes for a good management team?
32 ©2013 Street of Walls
What 3 questions would you ask a CEO of a company you were looking to invest in?
You have two companies with different EV/EBITDA multiples in different industries. What are some reasons
why their EBITDA multiples might be different?
What is the difference between senior and subordinated notes?
What are the key considerations to structuring a carve-out transaction?
How would you decide what amount of leverage to use in building a company’s capital structure?
Financial Statements / Accounting
Company A has depreciation that is overstated by $10 million. Walk me through the impact of this
overstatement on the financial statements.
Tax depreciation is $20 million over 10 years, while financial statement depreciation for the asset is $10
million over 10 years. Walk me through the impact of these differences on the financial statements, assuming a
tax rate of 40%.
Assume that your company bought an asset for $10 million, of which $7 million was financed through debt.
Walk me through the impact of this transaction on the financial statements.
Assume that your company sold an asset for a loss of $10 million (it had originally been bought for $20
million). Walk me through the impact of this transaction on the financial statements.
Your company sells a yearly subscription for $120. Walk me through the impact that this sale has on the
financial statements.
What is the difference between gross revenue and net revenue?
Brainteasers
The New York City subway currently costs $2.50 to ride one way. Pretend that tomorrow, the cost is going to
increase to $3.00. Assuming you can lock in the $2.50 rate in the future by paying for the future rides now,
how many coins would you purchase? What are the key considerations to make?
What is the angle (in degrees) formed by the minute and hour hands on a clock when the time is 3:15?
Sample Questions to Ask
During the PE associate interview process, you will have the opportunity to ask the interviewers a few questions that
will show them how interested you are in working for the firm. The following list provides good examples of questions
to ask to demonstrate this interest.
Examples of questions to ask a junior member of the private equity firm:
Can you elaborate on the typical day-to-day activities and responsibilities for this position?
How did you get interested in private equity?
What did you take into consideration when you chose this firm?
What is one thing you like about working at this firm and what is one thing you thing you would improve about
the firm? (This question shows that you are trying to get more insight into the reality of working at this specific
firm.)
What differentiates a good analyst from a great analyst?
What’s your favorite deal that you’ve worked on at the firm?
Have you completed any transactions while working at the firm?
How is the quality of the investment opportunity sourcing at the firm?
Examples of questions to ask a senior member of the private equity firm:
Can you elaborate on your past successes that led you to this firm?
What are the key characteristics that you expect from an individual that will be selected for this position?
In brief, what are the firm’s long-term goals?
Is there an opportunity for an associate to build his or her career at this firm over the medium to long-term?
What qualities do you have that helped you succeed in private equity?
Why did you choose this career path?
How do you manage work, family, and community involvement?
What part of this job do you find the most rewarding and challenging?
The questions you ask should be selected carefully so that you receive the maximum amount of information about the
job. This information will help you select the right firm for your background and personality. You will want to make
sure you work with a group of people that you can get along with and will enjoy working with as part of the investment
team. You will be spending a lot of time with this group, and making the right choice is critical.
33 ©2013 Street of Walls
Chapter 8: Basics of an LBO Model
During a private equity interview, analyst and associate interview candidates may be asked to build an LBO model at
various stages of the interview process. Therefore, a well-prepared interview candidate must be able to successfully
complete any variation of a LBO model prior to his or her interview process.
Leveraged Buyouts: Basic Overview
A leveraged buyout is the acquisition of a public or private company with a significant amount of borrowed funds. A
private equity firm (or group of private equity firms) acquires a company using debt instruments as the majority of the
purchase price. After the purchase of the company, the debt/equity ratio is generally greater than 1.0x (debt generally
constitutes 50-80% of the purchase price). During the ownership of the company, the company’s cash flow is used to
service and pay down the outstanding debt. The overall return realized by the investors in an LBO is determined by the
exit cash flow of the company (EBIT or EBITDA), the exit multiple (of EBIT or EBITDA), and the amount of debt that
has been paid off over the time horizon of the investment. Companies of all sizes and industries can be targets of
leveraged buyout transactions, although certain types of businesses, as discussed earlier, make better LBO targets than
others.
A sample LBO model given to candidates during interviews can be used to test on a variety of issues:
Determining a fair valuation for a company (including an ability-to-pay analysis)
Determining the equity returns (through IRR calculations) that can be achieved if a company is taken private,
grown, and ultimately sold or taken public
Determining the effect of recapitalizing the company through issuance of debt to replace equity
Determining the debt service limitations of a company from its cash flows
In order to prepare for an LBO modeling test, the first step is to understand the key assumptions and the process.
These are provided in the tables below:
Category
Entry assumptions
Main Assumptions
Earnings metric (P/E or EBITDA)
Entry multiple
Net Debt
Transaction Funding
Debt / Equity funding %
Debt Capital Structure
Debt funding mix
Revolver
Senior Debt
Subordinated / High Yield Debt
Mezzanine / Quasi-Debt
Transaction Expenses
Cash (available, minimum cash)
Sources and Uses
Growth Projections
Exit assumptions
Other
Management model
Exit multiple
Time Horizon
Management roll-over equity
Management incentive option pool
34 ©2013 Street of Walls
Ranges / Factors
Public companies - % premium to stock price (20-50%)
Private companies - LTM EBITDA multiple dependent on precedent
transactions and public comparables
Public companies - Latest financials or management's guidance
Private companies - Assume cash-free, debt-free transaction
Mix ranges from 25%/75% to 45%/55%
Dependent on size of transaction (Growth equity vs. LBO)
and financing markets
Total leverage ranges from 4-7x Total Debt/EBITDA
4-6% floating coupon, 5-7 years to maturity, unfunded at close
5-8% floating coupon, 1% amortization, 5-7 years to maturity
8-12% floating/fixed coupon, no amortization, 6-8 years to maturity
12-15+% fixed coupon, conversion to equity provisions
Ranges from 3-6% of transaction value
Dependent on if a public/private company and normal
level of working capital
Management, Base, upside, and downside scenarios created
Typically same as entry multiple - coupled w/ sensitivities
Dependent on markets, sponsor investment strategy
Dependent on sponsor preference, 30-50% of after-tax proceeds
Ranges from 6-12%, dependent on size/growth of company
LBO Steps
Purchase Price Assumptions
First step is making assumptions on the purchase price, debt interest rate, etc.
Create Sources and Uses
"Sources" lists how the transaction will be financed and "Uses" lists the capital uses.
Financial Projections
Project out the three financial statements (usually 5 years) and determine how much debt is paid down each year.
Balance Sheet Adjustments
Adjust the balance sheet for the new debt and equity.
Exit
Last step is calculating exit value based on a EV/EBITDA multiple on year 5 EBITDA and then subtracting net
debt to get the company's exit equity value.
Calculate Internal Rate of Return (IRR) on Your Initial Investment
Using XIRR excel formula, enter the date of purchase and the equity amount invested in one column and the date
of exit and equity value in second column with respective dates.
"=XIRR(range of dates, range of values)"
In order to correctly complete the test, you must understand the basic assumptions and steps to create an LBO because
most modeling tests will only provide a few of the assumptions you will need. You will need to make other basic
assumptions based on what you know about the private equity firm you’re interviewing with, and use that to create the
model. To make the accurate assumptions, you will have to understand the types of companies the sponsor likes to
invest in and their investment strategy, such as the purchase price, capital structure, growth and margin assumptions,
and exit strategy. Whenever you have to make assumptions that are not given or standard, document the assumptions
that you make and be prepared to defend them.
To prepare for this test, practice creating the different types of LBO tests you may receive from scratch (paper LBOs,
short-form excel LBOs, long-form detailed 3-statement LBOs). This will help you become more familiar with modeling,
but it also will give you a better idea of how an LBO works. For example, one of your goals should be to comprehend
how an investment’s IRR is affected if you adjust the values of key levers such as the purchase price, the amount of
leverage, revenue growth rates, and the exit multiple. This is especially important for investment banking analysts and
consultants who haven’t had a lot of exposure to LBO modeling. The more you practice these tests, the more prepared
you’ll be, so spend as much time on this as you can.
In the following chapters, we will walk through variations of an LBO modeling test and case study.
35 ©2013 Street of Walls
Chapter 9: Paper LBO Model Example
An illustrative example of a paper LBO is provided below in 5 simple steps. In a paper LBO exercise, you will be
expected to complete the important components of a working LBO model with the use of paper and pencil and without
the use of a computer.
Given LBO Parameters and Assumptions
XYZ Private Equity Partners purchases ABC Target Company for 5.0x Forward 12 months (FTM) EBITDA at
the end of Year 0.
The debt-to-equity ratio for the LBO acquisition will be 60:40.
Assume the weighted average interest rate on debt to be 10%.
ABC expects to reach $100 million in sales revenue with an EBITDA margin of 40% in Year 1.
Revenue is expected to increase by 10% year-over-year (y-o-y).
EBITDA margins are expected to remain flat during the term of the investment.
Capital expenditures are expected to equal 15% of sales each year.
Operating working capital is expected to increase by $5 million each year.
Depreciation is expected to equal $20 million each year.
Assume a constant tax rate of 40%.
XYZ exits the target investment after Year 5 at the same EBITDA multiple used at entry (5.0x FTM EBITDA).
Assume all debt pay-down occurs at the moment of sale at the end of Year 5 (this eliminates the
iterative/circular dependency between debt pay-down/cash balances and interest expense in a computer-based
LBO model).
1.
Calculate the purchase price of ABC.
Using a 5.0x entry multiple, calculate the price paid by multiplying by Year 1 EBITDA. $40 million in
EBITDA (which represents a 40% EBITDA margin on $100 million in revenue) multiplied by 5. The purchase
price is $200 million.
2. Calculate the debt and equity funding amounts used for the purchase price.
The given information assumes debt to equity ratio of 60:40 for the purchase price.
Debt portion = 60% × $200 million, or $120 million.
Equity portion = 40% × $200 million, or $80 million.
Entry Assumptions
Entry multiple
EBITDA (Year 1)
Price paid
5.0x
$40
$200
Debt
Equity
Total
$120
80
$200
60%
40%
100%
3. Build the Income Statement.
Year
($ in millions)
Sales revenue
EBITDA
Less: D&A
EBIT
Less: Interest expense
EBT
Less: Taxes
EBT (Tax-effected)
36 ©2013 Street of Walls
1
2
3
4
5
6
$100
40
(20)
20
(12)
8
(3)
$5
$110
44
(20)
24
(12)
12
(5)
$7
$121
48
(20)
28
(12)
16
(7)
$10
$133
53
(20)
33
(12)
21
(8)
$13
$146
59
(20)
39
(12)
27
(11)
$16
$161
64
(20)
44
(12)
32
(13)
$19
(Notice that, because the exit value at the end of Year 5 will be based on a forward EBITDA multiple, we must
calculate six year’s worth of income statement, not 5. Also note that the numbers might not agree perfectly
because of rounding. It is reasonable to round your intermediate calculations to the nearest integer in carrying
over calculations to the next step.)
a.
Project revenue: Revenue is expected to grow 10% annually.
$100 million Year 1 sales × (1 + 10% growth rate) = $110 million sales in Year 2.
$110 million Year 2 sales × (1 + 10% growth rate) = $121 million sales in Year 3.
$121 million Year 3 sales × (1 + 10% growth rate) = $133.1 million sales in Year 4.
$133 million Year 4 sales × (1 + 10% growth rate) = $146.3 million sales in Year 5.
$146 million Year 5 sales × (1 + 10% growth rate) = $160.6 million sales in Year 6.
b. Use EBITDA margin to calculate EBITDA.
$100 million Year 1 sales × 40% EBITDA margin = $40 million Year 1 EBITDA.
$110 million Year 2 sales × 40% EBITDA margin = $44 million Year 2 EBITDA.
$121 million Year 3 sales × 40% EBITDA margin = $48 million Year 3 EBITDA.
$133 million Year 4 sales × 40% EBITDA margin = $53 million Year 4 EBITDA.
$146 million Year 5 sales × 40% EBITDA margin = $59 million Year 5 EBITDA.
$161 million Year 6 sales × 40% EBITDA margin = $64 million Year 6 EBITDA.
c.
Subtract Depreciation & Amortization (D&A) to get EBIT.
$40 million Year 1 EBITDA – $20 million D&A = $20 million Year 1 EBIT. (etc. for Years 2-6)
d. Calculate interest expense using the debt amount used for purchase multiplied by the interest rate to
calculate the yearly interest expense line item.
$120 million of debt × 10% interest rate = $12 million interest expense per year.
e.
Calculate Earnings Before Tax (EBT).
$20 million Year 1 EBIT – $12 million int. exp. = $8 million Year 1 EBT. (etc. for Years 2-6)
f.
Subtract taxes using the tax rate to get to tax-effected EBT (a proxy for Net Income).
$8 million Year 1 EBT × 40% tax rate = $3 million taxes, so $5 million Year 1 t/e EBT.
$12 million Year 2 EBT × 40% tax rate = $5 million taxes, so $7 million Year 2 t/e EBT.
$16 million Year 3 EBT × 40% tax rate = $6 million taxes, so $10 million Year 3 t/e EBT.
$21 million Year 4 EBT × 40% tax rate = $8 million taxes, so $13 million Year 4 t/e EBT.
$27 million Year 5 EBT × 40% tax rate = $11 million taxes, so $16 million Year 5 t/e EBT.
$32 million Year 6 EBT × 40% tax rate = $13 million taxes, so $19 million Year 6 t/e EBT.
4. Calculate cumulative levered free cash flow (FCF).
Year
($ in millions)
EBT (Tax-effected)
Plus: D&A (non-cash expense)
Less: capital expenditures
Less: Increase in net working capital
Free cash flow (FCF)
a.
1
2
$5
20
(15)
(5)
$5
$7
20
(17)
(5)
$6
3
4
5
$10
20
(18)
(5)
$7
$13
20
(20)
(5)
$8
$16
20
(22)
(5)
$9
Start with EBT (Tax-effected) and then add back non-cash expenses (D&A).
37 ©2013 Street of Walls
6
$5 million Year 1 tax-effected EBT + $20 million D&A.
b. Subtract capital expenditures (Capex).
(NOTE: We do not need Year 6 capital expenditures, or Free Cash Flow for that matter, because EBITDA
does not incorporate capex and because only FCF in Years 1-5 can be used to pay down debt.)
$100 million Year 1 sales × 15% capex/sales = $15 million Year 1 capital expenditures.
$110 million Year 2 sales × 15% capex/sales = $17 million Year 2 capital expenditures.
$121 million Year 3 sales × 15% capex/sales = $18 million Year 3 capital expenditures.
$133 million Year 4 sales × 15% capex/sales = $20 million Year 4 capital expenditures.
$146 million Year 5 sales × 15% capex/sales = $22 million Year 5 capital expenditures.
c.
Subtract the annual increase in operating working capital to get to Free Cash Flow (FCF).
$5mm Y1 t/a EBT + $20mm D&A – $15mm Y1 capex –
$7mm Y1 t/a EBT + $20mm D&A – $17mm Y2 capex –
$10mm Y1 t/a EBT + $20mm D&A – $18mm Y3 capex –
$13mm Y1 t/a EBT + $20mm D&A – $20mm Y4 capex –
$16mm Y1 t/a EBT + $20mm D&A – $22mm Y5 capex –
$5mm
$6mm
$7mm
$8mm
$9mm
Year
Year
Year
Year
Year
1
2
3
4
5
FCF.
FCF.
FCF.
FCF.
FCF.
d. Calculate Cumulative Free Cash Flow during the life of the LBO.
Cumulative FCF until exit equals total debt pay-down, if it is assumed that 100% of FCF is used to pay
down debt. (This is a standard assumption for a basic LBO model.)
$5 mm Year 1 FCF + $5 mm Year 2 FCF + $7 mm Year 3 FCF + $8 mm Year 4 FCF +
$9 mm Year 5 FCF = $34 mm Cumulative FCF.
5.
Calculate Ending Purchase Price (Exit Value) and Returns
a.
Calculate Total Enterprise Value (TEV) at Exit.
Take Forward EBITDA at exit (Year 6 EBITDA) along with a 5.0x exit multiple to calculate Exit TEV. $64
million Year 6 EBITDA × 5.0x multiple = $320 million Enterprise Value at Exit.
b. Calculate Net Debt at Exit (also known as Ending Debt).
Beginning Debt – Debt Pay-down = Ending Debt.
$120 million in Beginning Debt – $34 million in Cumulative FCF = $86 million in Ending Debt.
c.
Calculate ending Equity Value (EV) by subtracting Ending Debt from Exit TEV.
$320 Exit TEV – $86 million Ending Debt = $234 million Ending EV.
d. Calculate the Multiple-of-Money (MoM) EV return (Ending EV ÷ Beginning EV).
$234 million Ending EV ÷ $80 Beginning EV = 2.93x MoM.
e.
Estimate IRR based on the MoM multiple.
The following table is useful for estimating IRR based upon 5-year MoM multiples:
2.0x MoM over 5 years
2.5x MoM over 5 years
3.0x MoM over 5 years
3.7x MoM over 5 years
~15% IRR
~20% IRR
~25% IRR
~30% IRR
Therefore, we can assume that the implied IRR for the paper LBO case study is approximately 25%, or
slightly below. (It is actually very close to 24%.)
38 ©2013 Street of Walls
The following is the full paper LBO case study exhibit, calculated using Excel rather than pen and paper. As a result,
some of the numbers might be slightly different, as rounding has been eliminated:
Year
($ in millions)
Sales revenue
EBITDA
Less: D&A
EBIT
Less: Interest expense
EBT
Less: Taxes
EBT (Tax-effected)
EBT (Tax-effected)
Plus: D&A (non-cash expense)
Less: capital expenditures
Less: Increase in net working capital
Free cash flow (FCF)
Revenue Growth
EBITDA Margin
Tax rate
Capex
1
2
3
4
5
6
$100
40
(20)
20
(12)
8
(3)
$5
$110
44
(20)
24
(12)
12
(5)
$7
$121
48
(20)
28
(12)
16
(7)
$10
$133
53
(20)
33
(12)
21
(8)
$13
$146
59
(20)
39
(12)
27
(11)
$16
$161
64
(20)
44
(12)
32
(13)
$19
$5
20
(15)
(5)
$5
$7
20
(17)
(5)
$6
$10
20
(18)
(5)
$7
$13
20
(20)
(5)
$8
$16
20
(22)
(5)
$9
40%
40%
15%
Entry Assumptions
Entry multiple
EBITDA (Year 1)
Price paid
Interest rate
5.0x
$40
$200
10%
Debt
Equity
Total
$120
80
$200
60%
40%
100%
10%
40%
40%
15%
10%
40%
40%
15%
FTM EBITDA (Year 6)
Exit Multiple
Ending TEV
Beginning debt
Cash generated (total FCF)
Ending debt
Ending equity value
Beginning equity value
Approximate EV Multiple
IRR
10%
40%
40%
15%
10%
40%
40%
15%
10%
40%
40%
15%
64
5.0x
322
120
34
86
236
80
3.0x
> 25%
Approximation
MoM
IRR
2.0x
15%
2.5x
20%
3.0x
25%
Final Steps
Make sure to take your time and calculate every formula correctly since this is not a race, and any error that you make
will flow through the model you’re building. If you catch a mistake part-way through, you will have to go back and
correct it—sometimes causing you to have to recalculate nearly everything, and possibly leading to compounding
mistakes on top of the original one.
In addition, the interviewer will ask you to walk through your thought process and calculations. Thus it is important to
be able to build the proper paper LBO in simple, accurate steps, and make sure you can walk through the reasoning
regarding the process and each calculation. This takes practice, so be sure to practice at least one more paper LBO
before your next private equity interview.
Good luck on the case!
39 ©2013 Street of Walls
Chapter 10: LBO Modeling Test Example
When interviewing for a junior private equity position, a candidate must prepare for in-office modeling tests on
potential private equity investment opportunities—especially LBO scenarios. In this module, we will walk through an
example of an in-office LBO modeling test. In-office case studies and modeling tests can occur at various stages of an
interview process, and additional interviews with other members of the private equity team could occur on the same
day. Therefore, you should strive to be able to do these studies effectively and efficiently without draining yourself so
much that you can’t quickly rebound and move on to the next interview. Make sure to take your time and build every
formula correctly, since this process is not a race. There are many complex formulas in this test, so make sure you
understand every calculation.
This type of LBO test will not be mastered in a day or even a week. You must therefore begin practicing this technique
in advance of meeting with headhunters. Repeated practice, checking for errors and difficulties and learning how to
correct them, all the while enhancing your understanding of how an LBO works, is the key to success.
In the following LBO Case Study module, we will cover the following key areas:
Investment Scenario Overview
Given Information (Parameters and Assumptions)
Exercises
o Step 1: Income Statement Projections
o Step 2: Transaction Summary
o Step 3: Pro Forma Balance Sheet
o Step 4: Full Income Statement Projections
o Step 5: Balance Sheet Projections
o Step 6: Cash Flow Statement Projections
o Step 7: Depreciation Schedule
o Step 8: Debt Schedule
o Step 9: Returns Calculations
Given Information (Parameters and Assumptions)
Below we provide the given information from a real-life LBO test that was given to a pre-MBA associate candidate at a
large PE firm. We will use it as an example of how to build an LBO model from scratch during the interview.
Remember that candidates will receive a laptop and a printout with key information regarding the transaction to
complete this assignment.
40 ©2013 Street of Walls
ABC Company, Inc.
Scenario Overview and Revenue Assumptions:
ABC Company, Inc. is a developer of software applications for smartphone devices. The company sells two products for
the various smartphones. The first is a software application called Cloud that tracks weather data. The second
application, Time, acts as a calendar that keeps track of a user’s schedule. ABC Company prices Cloud at $16.00 and
Time at $36.00 per software license. ABC Company sold 1.5 million copies of Cloud and 3 million copies of Time in
2010. That was the first year ABC Company generated any revenue.
Each software application requires the payment of a $5.00 renewal fee every year. ABC Company renews
approximately 25% of the licenses it sold in the prior year; this renewal fee acts as a source of recurring revenue. To
simplify, assume that renewals happen for only one additional year and that the recurring revenue stream is based on
the prior year’s new licenses. Note that ABC Company does not incur any additional costs for renewals.
COGS assumptions (assume constant throughout the projection period):
Packaging costs = $1.50 per unit
Royalties to technology patent owners = $3.00 per unit
Marketing expense = $3.00 per unit
Fulfillment expense = $4.00 per unit
Fees to smartphone companies = 15% of sale price (does not include renewal fees)
ABC Company incurs a 15% bad debt allowance on total revenues (consider this as part of cost of sales, wherein
ABC Company is unable to collect from customers’ credit card companies).
G&A and other assumptions (assume constant throughout the projection period):
Rent of development property and warehouse facilities = $350,000 annually
License fee to telecom internet providers = $1.5 million annually
Salaries and benefits = $1.75 million annually
Sales commissions = 5% of all sales including renewals
Offices and other administrative costs = $750,000 annually
CEO salary and bonus = $1.25 million annually + 3% of all sales including renewals
Federal tax rate = 35% and state tax rate = 5% on EBT
Starting Balance Sheet:
($ in thousands, except per unit data)
2011
Cash
AR
Inventory
Other Current
PP&E
Goodwill
Def. Financing Fees
Other Non-Current
Total Assets
-9,816
10,268
2,279
6,500
602
-2,587
32,052
AP
Other Current
New Credit Facility
New Subordinated Debt
Other Non-Current
Equity
Total Liabilities & Equity
7,550
3,793
--1,871
18,838
32,052
Investment Assumptions:
Due to the depressed macroeconomic and investing environment, the PE fund is able to acquire ABC Company for the
inexpensive purchase price of 5.0x 2011 EBITDA (assuming a cash-free debt-free deal), which will be paid in cash. The
transaction is expected to close at the end of 2011.
Assumptions include the following:
Senior Revolving Credit Facility: 3.0x (2.0x funded at close) 2011 EBITDA, LIBOR + 400bps, 2017 maturity,
commitment fee of 0.50% for any available revolver capacity. RCF is available to help fund operating cash
requirements of the business (only as needed).
41 ©2013 Street of Walls
Subordinated Debt: 1.5x 2011 EBITDA, 12% annual interest (8% cash, 4% PIK interest), 2017 maturity, $1
million required amortization per year. (Hint: add the PIK interest once you have a fully functioning model
that balances.)
Assume that existing management expects to roll-over 50% of its pre-tax exit proceeds from the transaction.
Existing management’s ownership pre-LBO is 10%.
Assume a minimum cash balance (Day 1 Cash) of $5 million (this needs to be funded by the financial sponsor
as the transaction is a cash-free / debt-free deal).
Assume that all remaining funding comes from the financial sponsor.
Assume that all cash beyond the minimum cash balance of $5 million and the required amortization of each
tranche is swept by creditors in order of priority (i.e. 100% cash flow sweep).
Assume that LIBOR for 2012 is 3.00% and is expected to increase by 25bps each year.
The M&A fee for the transaction is $1.5 million. Assume that the M&A fee cannot be expensed (amortized) by
ABC and will be paid out of the sponsor equity contribution upon close.
In addition, there is a financing syndication fee of 1% on all debt instruments used. This fee will be amortized
on a five-year, straight-line schedule.
Assume New Goodwill equals Purchase Equity Value less Book Value of Equity.
Assume Interest Income on average cash balances is 1%.
Hint: The first forecast year for the model will be 2012. However, you will need to build out the income statement for
2010 and 2011 to forecast the financial statements for years 2012 through 2016.
Exercises:
As part of the in-person LBO test, pre-MBA and post-MBA candidates are expected to complete the following exercises
in their entirety. Please note the assumptions given here apply for multiple scenarios:
Build an integrated three-statement LBO model including all necessary schedules (see below).
Build a Sources and Uses table.
Make adjustments to the closing balance sheet of ABC Company post-acquisition.
Build an annual operating forecast for ABC Company with the following scenarios (using 2010 as the first year
for the revenue forecast; note that 2010 EBITDA should be approximately $25 million). Assume that in 2011
there is 5% growth in units sold (both Cloud and Time units).
2012-2016 assumptions include:
o Upside Case: 5% annual growth in units sold (both Cloud and Time units)
o Conservative Case: 0% annual growth in units sold (both Cloud and Time units)
o Downside Case: 5% annual decline in units sold (both Cloud and Time units)
Build a Working Capital schedule using Accounts Receivable Days, Accounts Payable Days, Inventory Days,
and other assets and liabilities as a percentage of Revenue. Assume working capital metrics stay constant
throughout the projection period and assume 365 days per year.
Build a Depreciation Schedule that assumes that existing PP&E depreciates by $1 million per year, and that
new capital expenditures of $1.5 million per year depreciate on a five-year, straight-line basis.
Build a Debt schedule showing the capital structure described earlier. Use average balances for calculating
Interest Expense (except for PIK interest—assume that PIK interest is calculated based on the beginning year
Subordinated Debt balance and not the average over the year).
Create an Exit Returns schedule (including both cash-on-cash and IRR) showing the returns to the PE firm
equity based on all possible year-end exit points from 2012 to 2016, with exit EBITDA multiples ranging from
4.0x to 7.0x.
Display the results of all of these calculations using the “Upside Case.”
Note that the above description incorporates all of the information, assumptions and assignments that were given in
this LBO in-person test example.
42 ©2013 Street of Walls
Step 1: Income Statement Projections
As part of the first step, build out the core operating Income Statement line items for years 2010 through 2016.
($ in thousands, except per unit data)
2010
2011
2012
Revenue
Cloud Revenue
Price
Units
Revenue
% Growth
$16.00
1,500
24,000
--
$16.00
1,575
25,200
5.0%
$16.00
1,654
26,460
5.0%
Time Revenue
Price
Units
Revenue
% Growth
$36.00
3,000
108,000
--
$36.00
3,150
113,400
5.0%
-$5.00
25.0%
--$132,000
Licensing
Total Units Sold (Previous Year)
Per Unit Fee
Retention
Licensing Revenue
% Growth
Total Revenue
Year End
2013
2014
2015
2016
$16.00
1,736
27,783
5.0%
$16.00
1,823
29,172
5.0%
$16.00
1,914
30,631
5.0%
$16.00
2,010
32,162
5.0%
$36.00
3,308
119,070
5.0%
$36.00
3,473
125,024
5.0%
$36.00
3,647
131,275
5.0%
$36.00
3,829
137,838
5.0%
$36.00
4,020
144,730
5.0%
4,500
$5.00
25.0%
5,625
--
4,725
$5.00
25.0%
5,906
5.0%
4,961
$5.00
25.0%
6,202
5.0%
5,209
$5.00
25.0%
6,512
5.0%
5,470
$5.00
25.0%
6,837
5.0%
5,743
$5.00
25.0%
7,179
5.0%
$144,225
$151,436
$159,008
$166,958
$175,306
$184,072
2011
0.0%
5.0%
2012-16
0.0%
5.0%
0.0%
5.0%
0.0%
5.0%
Based on the provided assumptions, the Upside Case estimates an annual increase of 5.0% for Revenue from 20122016. Next, you should build the following exhibit in Excel in order to be able to change the case scenarios easily (with
the selected case driving the revenue growth numbers in the operating model).
Make a distinction between 2011 assumptions and 2012-2016 assumptions
Take the provided assumptions and make the revenue and cost build based upon them.
Case
Running
Growth
1
Upside
5.0%
1
Upside
5.0%
2
Base Case
0.0%
3
Downside
(5.0%)
Note that the highlighted “1” is the input to the operating model, and the “5.0%” in grey background represents the
formula that is built to pick up the appropriate case. We use the =OFFSET() function in Excel to drive this formula.
OFFSET is a simple Excel formula that is used commonly to interchange scenarios, especially if the model
becomes very complex. It simply reads the value in a cell that is located an appropriate number of
rows/columns away, based on the parameters given to the function. Thus, for example, =OFFSET(A1, 3, 1) will
read the value in cell B4 (3 rows and 1 column after A1).
Next, build the costs related to Revenue based upon the information given in the case.
43 ©2013 Street of Walls
($ in thousands, except per unit data)
2010
2011
2012
Fiscal Year Ending,
2013
2014
2015
2016
COGS
Total Units Sold
4,500
4,725
4,961
5,209
5,470
5,743
6,030
Packaging Costs Per Unit
Total Packaging Costs
$1.50
6,750
$1.50
7,088
$1.50
7,442
$1.50
7,814
$1.50
8,205
$1.50
8,615
$1.50
9,046
Royalty Costs Per Unit
Royalties to Patent Holders
$3.00
13,500
$3.00
14,175
$3.00
14,884
$3.00
15,628
$3.00
16,409
$3.00
17,230
$3.00
18,091
Marketing Expense Per Unit
Marketing Costs
$3.00
13,500
$3.00
14,175
$3.00
14,884
$3.00
15,628
$3.00
16,409
$3.00
17,230
$3.00
18,091
Fulfillment Costs
Fulfillment Costs
$4.00
18,000
$4.00
18,900
$4.00
19,845
$4.00
20,837
$4.00
21,879
$4.00
22,973
$4.00
24,122
Total Revenue (Excl. Renewals)
Smartphone Company Fees
Total Smartphone Company Fees
132,000
15.0%
19,800
138,600
15.0%
20,790
145,530
15.0%
21,830
152,807
15.0%
22,921
160,447
15.0%
24,067
168,469
15.0%
25,270
176,893
15.0%
26,534
Total Revenue (Incl. Renewals)
Bad Debt
Total Bad Debt Costs
132,000
15.0%
19,800
144,225
15.0%
21,634
151,436
15.0%
22,715
159,008
15.0%
23,851
166,958
15.0%
25,044
175,306
15.0%
26,296
184,072
15.0%
27,611
($91,350)
($96,761)
($101,599)
($106,679)
($112,013)
($117,614)
($123,495)
2015
2016
Total COGS
Then, build the G&A expenses from the given information.
($ in thousands, except per unit data)
2010
2011
2012
Fiscal Year Ending,
2013
2014
G&A
Rent & Warehouse Facilities
License Fee to Telecom Companies
Salaries & Benefits
350
1,500
1,750
350
1,500
1,750
350
1,500
1,750
350
1,500
1,750
350
1,500
1,750
350
1,500
1,750
350
1,500
1,750
132,000
5.0%
6,600
144,225
5.0%
7,211
151,436
5.0%
7,572
159,008
5.0%
7,950
166,958
5.0%
8,348
175,306
5.0%
8,765
184,072
5.0%
9,204
750
1,250
750
1,250
750
1,250
750
1,250
750
1,250
750
1,250
750
1,250
Total Revenue
CEO Bonuses %
Total CEO Bonus
132,000
3.0%
3,960
144,225
3.0%
4,327
151,436
3.0%
4,543
159,008
3.0%
4,770
166,958
3.0%
5,009
175,306
3.0%
5,259
184,072
3.0%
5,522
Total G&A Costs
(16,160)
(17,138)
(17,715)
(18,321)
(18,957)
(19,625)
(20,326)
Total Revenue
Sales Commissions %
Total Sales Bonuses
Office Maintenance & Other
CEO Salary
Finally, build a simple summary schedule for the above projections.
($ in thousands, except per unit data)
Fiscal Year Ending,
2013
2014
2010
2011
2012
2015
2016
132,000
--
144,225
9.3%
151,436
5.0%
159,008
5.0%
166,958
5.0%
175,306
5.0%
184,072
5.0%
(91,350)
(96,761)
(101,599)
40,650
30.8%
47,464
32.9%
49,837
32.9%
(106,679)
(112,013)
(117,614)
(123,495)
52,329
32.9%
54,945
32.9%
57,692
32.9%
60,577
32.9%
(16,160)
(17,138)
24,490
18.6%
30,326
21.0%
(17,715)
(18,321)
(18,957)
(19,625)
(20,326)
32,122
21.2%
34,008
21.4%
35,989
21.6%
38,068
21.7%
40,251
21.9%
Summary
Revenue
% Growth
Less: COGS
Gross Profit
% Margin
Less: G&A
EBITDA
% Margin
44 ©2013 Street of Walls
Step 2: Transaction Summary
As part of the second step, build out the transaction summary section which will consist of the Purchase Price
Calculation, Sources and Uses, and the Goodwill calculation.
($ in thousands, except per unit data)
Valuation
2011E EBITDA
Multiple
Transaction Value
Less: Debt
Plus: Cash
Offer Value
Other Assumptions
Revolver EBITDA multiple
Revolver Availibility
Minimum Cash
M&A Fee
Existing management ownership
Mgmt Rollover (pre-tax)
30,326
5.0x
151,629
--151,629
3.0x
90,977
5,000
1,500
10.0%
50.0%
Sources
BS Cash
Credit Facility
Sub. Debt
Mgmt. Rollover
Cash Equity
Total Sources
Uses
Purch. of Equity
Mgmt. Rollover
Minimum Cash
Trans. Expenses
Fin. Expenses
Total Uses
$
%
-60,652
45,489
7,581
45,469
159,190
0.0%
38.1%
28.6%
4.8%
28.6%
100.0%
144,047
7,581
5,000
1,500
1,061
159,190
90.5%
4.8%
3.1%
0.9%
0.7%
100.0%
Sources and Uses
x
Term
2.00x
1.50x
0.25x
1.50x
5.25x
Synd. Fee %
5
5
1.0%
1.0%
Fees ($)
607
455
1,061
Purchase Accounting (Goodwill Calculation)
Purchase of Equity
Less: Book Value of Equity
New Goodwill
151,629
(18,838)
132,791
Using this graphic, you should be able to understand and build all the formulas. Be sure to think through each number
and how it is calculated, as this is the main summary of the LBO transaction as a whole. A few points worth noting:
This model assumes a debt-free/cash-free balance sheet pre-transaction for simplification. Without debt or
cash, the transaction value is simply equal to the offer price for the equity (before fees and minimum cash—
discussed below).
The funding for this model is fairly simple: the funded credit facility is 2.0x 2011E EBITDA, the subordinated
debt is 1.5x, and the remaining portion is the equity funding, which is a combination of management rollover
equity and sponsor (PE firm) equity. (Note that the 5.0x 2011E EBITDA is the offer value for the equity before
the M&A and financing fees and the minimum cash balance, not after. After fees/cash, it ends up being 5.25x.)
The management rollover is simply half of the management team’s proceeds from selling the company. Since
management owned 10% of the company before the transaction, it constitutes 5% of the offer price for the
original equity.
The sponsor equity is the “plug” in this calculation. In other words, it is the amount that is solved for once all
other amounts are known (offer price + minimum cash + fees – debt instruments – management rollover
equity).
The total equity (including management rollover) represents about 30-35% of the funding for the deal, which
is about right for a typical LBO transaction.
Goodwill is simply the excess paid for the original equity (offer price – book value of equity).
45 ©2013 Street of Walls
Step 3: Pro Forma Balance Sheet
As a next step, build out the Pro Forma Balance Sheet using the given 2011 balance sheet. To do this, you need to
incorporate all the transaction and financing-related adjustments needed to produce the Pro Forma Balance Sheet.
Each adjustment is discussed in detail below.
Balance Sheet
($ in thousands, except per unit data)
2011
Cash
AR
Inventory
Other Current
PP&E
Goodwill
Def. Financing Fees
Other Non-Current
Total Assets
-9,816
10,268
2,279
6,500
--2,587
31,450
AP
Other Current
New Credit Facility
New Subordinated Debt
Other Non-Current
Equity
Total Liabilities & Equity
Check
7,550
3,793
--1,269
18,838
31,450
--
Transaction
Adjustments
5,000
132,791
1,061
138,852
60,652
45,489
32,712
138,852
2011 PF
5,000
9,816
10,268
2,279
6,500
132,791
1,061
2,587
170,302
7,550
3,793
60,652
45,489
1,269
51,550
170,302
--
Since this is a cash-free and debt-free deal to start, there are no Pro Forma adjustments for the cancelling or
refinancing of debt.
Cash increases by $5 million upon close because the sponsor is funding the minimum cash balance (minimum
cash that is assumed to be needed to run the business).
The New Goodwill is simply the purchase value of the equity (not including fees) less the original book value of
the equity.
The adjustment for Debt Financing Fees reflects the cost of issuing the new debt instruments to buy the
company. This fee is considered an asset, and is capitalized and amortized over 5 years.
The Debt-related adjustments reflect the new debt instruments for the new capital structure.
The Equity adjustment reflects the fact that the original equity is effectively wiped out in the transaction—the
“adjustment” amount shown here is simply the difference between the new equity value and the old one. The
new equity value will equal the amount of the total equity funding for the transaction (sponsor plus
management’s rollover) less the M&A fee, which is accounted for as an off balance-sheet cost.
VERY IMPORTANT: This stage of the LBO model development (once Pro Forma adjustments have been made
to reflect the impact of the transaction on the balance sheet) is a very good time to check to make sure that
everything in the model so far balances and reflects the given assumptions. This includes old and new assets
equaling old and new liabilities plus equity; new sources of capital equaling the transaction value, which equals
the offer price for the original equity (adjusting for cash, old debt and fees), etc.
46 ©2013 Street of Walls
Step 4: Full Income Statement
Next, build the full Income Statement projections all the way down to Net Income. Note that a few line items
(especially Interest Expense!) will be calculated in later steps. Once the Cash Flow section and other schedules are built,
link all the final line items to complete the integrated financials.
Income Statement
($ in thousands, except per unit data)
Revenue
Less: COGS
Gross Profit
Less: SG&A
EBITDA
Less: D&A
EBIT
Less: Cash Interest
Less: Non-Cash Interest
Plus: Interest Income
Less: Def. Financing Fees
Profit Before Taxes
Less: Taxes
Net Income
Revenue Growth
Gross Margin
EBITDA Margin
EBIT Margin
Taxes
2011
144,225
(96,761)
47,464
(17,138)
30,326
9.3%
32.9%
21.0%
---
2012
151,436
(101,599)
49,837
(17,715)
32,122
(1,300)
30,822
(7,647)
(1,820)
50
(212)
21,194
(8,477)
12,716
5.0%
32.9%
21.2%
20.4%
40.0%
Fiscal Year Ending,
2013
2014
159,008
(106,679)
52,329
(18,321)
34,008
(1,600)
32,408
(6,915)
(1,852)
50
(212)
23,478
(9,391)
14,087
5.0%
32.9%
21.4%
20.4%
40.0%
166,958
(112,013)
54,945
(18,957)
35,989
(1,900)
34,089
(5,994)
(1,886)
50
(212)
26,046
(10,418)
15,628
5.0%
32.9%
21.6%
20.4%
40.0%
2015
175,306
(117,614)
57,692
(19,625)
38,068
(2,200)
35,868
(4,848)
(1,922)
50
(212)
28,935
(11,574)
17,361
5.0%
32.9%
21.7%
20.5%
40.0%
2016
184,072
(123,495)
60,577
(20,326)
40,251
(2,500)
37,751
(3,408)
(1,875)
50
(212)
32,306
(12,923)
19,384
5.0%
32.9%
21.9%
20.5%
40.0%
You can link the Revenue, COGS and SG&A calculations to the operating model (built in Step 1) to get to
EBITDA.
To get from EBITDA to Net Income, set up the framework first (include line items to subtract D&A, and to
subtract Interest and fees, to get to EBT. Then subtract taxes to get Net Income—but keep in mind for now that
calculating D&A and Interest will come a bit later, from other schedules you have not yet created).
o D&A will be linked to the Depreciation Schedule that you will need to build (schedule of the Depreciation
of the existing PP&E and new Capital Expenditures made over the projection period).
o Interest Expense and Interest Income will be linked to the Debt Schedule that you will need to build. There
will be a natural circular reference because of the cash flow sweep feature of the LBO model, combined
with the fact that Interest Expense is dependent upon Cash balances. This is usually one of the last things
you should build in an LBO model.
o The amortization of Deferred Financing Fees is fairly straightforward: it uses a straight-line, 5 year
amortization of the fees described in the case write-up and computed in Step 2.
o The tax rates apply to EBT after all of these expenses have been subtracted out. They are given in the case
write-up.
47 ©2013 Street of Walls
Step 5: Balance Sheet Projections
Next, forecast the Balance Sheet from 2011 to 2016. Note that we start with the 2011 Pro Forma Balance Sheet from
Step 3, not the original Balance Sheet.
Balance Sheet
Fiscal Year Ending,
2013
2014
2011PF
2012
2015
2016
Cash
Accounts Receivable
Inventory
Other Current
PP&E
Goodwill
Deferred Financing Fees
Other Non-Current
Total Assets
5,000
9,816
10,268
2,279
6,500
132,791
1,061
2,587
170,302
5,000
10,307
10,781
2,393
6,700
132,791
849
2,587
171,408
5,000
10,822
11,320
2,513
6,600
132,791
637
2,587
172,270
5,000
11,363
11,886
2,638
6,200
132,791
425
2,587
172,890
5,000
11,931
12,481
2,770
5,500
132,791
212
2,587
173,272
5,000
12,528
13,105
2,909
4,500
132,791
-2,587
173,419
Accounts Payable
Other Current
New Credit Facility
New Subordinated Debt
Other Non-Current
Equity
Total Liabilities & Equity
Check
7,550
3,793
60,652
45,489
1,269
51,550
170,302
--
7,928
3,983
47,655
46,308
1,269
64,266
171,408
--
8,324
4,182
32,981
47,160
1,269
78,353
172,270
--
8,740
4,391
16,463
48,047
1,269
93,981
172,890
--
9,177
4,610
-46,874
1,269
111,342
173,272
--
9,636
4,841
-26,947
1,269
130,726
173,419
--
11,020
11,571
(551)
12,150
(579)
12,757
(607)
13,395
(638)
14,065
(670)
144,225
96,761
151,436
101,599
159,008
106,679
166,958
112,013
175,306
117,614
184,072
123,495
24.8
38.7
1.6%
28.5
2.6%
24.8
38.7
1.6%
28.5
2.6%
24.8
38.7
1.6%
28.5
2.6%
24.8
38.7
1.6%
28.5
2.6%
24.8
38.7
1.6%
28.5
2.6%
24.8
38.7
1.6%
28.5
2.6%
($ in thousands, except per unit data)
Operating Working Capital
Change in Operating Working Capital (Increase)
Sales
COGS
Receivable Days
Inventory Days
Other Current Assets (% of Sales)
AP Days
Other Current Liabilities (% of Sales)
Laying out the Balance Sheet is similar to laying out the Income Statement—you’ll have to set up the
framework for some line items and leave the formulas blank at first, as they will be calculated in the other
schedules you will create.
Cash remains at $5 million throughout the life of the model, as we’re assuming a 100% cash flow sweep and
that the minimum cash balance is $5 million. (Cash would only start to increase if we project out long enough
that all outstanding Debt is paid off.)
You’ll need to build out the Operating Working Capital line items (Accounts Receivable, Inventory, Other
Current Assets, Accounts Payable, Other Current Liabilities) according to the assumptions stated in the case
write-up.
o Accounts Receivable (AR): Calculate AR days (AR ÷ Total Revenue × 365) for 2011 and keep it constant
throughout the projection period.
o Inventory: Calculate Inventory days (Inventory ÷ COGS × 365) for 2011 and keep it constant throughout
the projection period.
o Other Current Assets: Keep this line item as a constant percentage of revenue throughout the projection
period.
o Accounts Payable (AP): Calculate AP days (AP ÷ COGS × 365) for 2011 and keep it constant throughout the
projection period.
o Other Current Liabilities: Keep this line item as a constant percentage of revenue throughout the
projection period.
Total Deferred Financing Fees are computed based upon the Debt balances and percentage assumptions given
in the model. Deferred financing fees are then amortized, straight-line, over 5 years.
The Credit Facility and Subordinated Debt line items will link to your Debt schedule. Their balances will
decrease over time as a function of the cash available for Debt paydown (since the case write-up specifies a
100% cash sweep function).
Equity (specifically Retained Earnings) will increase each year by the same amount as Net Income, because
there are no dividends being declared. If dividends were to be added into the model, you would calculate
ending Retained Earnings as Beginning Retained Earnings + Net Income – Dividends Declared.
As discussed earlier, the balance sheet has the pleasing feature that if it balances, the model is probably
operating correctly! Now is another good time to make sure everything balances before proceeding.
48 ©2013 Street of Walls
Step 6: Cash Flow Statement Projections
Next, forecast the Cash Flow Statement as requested in the Exercises section.
Cash Flow Statement
($ in thousands, except per unit data)
Net Income
D&A
Non-Cash Interest
Deferred Financing Fees
Change in Operating Working Capital
Capex
Levered Free Cash Flow (LFCF)
Beg. Cash Balance
Less: Minimum Cash
Plus: LFCF
LFCF before Mandatory Paydown
Less: Mandatory Paydown
LFCF before Discretionary Paydown
Less: Discretionary Paydown
Change in Cash
Ending Cash Balance
2011
2012
Fiscal Year Ending,
2013
2014
2015
2016
12,716
1,300
1,820
212
(551)
(1,500)
13,997
14,087
1,600
1,852
212
(579)
(1,500)
15,673
15,628
1,900
1,886
212
(607)
(1,500)
17,519
17,361
2,200
1,922
212
(638)
(1,500)
19,558
19,384
2,500
1,875
212
(670)
(1,500)
21,801
5,000
(5,000)
13,997
13,997
(1,000)
12,997
(12,997)
-5,000
5,000
(5,000)
15,673
15,673
(1,000)
14,673
(14,673)
-5,000
5,000
(5,000)
17,519
17,519
(1,000)
16,519
(16,519)
-5,000
5,000
(5,000)
19,558
19,558
(1,000)
18,558
(18,558)
-5,000
5,000
(5,000)
21,801
21,801
(1,000)
20,801
(20,801)
-5,000
The primary purpose of the Cash Flow Statement in the integrated financial model is to calculate the Levered Free
Cash Flow (LFCF) being generated by the business. This is for obvious reasons: cash generation is very important in
the eyes of PE investors, as it is used to pay down debt and thereby increase equity value (and thereby decrease future
interest burdens on the business, which helps to decrease risk over time).
Start with Net Income and add back non-cash expenses from the Income Statement, such as D&A, Non-Cash
Interest (PIK), and Deferred Financing Fees.
Next, subtract uses of Cash that are not reflected in the Income Statement. These include the increase in
Operating Working Capital (which you calculated using your balance sheet) and Capital Expenditures (which is
calculated here or, alternatively, could be calculated in the Depreciation Schedule to be built shortly).
Next, calculate the change in cash, which will be interconnected with the Debt schedule. In this case, the model
is assuming a 100% cash flow sweep (after mandatory debt amortization payments), so cash should not change
after the 2011PF Balance Sheet amount of $5 million.
Even though the amount is not changing, the Cash line item should link back to the Balance Sheet. This is
because the model could later be used to relax the assumption that 100% of excess cash is swept to pay down
Debt. If it’s less than 100%, Cash would accumulate, and that would need to tie in to the other financial
statements.
49 ©2013 Street of Walls
Step 7: Depreciation Schedule
Next, forecast the Depreciation schedule as requested in the Exercises section.
Depreciation Schedule
Fiscal Year Ending,
2013
2014
2011
2012
Existing PP&E Depreciation
New Depreciation
1,000
1,000
300
1,000
300
300
Total Depreciation
1,000
1,300
1,600
($ in thousands, except per unit data)
Life
2015
2016
1,000
300
300
300
1,000
300
300
300
300
1,900
2,200
1,000
300
300
300
300
300
2,500
5
The Depreciation schedule is broken into two parts:
The original PP&E is depreciated $1 million annually, as stated in the assumptions.
New Depreciation is calculated based on the annual investment in Capital Expenditures over the projection
period. This new Depreciation is created using a waterfall (see above): each year new Capital Expenditures
occur and need to be depreciated; each year, Capital Expenditures from previous projection years in the model
may have to be partially depreciated in that year. The sum of all of the component Depreciation line items (one
row for each year, plus the Depreciation on the original PP&E) gives the total Depreciation Expense for the
year.
Note that this model is less complex than it could be. Given that Capital Expenditures do not change each year, and
that each new Capital Expenditure is depreciated according to the same simple schedule, the numbers and calculations
are fairly straightforward. Here, we’re simply assuming that new Capital Expenditures are expensed evenly over a 5
year period (using straight-line depreciation), as specified in the case write-up.
50 ©2013 Street of Walls
Step 8: Debt Schedule
Next, forecast the Debt Paydown and Interest Expenses for each year via the Debt Schedule, as requested in the
Exercises section.
Debt Schedule
2011
($ in thousands, except per unit data)
Senior Revolving Credit Facility
Beginning Balance
Mandatory Paydown
Discretionary Paydown
Ending Balance
Availability
Subordinated Debt
Beginning Balance
Mandatory Paydown
Discretionary Paydown
Accumulated PIK Interest
Ending Balance
Interest Schedule
Type
Senior Revolving Credit Facility
Floating
Subordinated Debt Cash Interest Fixed
Revolver Commitment Fee
Fixed
Total Cash Interest
Rate
4.0%
8.0%
0.5%
Subordinated Debt PIK Interest
Non-Cash Interest
Total Interest Expense
4.0%
Interest Income on Cash
Fixed
1.0%
LIBOR
Step
Capacity
90,977
2012
Fiscal Year Ending,
2013
2014
2015
2016
60,652
30,326
60,652
-(12,997)
47,655
43,323
47,655
-(14,673)
32,981
57,996
32,981
-(16,519)
16,463
74,515
16,463
-(16,463)
-90,977
----90,977
45,489
45,489
(1,000)
-1,820
46,308
46,308
(1,000)
-1,852
47,160
47,160
(1,000)
-1,886
48,047
48,047
(1,000)
(2,095)
1,922
46,874
46,874
(1,000)
(20,801)
1,875
26,947
(3,791)
(3,672)
(184)
(7,647)
(2,923)
(3,739)
(253)
(6,915)
(1,854)
(3,808)
(331)
(5,994)
(638)
(3,797)
(414)
(4,848)
-(2,953)
(455)
(3,408)
(1,820)
(1,820)
(9,466)
(1,852)
(1,852)
(8,767)
(1,886)
(1,886)
(7,880)
(1,922)
(1,922)
(6,770)
(1,875)
(1,875)
(5,283)
50
50
50
50
50
3.00%
3.25%
0.25%
3.50%
0.25%
3.75%
0.25%
4.00%
0.25%
We need to build this schedule correctly! The Debt Schedule is probably the trickiest part of the LBO model to
build—especially for anyone who has not built an LBO model before. The Debt Schedule will create the circular
(iterative) reference that is the defining characteristic of a true LBO model. Before linking the Debt, Cash, and
Interest calculations to one another in the Debt schedule, be sure to turn “Iterations” on in the Formulas
section of Microsoft Excel’s Options menu.
o WARNING: Be very careful about changing formulas once you have built the iterative calculation. If you
do so and introduce an error, it could bust your entire model if you’re not careful. This is because the error
will travel all the way through the iterative calculations and end up everywhere! If you run into this
problem, break the circular reference entirely (by deleting it), reconstruct the calculations for the first
forecast year (2012), and then copy and paste them across the columns, one year at a time (2013, then
2014, etc.). Many PE professionals have spent late nights in the office trying to recover from an
accidental error introduced into a circular LBO model formula!
To compute the changes in Debt balances, calculate LFCF (the framework for this started already on the
Statement of Cash Flows). This determines how much debt is going to be paid down (both discretionary and
non-discretionary).
o The non-discretionary portion is the required amortization payments made on debt (in this case, there is
only required pay-down for subordinated debt).
o The discretionary portion is the sweep portion of the remaining LFCF less required amortization. Since
we’re assuming a 100% cash flow sweep, all of the LFCF is used to pay down debt—first the Senior Credit
Facility, then the Subordinated Debt. The cash flow sweep and required payments will help you calculate
the beginning and ending balances of both of the debt tranches.
o The Senior/Revolving Credit Facility (S/RCF) is the first priority to get paid off via the cash flow sweep. It
should be completely paid off before later tranches receive any discretionary principal repayment in the
Debt Schedule.
Also note that we need to include a fee for the availability of the unused portion of the RCF, even if the
business never uses it—this is a typical, annual commitment fee arrangement for revolving credit
facilities.
The interest rate on the debt is a floating rate (this means an interest rate that is dependent on LIBOR,
according to the assumptions provided). We need to calculate interest based on this rate times the
average S/RCF balance over the year.
51 ©2013 Street of Walls
Subordinated debt is the second priority to get paid off through the cash flow sweep. Other than required
amortization, none of the Subordinated Debt gets paid off before the S/RCF is fully paid off.
The 8% cash interest is calculated based upon the average of the debt balance, just like with the S/RCF.
However, the 4% PIK (non-cash) interest will accrue based upon the beginning debt balance, not the
average.
Because of this difference (and the fact that one source of interest uses cash and the other does not),
we need to make sure we’re using separate line items for the two types of Interest Expense.
We also need to be aware of the mandatory amortization payment of $1 million per year, provided in
the assumptions. This amount will get paid down out of LFCF no matter what.
o Interest Income on Cash is fairly easy to calculate—it is the Cash interest rate (1%) times the average
balance throughout the year. This amount will increase Cash.
When we’ve finished with these calculations, we need to link these line items to various line items in the
integrated financial statement.
o Total Interest needs to be linked to the Income Statement.
o Non-Cash Interest needs to be added back to Net Income in the Statement of Cash Flows to assist in
deriving LFCF (it’s a non-cash expense).
o Any LFCF that is not used to pay down Debt needs to link to the Cash line item of the Balance Sheet. (In
this model none will, but you should include this measure in case the model is later used to either relax the
100% cash sweep assumption, or to project financials beyond the point at which all debt has been paid off).
o All Debt balances paid down by LFCF need to link to the Debt line items on the Balance Sheet.
o
52 ©2013 Street of Walls
Step 9: Returns Calculations
In the final step of the LBO test, build out the Returns calculation required in the Exercises section.
Returns Calculation
($ in thousands, except per unit data)
Period
EBITDA
Exit Mult.
4.0x
5.0x
6.0x
7.0x
Enterprise Value
Less: Net Debt
Equity Value
Management Equity
Sponsor Equity
Returns Calculation
Cash on Cash Returns
14.3%
Fiscal Year Ending,
2014
2015
2012
2013
1
32,122
2
34,008
3
35,989
4
38,068
2016
5
40,251
128,488
160,610
192,732
224,854
136,033
170,041
204,049
238,057
143,954
179,943
215,931
251,920
152,272
190,340
228,408
266,476
161,005
201,257
241,508
281,760
(88,963)
(75,142)
(59,509)
(41,874)
(21,947)
Exit Mult.
4.0x
5.0x
6.0x
7.0x
39,525
71,647
103,769
135,892
60,891
94,899
128,907
162,915
84,445
120,433
156,422
192,410
110,398
148,466
186,534
224,602
139,058
179,309
219,561
259,812
Exit Mult.
4.0x
5.0x
6.0x
7.0x
5,649
10,239
14,830
19,420
8,702
13,562
18,422
23,282
12,068
17,211
22,354
27,498
15,777
21,217
26,658
32,098
19,873
25,625
31,378
37,130
Exit Mult.
4.0x
5.0x
6.0x
7.0x
33,877
61,408
88,940
116,471
52,189
81,337
110,485
139,633
72,377
103,222
134,067
164,913
94,621
127,249
159,876
192,504
119,185
153,684
188,183
222,682
7.1%
33.7%
55.9%
75.2%
16.8%
31.4%
43.4%
53.6%
20.1%
29.3%
36.9%
43.4%
21.3%
27.6%
32.9%
37.4%
1.1x
1.8x
2.4x
3.1x
1.6x
2.3x
2.9x
3.6x
2.1x
2.8x
3.5x
4.2x
2.6x
3.4x
4.1x
4.9x
Initial
Equity Exit Mult.
45,469
4.0x
5.0x
6.0x
7.0x
(25.5%)
35.1%
95.6%
156.2%
Initial
Equity Exit Mult.
45,469
4.0x
5.0x
6.0x
7.0x
0.7x
1.4x
2.0x
2.6x
The last portion of the model to complete is the Equity Returns schedule. This is essentially a simple
calculation based upon the outputs generated by rest of the model.
o For each year, we simply take EBITDA multiplied by a range of purchase multiples to get to a total Exit
Value for the company (Transaction Enterprise Value, or TEV).
o Next, we subtract out Net Debt (which is dependent on the 3-statement model you just created) to get to
Equity Value.
o Next, we calculate the portion of the Equity Value that belongs to the management and the sponsor by
using the initial equity breakdown for each party.
From there it’s important to calculate both the internal rate of return (IRR) and the cash-on-cash returns (also
known as the Multiple of Money or Multiple of Invested Capital). The only tricky part of this calculation is to
make sure that you’re calculating IRR correctly, by using the correct Net Present Value or IRR formula and
that, very importantly, you’re discounting by the right number of years! After all the mental energy you’ve
expended to get to this point, it’s easy to make this mistake.
o Put simply, the IRR is equal to the cash-on-cash returns compounded by the number of years, minus 1.
Thus, for example, for the 5-year, 5.0x Exit Multiple scenario:
IRR
53 ©2013 Street of Walls
3.4
1
5
1 3.40.2 1 0.276 27.6%
LBO Case Study: Conclusion and Final Comments
We hope that this case study provides some insight into all of the considerations that need to be made in building a
realistic LBO model based on a case study in a Private Equity interview, and that the 9-step breakdown helps you
simplify the task into easy-to-replicate and easy-to-execute steps.
No one becomes an expert LBO modeler overnight, so the key to doing well in this portion of the process is practice,
practice, and more practice. With enough sample LBO cases, you should be able to master the steps needed to
confidently build a fully functioning, professional LBO model on interview day.
Good luck with the modeling case and with the interviews!
54 ©2013 Street of Walls