Why Private Equity

passion for investing and that you want to apply your skill set to working hands - on with companies, building
businesses and creating value.

In private equity you do more analysis and due diligence. You ’ re taking a deeper dive into a company in which you
are considering investing, and it ’ s not just fi nancial diligence. You are looking into every aspect of a company,
including its management team, its insurance, its products, competitors, and so on. The level of analysis is nothing
like investment banking. You take a completely different approach. At a PE fund you have to have the mind - set
that this is our money and we ’ re going to have to live with our decision for a long time, so there is fi duciary
responsibility of being in PE. That leads to a much more thorough diligence process.

his middle market investment bank provides investment advisory, fairness opinion, solvency opinion, valuation
opinion, restructuring advisory, and portfolio management services to over 1,000 clients ranging from closely held
companies to Global 500 corporations. • Performed extensive modeling and quantitative valuation analyses,
including leveraged buyout, discounted cash flow, accretion/dilution, and merger analyses; constructed integrated
stand-alone and pro forma financial models. Completed covenant flexibility, borrowing base availability, cash flow,
and debt instrument analyses for clients on both financing and M&A transactions • Conducted due diligence,
analyzed potential synergies, and sensitized financial models • Conducted industry research (market size, market
share, industry trends, competitive landscape, c

#2 – What do you think this company does right? What do you think we
do wrong?
Tell the interviewers about the strengths of the company and what sorts of deals it has closed and
how it added value to its clientele

Why not work for Hedge Fund / Portfolio Company?

Tell all the pros of the private equity (great work environment, great peers, great fund
management etc.) and all the cons of hedge fund (high risk, huge uncertainty etc.). And then tell
the interviewer why you are perfect for private equity.

How did you help your previous company find value?

e. It can be creating operational efficiencies which saved cost on M&A deal, or it can be your
research which helped the company launched new services/product line.

What makes a great private equity associate/ researcher/deal-maker?

Private equity firms want three things –

 To find new, recurring & better investment opportunities.

 To make more money &

 To save more money.

What industry trends you will look at when you are looking for a
potential investment?
This is not exactly a technical Private equity interview question. For a PE candidate like you, it

would be easier to answer this question. Here’s what you should focus on while answering this

question –

 Market position & competitive advantage: Before LBO, it’s important to know the

market position & competitive advantage of the potential investment. The characteristics

would include high entry barriers, strong customer relationships & high switching cost.

 Stable & recurring cash flows: Without continuous and stable cash flow, no PE firm

would buy an investment.

 Multiple drivers to trigger growth: This one is crucial. Only one driver wouldn’t propel

the company to an expansive stage. More drivers, better-diversified growth strategies,

and better execution would be essential for long-term growth.

 Strong management: Most of the companies in the industry should have strong

management team so that the PE firm can get strategic

guidance toward better future.

These are the keys that a PE investor would look at before thinking of an LBO. Other than these,

he would also look at changing habits of the customer, enhanced automation, application of

disruptive technologies etc.

If I would like to protect my downside, how would I structure the
investment?
The best way to protect downside is to go for a structured deal, even at the later stage of the

investment. For example, in 2010, Temasek invested into GMR Energy through a structured

paper which needs to be compulsorily converted into equity. Temasek invested $200 million in

GMR through its fully owned subsidiary Claymore Investments.

What to learn for Private Equity

Structure – In this learn the Basic Structure of Private Equity, How to Structure a deal, Pre
money and post money concepts, what are participating preference shares and how to calculate
effective share price.
b) Private Equity Strategies – Here we discuss what strategies PE players deploy like Venture
Capital, Growth Capital, Leverage Buyouts, Real Estate. We also discuss the role of Banks in
PE and how its performances are measured.
c) Private Equity Fund – Here we discuss topics like PE Fund structure, Investment Funds, GP-
LP, Parallel Fund, Alternative Investment Vehicles, Feeder Funds, Co-investment Vehicles, what
are capitlal commitments, Carried Interest, Catch Up, Claw back, Fund Fees, Placement Agents,
Legal Documentation and Investment Management Agreement.
d) Business Plan – In this we discuss a step by step guide to prepare a financial model and
business plan for a private company. We also learn how to value a start up and calculate pre-
money and post-money valuations of the company. At the end, we look at the term sheet and
why it is important.

LBO analysis is similar to a DCF analysis. In LBO analysis one focuses on the IRR, projected

cash flows and the ability to pay debt and interest payments. The concept of a leveraged buyout

is very simple: Buy a company –> Fix it up –> Sell it. Usually, the entire plan is, a private

equity firm targets a company, buys it, fixes it up, pays down the debt, and then sells it for large

profits. In this Private Equity course on LBO modeling, we take the cash flow projections along

with IRR calculations of Seimens

If you want to improve IRRs, what different levers can be used?
This is a technical private equity interview question and you need to know the exact answer.

Here are some possible levers you can use –

 You can increase the amount of debt in the deal. It will increase the leverage.

 You can reduce the purchase price that the private equity company has to pay to buy out.

 You can also increase the company’s growth rate to enhance operating income / EBITDA

of the company.

What are the limitations of a DCF model?

1) The terminal value represents a disproportionately large amount of the value of the total business, and the
assumptions used to calculate the terminal value (perpetual growth or exit multiple) are very sensitive.
2) Another issue is that the discount rate used to calculate net present value is very sensitive to changes in
assumptions about the beta, risk premium, etc.
3) Finally, the entire forecast for the business is based on operating assumptions that are nearly impossible to
precisely pin down.

What are the most important factors in a merger model?

1) Synergies = Synergies enable the acquiring company to realize value by enhancing revenue or reducing
operating costs
2) The form of consideration (cash vs shares)= The mix of cash vs share consideration can have a major
impact on accretion/dilution of per share metrics (such as EPS). To make a deal more accretive, the
acquirer can add more cash to the mix and issue fewer shares.
3) Purchase price and takeover premium.

What indicators would quickly tell you if an M&A deal is accretive or dilutive?

The quickest way to tell if a deal between two public companies would be accretive is to compare their P/E
multiples. The company with a higher P/E multiple can acquire lesser valued companies on an accretive basis
(assuming the takeover premium is not too high). Another important factor is the form of consideration and mix of
cash vs share.

What assumptions is an LBO model most sensitive to?

1) The total leverage the business can service (typically based on the debt/EBITDA ratio)
2) The cost of debt
3) The acquisition or exit multiple assumptions. In addition, operating assumptions for the business play a
major role as well.
Given two companies (A and B), how would you determine which one to invest it?

Comprehensive analysis of both quantitative and qualitative factors:

 Business model – how they generate money, how the company works
 Market share/Size of the market – how defensible is it, opportunities for growth
 Margins & cost structure – fixed vs. variable costs, operating leverage and future opportunity
 Capital requirements – sustaining vs. growth CapEx, additional funding required
 Operating efficiency – analyzing ratios such as inventory turnover, working capital management, etc.
 Risk – assessing the riskiness of the business across as many variables as possible
 Customer satisfaction – understanding how customers regard the business
 Management team – how good is the team at leading people, managing the business, etc.
 Culture – how healthy is the culture and how conducive to success

All of the above criteria need be assessed in three ways: how they are in (1) the past, (2) the near-term future and (3)
the long-term future. This will be the basis of a DCF model (which will have multiple operating scenarios), and the
risk-adjusted NPV for each business can be compared against the price the business might be purchased at.

What do you know about us and why do you want to work at our firm?

Have a solid understanding of the firm’s approach to investing, their track record, who the founders and
management team are, and most important, what you like about their approach.

What do you think about some of our portfolio companies?

 Business model
 Management team
 The transaction the PE firm acquired them in
 The industry they operate in
 Their competitors
 Whatever else you can find out about them

What is our firm’s investment strategy?

Why do you want to work in private equity?

Walk me through your resume

What are your personal strengths and weaknesses?

What do you like to do when you’re not working?

How do you de-stress?

How do you manage risk in your personal life? How do you get to free cash fl ow? Walk me through an LBO that you
worked on. How would you model it? They grilled me on my deals, asking if I thought they were good ones — basically
anything on my resume was fair game.
What is Accretion Dilution Analysis?

Accretion and Dilution refer to a simple test that determines the impact of an acquisition or
merger on the buying firm’s Earnings per Share (EPS). Accretion Dilution analysis helps the
acquirer (buyer) weight the consequences of the merger, incorporating all factors and
complexities.

Accretion
An accretive acquisition or merger is one where the pro forma (post-deal) Earnings per Share is
greater than the acquirer’s (buyers) EPS before the deal is made.

Pro Forma (Post-Deal) EPS > Acquirer’s EPS

Dilution
A dilutive acquisition or merger is one where the pro forma (post-deal) EPS is less than the EPS
of the acquiring business when it stands alone/ before the deal is made.

Pro Forma (Post-Deal) EPS < Acquirer’s EPS

The test determines if the transaction is affordable for the acquirer and what synergy they may be
receiving and whether the reduced interest costs as they are repaid in the future leads to accretion
over time or not.

What is Value Added?

Value Added is the extra value created over and above the original value of something. It can
apply to products, services, companies, management, and other areas of business. In other
words, value-added is the enhancement made by a company/individual to a product or service
before offering it to the end customer.

Economic Value Added

Economic Value Added (EVA) can be defined as the incremental difference between a
company’s rate of return and its cost of capital.

Economic Value-Add is used to measure the value that a company generates from the funds
invested into it.

Where:
  NOPAT – Net Operating Profit After Tax is the profit generated by a company through
its operations after adjusting for cash taxes but before adjusting for financing costs and
noncash costs.
 CE – Capital Employed is the amount of cash that is invested in the business.
 WACC – Weighted Average Cost of Capital is the minimum rate of return expected by
the provider of capital, that is, the investors of the business.

EVA helps to quantify the cost of investing capital into a project. It also helps to assess whether
the project is generating enough cash to be considered a good investment. EVA indicates the
performance of a company on the basis of where and how the company created wealth.

Market Value Added

Market Value Added (MVA) can be defined as the difference between the market value of a
business and the capital invested by both the shareholders and debt holders.

MVA indicates a company’s capacity to increase shareholder value over time. A high MVA
indicates an effective management and strong operational capabilities whereas a low MVA can
indicate that the value of management’s actions and investments is less than the value of capital
contributed by the company’s investors.

Ways to do Value Addition for Customers

 Customer’s perspective – To understand what customers from the target market want
from the product or service of the company. Doing business according to customers’
expectations is something that many businesses miss out or fall short on.
 Improving customer satisfaction – To get the customer’s feedback through surveys
about the product or service, and then continue working to enhance customer satisfaction
delivered through the product or service.
 Customer experience – To provide customers with not only a satisfactory product or
service but also with satisfactory after-sales services to create a memorable experience
for the customer.
 Marketing – To implement a marketing strategy after well-informed market
research about what customers expect and what is the best way to make the product or
service available to customers.

How Private Equity Firms Work

In return for providing substantial funding, a private equity firm is usually recompensed as
follows:

 It obtains a controlling or sizeable minority equity interest in the company receiving

funds, sufficient to effectively provide the private equity firm with managerial control of
the company. It then utilizes that control to hopefully direct the company’s growth along
a path that maximizes returns on the private equity firm’s investment.
 It also receives a periodic management fee from the company receiving financing (for
example, an annual management fee equal to 2% of the total financing provided).
 For each capital fund that a private equity firm manages, it receives a share of yearly
profits, and a substantial share of the profits (a typical percentage is 20%-25%) when any
company the fund has invested in is sold privately or taken public through an initial
public offering (IPO). The investment horizon – the time frame for a private equity
investment paying off through a private or public sale of the company – is generally
between four to seven years. This means that within that time frame, the private equity
firm expects to be able to either profitably sell the company outright or relinquish its
equity interest in return for part of the proceeds from an IPO of the company.