WSO Private Equity Prep Package PDF

Private Equity
Industry & Interview Guide

How to Land Your Dream Job
Daniel Sheyne
Page 1
2014 Edition
Daniel Sheyner
Copyright 2014 by WallStreetOasis.com. All rights reserved.
All information in this guide is subject to change without notice. WallStreetOasis.com makes no claims as to the accuracy and reliability of this
guide and the information contained within. No part of this guide may be reproduced or transmitted in any form or by any means, electronic or
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ABOUT THE AUTHOR
Daniel Sheyner has worked as a Private Equity

investment professional for four years, the most recent
three years at Bain Capital Partners in Boston, MA.
Before Bain Capital he spent one year at Fidelity Equity
Partners, a middle market growth-LBO fund. Prior to
private equity, Daniel worked for three years as a
management consultant with Oliver Wyman in Chicago.
He is a graduate of the Math Methods in Social
Sciences (MMSS) program at Northwestern University
and is currently an MBA student in Harvard Business
School.
Daniel’s industry expertise stems from his years as a

pre-MBA Associate, study of the industry at HBS, and
over a hundred interviews with dozens of PE firms of
various types and sizes.

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TABLE OF CONTENTS
ABOUTTHEAUTHOR................................................................................................................................3
TABLEOFCONTENTS................................................................................................................................4
INTRODUCTION.......................................................................................................................................8
WhyIWroteThisGuide........................................................................................................................8
WhatThisGuideWillTeachYou..........................................................................................................8
HowtoUseThisGuide.......................................................................................................................10
CommonTraitsofSuccessfulPECandidates......................................................................................10
AsuccessfulPEcandidate:.................................................................................................................10
CHAPTER1:INDUSTRYOVERVIEW....................................................................................................11
INDUSTRYSTRUCTURE...........................................................................................................................12
BRIEFINDUSTRYHISTORY......................................................................................................................13
Origin(1946–1950s).........................................................................................................................13
EarlyGrowthStage(1950s–1981)....................................................................................................13
Thefirstboomandbust(1982–1992)..............................................................................................15
Thesecondboomandbust(1993–2002).........................................................................................16
Thethirdboomandbust(2003–2009).............................................................................................17
RecoveryandTheIndustry’sFuture(2010–)....................................................................................20
FUNDRAISING&DEALVOLUME............................................................................................................22
PEDEALTYPES........................................................................................................................................23
PEFIRMTYPES........................................................................................................................................24
Dimension1:Fundsize.......................................................................................................................24
Dimension2:DealStage....................................................................................................................25
Dimension3:VerticalFocus...............................................................................................................26
Dimension4:GeographicFocus.........................................................................................................26
Dimension5:DiligencePhilosophy.....................................................................................................27
FUNDECONOMICS.................................................................................................................................29
IllustrativeFundEconomicsExample.................................................................................................30
TITLESANDROLES..................................................................................................................................31
Analyst................................................................................................................................................31
Associate............................................................................................................................................31
SeniorAssociate/VicePresident(VP)................................................................................................32
VicePresident(VP)/Principal............................................................................................................32
Partner/ManagingDirector(MD)....................................................................................................33
NonͲInvestmentProfessionals............................................................................................................33
COMPENSATION....................................................................................................................................34
CHAPTER2:INDUSTRYOPERATIONS.................................................................................................36
DEALPROCESS.......................................................................................................................................37
Sourcedeal.........................................................................................................................................37
Reviewteaser&SignNDAtogetfullCIM..........................................................................................37
ReviewCIMandsubmitIOI................................................................................................................38
Dataroomreviewand“triage”diligence..........................................................................................38
DeepdiligenceandprofferofanLOI..................................................................................................39

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Closing................................................................................................................................................39
DEALSELECTION....................................................................................................................................40
DEALFUNNEL.........................................................................................................................................44
DEALLIFECYCLE......................................................................................................................................46
COMMONDILIGENCETOPICS................................................................................................................47
CommercialDiligence.........................................................................................................................47
ValuationDiligence............................................................................................................................48
AccountingDiligence..........................................................................................................................49
LegalDiligence...................................................................................................................... ..............50
HOWPEMAKESMONEY.............................................................................................................................51
Method#1:BuyCheap.......................................................................................................................52
Method#2:FinancialEngineering.....................................................................................................54
Method#3:ImproveOperations........................................................................................................55
Method#4:ExitRight.........................................................................................................................57
CHAPTER3:RECRUITINGOVERVIEW.................................................................................................59
COMMONPECAREERPATHS.................................................................................................................60
HOWTOBUILDAPEBACKGROUND......................................................................................................61
HighSchoolStudents..........................................................................................................................61
UndergraduateStudents....................................................................................................................63
PreͲMBAInvestmentBankers............................................................................................................70
PreͲMBAManagementConsultants..................................................................................................72
OtherPreͲMBABackgrounds.............................................................................................................73
MBAStudentswithPriorPEExperience.............................................................................................74
MBAStudentswithoutPriorPEExperience.......................................................................................75
RECRUITINGCYCLE.................................................................................................................................76
PreͲMBA.............................................................................................................................................76
PostͲMBA............................................................................................................................................78
HOWTOWORKWITHRECRUITERS........................................................................................................80
Whatdorecruitersdo?.......................................................................................................................80
Howdorecruitingfirmsdiffer?..........................................................................................................80
Whosesidearerecruiterson?............................................................................................................81
ShouldIworkwithrecruiters?............................................................................................................81
HowdoIcontactrecruiters?..............................................................................................................82
HowdoIgetthemostoutofrecruiters?...........................................................................................83
HOWTOCHOOSEANOFFER..................................................................................................................86
Topic1:Upwardmobility...................................................................................................................86
Topic2:JobSecurity...........................................................................................................................87
Topic3:ExitOpportunities.................................................................................................................88
HowdoIevaluatethesetopics?.........................................................................................................90
HOWTOWRITEYOURRESUME.............................................................................................................92
WhatyourCVMustSayAboutYou....................................................................................................92
CVTips................................................................................................................................................93
StandardPEResumeTemplate..........................................................................................................94
CHAPTER4:INTERVIEWPREPARATION.............................................................................................96

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INTERVIEWPROCESS.............................................................................................................................97
PhoneScreen......................................................................................................................................97
EarlyRounds.......................................................................................................................................97
ModelingTest.....................................................................................................................................98
Late/DecisionRounds.......................................................................................................................98
WHATISANLBO?...................................................................................................................................99
INCOMESTATEMENTOVERVIEW........................................................................................................101
BALANCESHEETOVERVIEW.................................................................................................................104
CASHFLOWSTATEMENTOVERVIEW...................................................................................................105
FINANCIALSTATEMENTCONNECTIONS..............................................................................................108
IncomeStatementandCashFlowStatementLinks.........................................................................109
BalanceSheetandCashFlowStatementLinks................................................................................110
CAPITALSTRUCTURE............................................................................................................................111
Equity................................................................................................................................................111
Debt..................................................................................................................................................112
LBOCapitalHierarchy.......................................................................................................................113
Covenants.........................................................................................................................................114
COMMONVALUATIONTECHNIQUES..................................................................................................116
ComparableMultiples......................................................................................................................116
PrecedentTransactions....................................................................................................................118
MarketValue....................................................................................................................................119
LBOModel........................................................................................................................................119
DiscountedCashFlow(DCF).............................................................................................................120
SumͲofͲtheͲParts..............................................................................................................................121
COMMONCALCULATIONS...................................................................................................................122
TotalEnterpriseValue(TEV).............................................................................................................122
FreeCashFlow(FCF)........................................................................................................................122
WeightedAverageCostofCapital(WACC)......................................................................................123
CostofEquity(ViaCAPM)................................................................................................................123
NetWorkingCapital(NWC).............................................................................................................125
ChangeinNWC.................................................................................................................................126
CalculatingReturns(IRR&MoM)....................................................................................................126
TerminalValue(TV)..........................................................................................................................128
DebtCoverageandLeverageRatios................................................................................................130
TOP30TECHNICALQUESTIONSANDANSWERS..................................................................................131
TOP15FITQUESTIONS&ANSWERS....................................................................................................150
PersonalattributesPEfirmslookfor................................................................................................150
FitQuestionsandAnswerApproaches.............................................................................................152
TOP10BRAINTEASERQUESTIONS&ANSWERS..................................................................................169
CHAPTER5:LBOMODELING............................................................................................................174
INTRODUCTIONTOLBOMODELINGTESTS..........................................................................................175
THEPAPERLBO....................................................................................................................................176
PaperLBOExample..........................................................................................................................176
THEBASIC(1ͲHOUR)LBO.....................................................................................................................182
BasicLBOExample...........................................................................................................................182

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THEFULL(3ͲHOUR)LBO.......................................................................................................................199
FullLBOExample..............................................................................................................................200
FinalThoughtsonLBOModelingTests............................................................................................229
APPENDIX.......................................................................................................................................232
SAMPLECVSOFSUCCESSFULPECANDIDATES.....................................................................................233
COMMONTERMSGLOSSARY...............................................................................................................237

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INTRODUCTION
Why I Wrote This Guide
My journey into PE featured innumerable ups, downs, and false starts. Throughout the process
I never felt sure that I was doing the right things to succeed, and the many setbacks I
experienced caused me to consider giving up several times. When I first set out to recruit for
PE, I searched everywhere for a single resource which could teach me the bulk of what I
needed to know, but no such resource existed. I owe my success in equal parts to
perseverance, luck, and the aid of several friends who cumulatively taught me enough bits and
pieces to finally get my foot in the door. This guide is the single resource I wish I had when I
was recruiting. In writing this guide, my aim is to demystify the PE recruitment process and
give future candidates the tools they need to approach it with confidence. My sincere hope is
that readers of this guide will have a much smoother ride in landing their dream job than I did.
Welcome to the PE Prep Package
[Placeholder: Video in future versions]
What This Guide Will Teach You

This guide will help you stand out by teaching you not only the technical aspects of the PE
industry, but also its history and the operating principles which drive it. Some candidates
assume that technical expertise is enough to break into PE, but there are far more technically
competent candidates than there are available PE jobs. This guide will help you graduate from
sounding like an analyst to thinking like an investor. Topics covered in this guide include:
- PE history so you can better demonstrate your passion for the industry

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- What a career in PE looks like so you can decide if it’s a good fit for you
- How PE firms differ in investing and recruiting so you can better target your search
- Which recruitment channels PE firms use so you can position yourself in advance
- How the recruiting cycle and the interview process are structured
- How PE firms make money so you can demonstrate your “investor judgment”
- The most important accounting, finance and deal-related concepts
- How to prepare your resume to increase your odds of getting interviews
- How to answer common Technical, Fit, and Brainteaser questions based on hundreds
of real life interview questions
- How to build and interpret an LBO model to pass a modeling test
- How to best utilize recruiters and choose between multiple offers
- And more…
You will notice throughout the guide that there are video placeholders. These are videos we
plan to add for the next version of the guide (they will redirect to the WSO Video Library) to
make it more interactive and in order for us to dive deeper into particular concepts you should
focus on. We expect to complete final production on these videos within 12 – 18 months of the
initial release of this package. As always, you are entitled to any and all upgraded versions of
the guide for free. We will make an announcement on WSO and e-mail all previous customers
when the new version is ready, so there is no need to do anything at this time.

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How to Use This Guide
This guide, along with its companion Excel files and 1-year access to the WSO Company
database are designed to teach you the bulk of what you need to know to succeed in PE
recruiting all in one comprehensive package. I assume a basic level of proficiency with finance
and accounting, but most of this guide should be accessible to any serious candidate. I focus
on Leveraged Buyout PE firms in the USA, but the principles are broadly applicable to both
earlier stage and international firms. I encourage you to read through the guide in the order
presented, but feel free to skip around if you are already familiar with certain sections. Do not
forget the resources available to you in the nine companion Excel modeling tests and in the
WSO Company database which contain data on hundreds of PE firms and their individual
recruitment processes.
Common Traits of Successful PE Candidates

A successful PE candidate:
- Plans months or years in advance for his/her opportunity to break in
- Is passionate about the industry and knowledgeable about its history
- Has a strong grasp on the PE investment process and due diligence practices
- Has the required technical and quantitative skills down cold
- Has excellent communication skills and displays their “investor’s judgment”
- Prepares diligently for interviews and leaves as little as possible to chance

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Chapter 1: Industry Overview
In this chapter… This chapter is a high level overview

x Industry Structure
of the industry and it evolved. This
x Industry History
x PE Deal Types chapter also explains the
x PE Firm Types differences between various deal
x PE Fund Economics
types, firm types, and professional
x Titles & Roles
x Compensation
roles, and discusses both PE fund
economics and compensation.

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INDUSTRY STRUCTURE
Private equity and venture capital (henceforth referred to collectively as PE) is an industry
which primarily buys pieces (equity) of companies with the goal of selling this equity 3 - 7 years
later at a profit. The funding for these investments comes primarily from a group of investors
known as limited partners (LPs). Typical LPs include endowments, pension funds, sovereign
wealth funds, wealthy individuals, and large corporations. Funding pledged by these LPs is
pooled into individual PE funds which are managed by general partners (GPs) who are co-
owners of a PE firm. These PE firms use the money in their respective funds to make
investments (deals) in a broad range of public and private companies with the hope of selling
them some day for large profits. When these investments make a profit, the PE firms return
about 80% of profit to their LPs along with the LPs’ original investment and keep the
remainder. This remainder, referred to as carried interest or carry, is split among the GPs. In
addition to this carried interest, LPs also pay an annual management fee to PE firms,
amounting to about 2% of total assets under management (AUM)1. When a PE firm is close to
fully investing one of its funds, it usually attempts to raise a new fund for further investments.
Industry Structure Diagram

2% management fee paid to PE Firm annually
LPs PE Firm
General Partners
X
(GPs)
& Other Employees
$ From LPs pooled into PE funds
Y
Fund Fund Fund

Z
I II III
PE firm uses funds to do deals

Deals
A B C
Principle & 80% of profit to LPs 20% of “carried interest” profit to PE Firm
1
20% carry and 2% management fees are industry standards, but can vary from firm to firm and fund to fund

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Here’s An Easy Way to Think of Carry
[Placeholder: Video in Future Version]
BRIEF INDUSTRY HISTORY

The exact origin of PE is hard to pin-point because people have been making private
investments in various assets for centuries. However, the modern asset class we know as
Private Equity traces its roots to the 1940s and has grown to its tremendous size through an
escalating series of booms and busts.2
Origin (1946 – 1950s)

Prior to 1946, private equity and venture capital investments, then known as development
capital, were done on an ad-hoc basis by wealthy groups and individuals using their own
capital. The modern PE industry began in 1946 with the founding of American Research and
Development Corporation (ARDC) and J.H. Whitney & Company (JHW). These early PE firms
raised 3rd party (limited partner) capital to make some milestone investments. For example, in
1957 ARDC invested $70 thousand in Digital Equipment Corporation (DEC), a stake valued at
$355 million by 1968 during DEC’s IPO (500x+ MoM return). JHW’s most famous investment
was in Florida Foods Corporation, now known as Minute Maid, which was sold to Coca-Cola in
1960. The headline grabbing successes of these two innovators brought several imitators to
market, and a new industry was born.
Early Growth Stage (1950s – 1981)
2
Industry history based on Wikipedia and other public sources

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The halcyon days of early stage venture capital focused on providing start-up and growth
capital to technology-related companies, mostly in or around Silicon Valley. In Menlo Park, the
first wave of venture capitalists clustered around Sand Hill Road to be near the action. This
was the time when the famous “2 & 20” model of 2% management fees and 20% carried
interest coalesced as the industry standard. Many of today’s blue chip VC firms got their start
in those days including Sequoia, Draper Fisher Jurvetson, and Kleiner, Perkins, Caufield &
Byers. Some of today’s top growth equity firms also got their start during this period including
TA Associates, Apax Partners, New Enterprise Associates and Oak Investment Partners.
These companies were instrumental in financing the inception and expansion of many of the
era’s most successful technology firms including Genentech, Apple Inc., Electronic Arts,
Compaq and Federal Express. Industry growth during this stage was steady with the exception
of a bust in 1974 which coincided with a recession that same year.
During the same period, late stage PE got its start. The first practitioners of leveraged buyout-
style (LBO) investing actually weren’t PE funds, but rather were publically traded holding
companies which employed leverage to buy other companies to form conglomerates. Early
practitioners of this model included Warren Buffett of Berkshire Hathaway, Victor Posner of
DWG Corporation, Nelson Peltz of Triarc, and Saul Steinberg of Reliance Insurance. These
investors may be seen as the forbearers of independent, pure-breed LBO funds because they
frequently targeted the same types of investments and used similar methods. In fact, Victor
Posner is commonly credited with popularizing the term “leveraged buyout”.
What we now think of as late stage LBO firms came into being in the mid-1970s with the
formation of Kohlberg Kravis Roberts (KKR) and Thomas H. Lee Partners (THL). Jerome
Kohlberg, Henry Kravis and George Roberts had spent the1960s and 1970s at investment
bank Bear Stearns using leverage to buy family-owned companies too small to go public and
no interest in selling out to a larger competitor. Some of their earliest deals included Orkin
Exterminating Company (1964), Stern Metals (1965), Incom (1971), Cobblers Industries
(1971), and Boren Clay (1973). In 1976, after a dispute with Bear Stearns, the three partners
founded KKR and closed their first institutional fund of $30 million in 1978. During that year
KKR set the record for the largest take-private to-date with their acquisition of Houdaille
Industries for $380 million. Founded in 1974, THL had actually beaten KKR to the punch in
focusing on LBOs of mature businesses. However, because THL’s early deals were smaller,

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they did not shoot to the top of the industry until the 1990s. Other top tier LBO firms that got
their start during this period and are still in business today include Cinven; Welsh, Carson,
Anderson & Stowe; Candover; and GTCR.
The first boom and bust (1982 – 1992)

The LBO industry took off like a rocket in the 1980s with fundraising growing tenfold from
~$2.4 billion to ~$22 billion annually between 1980 and 1989. Many factors drove this growth:
- The Employee Retirement Income Security Act (ERISA) of 1974 allowed corporate pension
fund managers to invest in PE and in the leveraged loans which fund LBOs.
- In 1981 the tax rate on capital gains (which is how carry is taxed) fell from 28% to 20%.
- Relaxed lending standards allowed LBO companies to buy targets with little equity (and
correspondingly high equity returns). The most famous example of this phenomenon is
Wesray Capital’s acquisition of Gibson Greetings in 1982 for ~$80 million while paying only
~$1 million in equity and the rest in debt. This deal made Wesray a $66 million profit when
Gibson Greetings IPOed at a $290 million valuation sixteen months later.
- Strong economic growth and a rising stock market created attractive exit opportunities.
- The high yield debt (or “junk bond”) market, driven by Michael Milken of Drexel Burnham
Lambert ballooned during the mid-80s and provided cheap, abundant leverage.
Several of today’s PE titans were founded during this period including Bain Capital, the
Blackstone Group, The Carlyle Group, and Hellman & Friedman. There are countless famous
deals during this period which peaked in 1989 with KKR’s $31 billion LBO of RJR Nabisco, the
largest LBO of all time for 17 years and inspired the book Barbarians at the Gate.
The industry hit a major speed bump during the early 1990s for the following reasons:
- The reckless use of leverage in the mid-late 80s took a toll as several high profile LBOs
went bankrupt including Federated Department Stores, Revco Drug Stores and Walter
Industries. Even the famous Nabisco ran into trouble and required an additional $1.7B
equity infusion from KKR.
- The high yield debt market collapsed in 1989 as Michael Milken was charged with stock
manipulation and Drexel Burnham Lambert went bankrupt, drastically increasing the cost of
leverage and making some refinancing impossible.
- The Savings & Loan crisis triggered a recession and forced many banks to exit the high
yield market.

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Despite this challenging environment several top PE firms such as Apollo Management, TPG
Capital, and Madison Dearborn were founded in the early 1990s.
The second boom and bust (1993 – 2002)

PE regained its stride in 1993 and grew steadily through the rest of the decade, buoyed by a
strong bull market and the resurgence of leverage financing. Fundraising, which had stagnated
at ~$21 billion in 1992, surged to ~$240 billion by 2000. Some key developments during this
era include:
- In the 1980s, fairly or not, PE was associated with corporate raiders, hostile take-overs,
and asset stripping (e.g. Wall Street, the movie). Many firms were wary of PE in the 1980s
and adopted defensive measures such as poison pills to ward off would-be interlopers. In
the 1990s, however, PE gained a newfound public respectability as most PE firms focused
on partnering with management teams instead of employing adversarial tactics. PE’s focus
shifted toward building businesses and turning around struggling companies rather than
optimizing capital structures. Consequently, corporate boards and management teams
became better disposed to PE advances.
o One of the best examples of this contrast is TPG’s friendly turn-around of
Continental Airlines in 1993 vs. Carl Icahn’s hostile takeover of Trans World Airlines
(TWA) in 1985. Icahn stripped and sold pieces of TWA to pay down the debt he had
used to acquire the company. TPG, on the other hand, saved Continental from
liquidation by recruiting a better management team, increasing aircraft utilization,
and refocusing on profitable routes.
- Whereas leverage levels of 85-95% of total purchase price were common in the 1980s, the
post junk bond bubble world normalized closer to 70-80%. This development forced PE

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firms to put “more skin in the game” and discouraged some of the wild gambling and
speculation which characterized PE’s “wild west” days.
- With PE’s newfound respectability many large, conservative, institutional money managers
became interested in PE’s high returns. David Swensen, the Chief Investment Officer of
Yale University’s endowment fund, was one of the first major proponents of endowment
investment in alternative assets like PE. Pension funds like CALPERS also got into PE in a
big way for the first time in the 1990s. Since endowments and pension funds manage
capital pools of tens or hundreds of billions of dollars they quickly became and remain the
dominant funding source for PE.
The bursting of the internet bubble in 2001 and the subsequent recession again put the brakes
on PE’s growth as credit markets dried up. Furthermore, many PE firms, who invested heavily
in telecommunications and technology companies, got burned. The highest profile PE
casualties of this downturn were two of the industry’s earliest titans, Forstmann Little &
Company and Hicks Muse. Both fundraising and the rate of new investments stalled in 2001 –
2002. In 2000 there had been 27 LBOs in excess of $500 million, but only six such
transactions occurred in 2001. The European LBO market surpassed the US for the first time
(oh no!). Although there were fewer large deals during this period, the low multiples paid during
the depths of the recession ensured that most of the deals that were done became unusually
successful.
The third boom and bust (2003 – 2009)

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PE’s most recent boom, sometimes referred to as “the golden era”, brought PE to
unprecedented heights. In 2006, PE companies completed $696 billion worth of deals, roughly
5x higher than the 2003 total. In 2007, PE raised $663 billion of fresh commitments, ~3x higher
than the 2000 peak. 13 of the 15 largest deals of all time happened between 2005 and 2008.
For the first time ever, PE companies began to go public themselves, with IPOs by the
Blackstone Group and KKR between 2006 and 2008. Deal sizes ballooned to massive
proportions. The record was set in 2007 when KKR, TPG and Goldman Sachs bought Texas
utility TXU for a whopping $44 billion. Other mega deals included Equity Office Properties ($39
billion by Blackstone), Hospital Corporation of America ($33 billion by Bain Capital, KKR and
Merrill Lynch), and First Data ($29 billion by KKR and TPG). For a while it seemed like any
company could be a PE target. There were rumors that LBOs of old blue chips like IBM and
General Motors had been considered. For a few years, PE bosses replaced bulge bracket
bankers and hedge fund managers as the kings of Wall Street.
This unprecedented boom was driven by several factors:

- The mid 2000s witnessed a huge swell in securitization by investment banks through
instruments such as Collateralized Debt Obligations (CDOs) and Collateralized Loan
Obligations (CLOs). Investment banks were able to raise large amounts of leverage capital
by bundling leveraged loans into aggregated pools and slicing them into different tranches
which were rated to have different levels of riskiness including some which were rated AAA
(very safe). This securitization allowed banks to raise leverage capital from many new
investors with limited or specific risk appetites. For example, some investors like insurance
companies considered leveraged loans too risky and therefore did not historically invest in
them. However, insurance companies were happy to invest in the AAA-rated tranches of
CLOs/CDOs. Securitization significantly increased the supply of leverage available for
LBOs while simultaneously lowering its interest rates.
- As more investors rushed in to provide leverage financing, investment banks began to
compete with each other for their share of the lucrative financing and securitization market.
In order to be chosen as debt providers, banks relaxed their lending standards by requiring
less equity and offering covenant-lite loans. Consequently, the looser lending standards
allowed PE firms to push the limits of their risk tolerance in their deals.
- Endowments and pension funds further increased their PE allocations, having seen terrific
overall returns over the past 10-15 years. In addition, new institutional investors began to

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heavily allocate so PE, including Sovereign Wealth Funds, which manage hundreds of
billions of dollars of capital on behalf of national governments.
- One of the hallmarks of this era was the “club” deal. Nearly all of the largest deals were
done jointly by two or more PE sponsors. When a deal required an equity check which was
too large for any single sponsor, PE firms routinely formed consortiums that bid on assets
jointly to share the risk and equity commitment.
The party came to an abrupt halt in 2008 with the onset of the mortgage meltdown, credit
crunch and Great Recession. When the lights came on and everyone saw what kind of loans
they had gotten in bed with … things got ugly pretty fast. Credit markets seized up and
CLO/CDO markets stopped operating virtually overnight. The stock market plummeted as did
the value of publicly traded leveraged loans. Many LPs were hit by a “denominator effect”
when the market values of their public portfolios fell along with the stock market. For example,
some LPs were bound to hold no more than 5% of their total assets in PE. When the value of
their total portfolio fell by ~30-40% suddenly their remaining commitments to PE represented
much more than 5% of the total. Such LPs attempted to sell their PE stakes on the secondary
market at fire-sale prices and could not fund additional commitments. Even though PE firms
nominally had a lot of money to spend from their 2005-2007 fundraising, few owners wanted to
sell during the recession and were focused on keeping their existing portfolio companies afloat.
As a result, deal volumes fell by 75 – 85% and fundraising fell by more than 50% (buoyed
somewhat by the long-cycle nature of fundraising). Practically the only few who did well in this
environment were distressed debt investors, restructuring advisors and everyone’s favorite:
bankruptcy lawyers.

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Recovery and The Industry’s Future (2010 – )3
The PE industry has experienced a tepid recovery from “The Great Recession” between 2010
and 2013, mirroring those of the US and global economies’. Both fundraising and deal activity
rebounded from their recent lows but remain far below their 2007 peaks. The following are
some of the important developments that have taken place during the ongoing recovery period:
- The leveraged debt markets have recovered as investors search for yield in a low interest
rate environment. Leverage multiples are back near their ’05-’07 levels while the cost of
leveraged debt is near all-time lows. This development has brought life back into large
LBOs as each year brings several LBOs with values between $1 billion and $10 billion.
However, there have been no mega LBOs over $10 billion and almost no club deals.
- PE portfolio companies largely experienced far fewer defaults than initially feared as PE
firms successfully cut costs and refinanced debt.
- The strong stock market rebound has finally given PE firms an opportunity to exit long-held
investments, leading to a rush of PE-backed IPOs between 2011 and 2013.
- LPs have begun to shift LBO commitment dollars away from mega buyout firms and toward
middle market firms thus accelerating several trends:
o The mega funds are all seeing their fund sizes shrink from the peak in some cases
by as much as 50%
o In response, mega funds are continuing to diversify into other asset classes such as
public equities, debt, middle market and wealth/asset management
o Some middle market funds have done well and raised larger funds (e.g. Berkshire
Partners, Leonard Green, Hellman & Friedman, GTCR)
- Since LPs have shown a strong interest in emerging markets, global PE firms are raising
local-currency funds in the BRIC nations and beyond.
- The industry shakeout is ongoing and will continue for some time. Since PE funds are
committed for periods of 10+ years, there are still many “zombie” PE firms out there which
are still in business from their 2005-2008 fundraising but will never raise another fund.
- There are no reliable statistics on industry hiring levels, but the general feeling is that it’s a
“buyer’s market”. There are fewer opportunities than before: many professionals who were
3
Bain and Company Global PE Report 2013

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hired during the peak are looking for jobs, fewer people are being promoted and
promotions are taking longer to achieve.
Thoughts for the future

- The PE industry is maturing so it is no longer as financially attractive as it once was.
However, the industry remains one of the most interesting and rewarding careers you could
choose.
- While the employment outlook is a little dull at the moment, look to history and take heart.
The industry has experienced three busts already and has come back stronger than ever.
- As an industry veteran once quipped, “There will always be another bubble … just make
sure that when it comes you’re sitting in the right chair.”
Know This 1 Fact About PE History

For Your PE Interviews

Page 21

FUNDRAISING & DEAL VOLUME4
Global PE Capital Raised by Fund Type
US Buyout Deal Value
4
Bain & Company Global PE Report 2013

Page 22

PE DEAL TYPES
PE deals come in all shapes and sizes. There is no easy or perfect way to characterize the full
universe of PE deals, but the following charts provide a useful guide:
PE Deal Types Table

Target Investment
Lifecycle range in $mm
Stage Deal Type Deal Description (% leverage) Biggest Drivers of Returns
- The earliest dollars into a new start-up - Heavy emphasis on revenue or
besides founder/family bootstrapping customer/user growth
0.5 – 5.0
Seed Capital - Provided by angel investors or VCs - Achieving profitability or at least
(0%)
- Typically a minority stake (5-10%), taken demonstrating the potential for
Startup as preferred equity and/or warrants profitability
(Early - Frequently the first institutional money, - Heavy emphasis on revenue or
Stage) provided by VCs to fund the expansion of customer/user growth
Venture Capital an unprofitable high-growth start-up 5 – 25 - More emphasis on achieving
(VC) - Typically a minority stake (5-10%), taken (0%) profitability relative to seed stage
as preferred equity and/or warrants
- Several rounds of funding are common
- Capital to help a young, profitable, high - Heavy emphasis on revenue growth
Growth Equity growth business to grow faster 10 – 100 - Profit margin expansion
Growth (GE) - Typically a minority stake (10-30%), (0%) - Exit multiple expansion
(Mid Stage) common/preferred equity, or warrants
- Same as GE, except a majority stake 20 – 200 - See Growth Equity, plus a little extra
Growth Buyout
- Occasionally employs light leverage (0% - 50%) return due to use of leverage
Private - Purchase of a large common or preferred - Growth of target’s stock price which
Investment in equity stake (5-20%) in the stock of a 25 – 500 appreciates in part due to the target’s
Public Equity publicly traded company (0%) utilization of cash from the PIPE
(PIPE)
- See LBO, except the investors purchase - See LBO, with some extra emphasis
Carve-out / 25 – 5,000+
a part (often non-core) of a bigger on improving the operations of what
Divestiture (50% - 80%)
company rather than the whole thing are frequently under-managed assets
- Majority control takeover of the equity of - Use of target’s free cash flow to pay
Mature
a profitable, mature (usually lower down debt (sometimes this is the top
(Late Leveraged 50 – 10,000+
growth) public or private business driver of LBO returns)
Stage) Buyout (LBO) (50% - 80%)
- Frequently utilizing a high debt/equity - Revenue and profit margin growth
ratio to fund the takeover - Exit multiple expansion
- The purchase, at a discount, of the debt - Whether investing in distressed
or equity of a company at risk of default equity or debt the key is almost
Distressed - Corporate restructurings, bankruptcies, 10 – 5,000+ always either correctly predicting that
Investment and financial covenant breaches are (0% - 95%) the target won’t default or helping it to
typical sources of distressed investment turn around its operations and
opportunities achieve solvency

Page 23

PE Deal Types: The 2 You Need to Know Best
PE FIRM TYPES
Much like deal types, there are many distinguishing characteristics of PE firms which impact
how they operate and whom they hire. The following five dimensions highlight the major
differences:
Dimension 1: Fund size

- Description: The larger a firm’s latest fund size, the larger its average deal size. PE firms
don’t want to invest too much of their available funding in any single deal because the deal
may lose money. As a good rule of thumb, a PE firm wants to make on average 10 – 12
investments out of each fund to remain diversified.
- Examples: GTCR’s 2011 fund is ~$3 billion so they’re unlikely to invest more than ~$300
million of equity in any single deal. Hellman & Friedman’s 2009 fund is ~$9 billion so their
average deal size is likely to be roughly 3x that of GTCR’s.
- Impact on hiring: PE firms want to hire investment professionals (IPs) with experience
doing the types of deals in which they specialize. For example, Hellman & Friedman is
more likely to hire an associate from a bulge bracket bank like Morgan Stanley, whereas
GTCR may look more favorably on applicants from middle market banks like Harris
Williams. Meanwhile, smaller PE firms are, in general, somewhat more likely to consider
candidates with non-traditional backgrounds.

Page 24

Dimension 2: Deal Stage
- Description: Most PE funds fall roughly into the three target lifecycle stage categories from
the previous section: Early Stage (Startup), Mid Stage (Growth) and Late Stage (Mature).
Most PE firms focus on targets and deal types within their deal stage category. Of course
some firms that focus on a particular stage do some deals in other stages. For example
there are many VCs that focus on early stage deals but do some growth equity deals
opportunistically. There are also some growth equity specialists that have done LBOs,
while some LBO shops have done growth equity. While it’s not unusual for the lines to get a
little blurred, it’s rare for firms to stray too far from their focus since deals at different stages
require very different expertise and relationships, and they drive their returns in different
ways. If single firm does want to focus on multiple stages, it typically creates separate
targeted internal funds and divisions to do so. Another general rule is that firms that focus
on later stages usually (but not always) have larger fund sizes because later stage deals
usually require larger equity checks. In fact, some successful firms over time tend to
migrate up the stage ladder to increase their AUM (and associated fees).
- Examples: Clayton Dubilier & Rice is a classic example of a dedicated late stage firm.
Summit Partners is a famed mid-stage player. Flybridge Capital is an early stage VC.
Meanwhile,TPG is an example of a firm that participates in all stages through different
internal funds: TPG Capital pursues large late stage LBOs, TPG Growth pursues mid stage
growth buyouts and growth equity, and TPG Biotech funds early stage life sciences
startups. Bain Capital is an example of a firm founded originally to focus on early stage
venture deals but has since migrated over the decades to the large cap LBO space.
- Impact on hiring: Deal stage focus has the largest impact on hiring of all five dimensions
because doing deals at different stages require different skills, relationships, and expertise:
o Late stage firms tend to use a lot of leverage and take majority positions in larger
companies. Therefore, they require investment professionals with LBO modeling
experience and relationships with large banks and CEOs of mature businesses.
Consequently, late stage firms tend to heavily focus on hiring investment bankers
and, to a lesser degree, management consultants with large cap finance and due
diligence experience.
o Early stage firms don’t use leverage and rarely build detailed models because their
investments are highly unpredictable. Therefore early stage firms focus much less

Page 25

on hiring people with a deep finance background or modeling skills but require
access to a broad network of entrepreneurs and deep vertical expertise in order to
choose future winners. They also tend to need operating expertise because some of
the startups they fund need help with both setting and executing strategy. As such,
early stage firms tend to hire people with startup experience, domain expertise
(engineering, bio-tech, software, etc.) and operating skills.
o Mid stage firms require a blend of expertise somewhere between the two stage
extremes, so they tend to hire a more unpredictable blend of IPs from both camps.
Mid stage firms are, as a general rule, more open to management consultants than
late stage firms.
Dimension 3: Vertical Focus
- Description: Some firms are generalists and will look at any type of business whereas
others specialize in a single industry or a handful of industries.
- Examples: KKR’s PE group has invested in businesses across 15 verticals and would
consider an investment in nearly any industry. Berkshire Partners, on the other hand,
generally limits itself to Business Services, Communications, CPG/Retail, Industrials and
Transportation. On the other extreme, Silver Lake is known for focusing almost exclusively
on technology and tech-enabled businesses.
- Impact on hiring: PE firms generally favor applicants with experience in their target
verticals.
Dimension 4: Geographic Focus

- Description: PE firms focus on different ranges of geographies depending on where they
have offices, where they have local expertise, and which industry verticals they target. A
PE firm typically won’t invest much in a region where they have no office. There are about
12-15 large PE firms with a truly global footprint, hundreds of regional firms, and thousands
of national/local firms.
- Examples: Large firms like Carlyle and Bain Capital have offices in and focus on dozens of
countries globally. Smaller firms like Madison Dearborn and Hg Capital focus on single
regions (North America and Europe respectively). There are also even smaller firms which
focus on a single country or niche geography like Gavea Investmentos and Teakwood
Capital (Brazil and Texas, USA respectively).

Page 26

- Impact on hiring: PE firms generally favor candidates with ties to and experience in their
target geographies. Local language skills are also valued where English is not the primary
language. For companies with many regional offices, candidates may have the most luck
applying to offices in geographies to which they have ties.
Dimension 5: Diligence Philosophy

- Description: This dimension is least clearly defined and most open to dispute. However,
there is some difference between firms with an “industry diligence” philosophy vs. a
“financial engineering” philosophy. There are some firms which have especially excellent
lender relationships and capital structure optimization skills. Such firms tend to focus a bit
more of their diligence effort on the finance side and outsource a bit more of their industry
diligence to 3rd party advisors. A few other firms view industry diligence as core to their
investment process and tend to do more of it in-house. Firms founded by ex-bankers
gravitate somewhat to the financial engineering side while firms founded by ex-consultants
gravitate somewhat to the industry diligence side.
- Examples: KKR and Blackstone both carry heavy banker genes and have a reputation for
a historical focus on financial engineering (though they would likely dispute this
categorization today). Bain Capital and its offshoots like Golden Gate and Audax come
from a consulting lineage and focus a lot on in-house industry diligence.
- Impact on hiring: Most PE firms hire investment bankers, but the firms with a financial
engineering skew hire bankers almost exclusively. Just take a look at their investment
professionals’ bios online. The few firms who focus deeply on industry diligence hire more
consultants but are still typically open to bankers.

Page 27

PE Firm Types – 3 Key Takeaways for Recruiting

Page 28

FUND ECONOMICS
While the full details of PE fund economics are very complex, at a high level it is simple. PE
funds generate nearly all of their revenue from management fees and carried interest.
Management Fees
Management fees are meant to cover a PE firm’s annual operating budget. Fees enable the
firm to make new investments and manage their existing portfolio. Since new PE investments
take several years to pay off, LPs pay management fees to the PE firm based on a percentage
of the PE firm’s Assets Under Management (AUM). This percentage differs from fund to fund
and year to year. It can be calculated based on assets committed or actually deployed by the
PE firm. As many PE firms’ fund sizes have ballooned rapidly, their revenues from
management fees have grown faster than their operating expenses and have become a
source of significant profit. However, limited partners have gotten wise to this game, and
management fees are declining from their historical 2% rate, especially for large funds.
Carried Interest
Carried interest is the PE firm’s share of profits generated by its investments and is the primary
incentive for GPs to make highly profitable investments. The basic concept is that GPs use
LPs’ money to make investments and keep a percentage of the profits (usually ~20%) after
returning principal. The lion’s share of carried interest is reserved for a PE firm’s senior MDs,
with junior IPs participating on a limited basis or not at all. Carried interest can be earned on
profits from successful exits and dividend recapitalizations. In order to earn full carried interest,
a PE fund typically has to generate returns in excess of a hurdle rate (usually ~7-8%). Because
the way performance vs. hurdle rate is calculated and the way carried interest is actually paid
out to GPs in real life can get very complicated, it won’t be covered in this guide.
Other Revenue Sources

PE firms get revenue from other sources which typically produce less than 10% of the total:
- Deal fees: When a PE firm closes a deal, it frequently charges the target a deal fee
calculated as a small % of the total deal size. These fees are often shared with LPs.
- Monitoring fees: Portfolio companies frequently pay nomina fees to their PE owners as
compensation for the owners’ ongoing monitoring and managerial assistance.

Page 29

Illustrative Fund Economics Example
A successful PE fund is highly lucrative. A ~$2 billion fund with standard terms can generate
~$900 million of revenue over 10 years if it achieves a ~20% gross IRR. Even if management
fees are eaten up by operating expenses, that still leaves ~$600 million of carried interest for
the GPs to split among 8-12 partners and 20-30 total IPs. The other important issue to note is
that many people assume the way to win big in PE is to grow fund size to generate more fees
and grow “dollars at work”. However, this is true only if the fund’s performance stays constant.
The sensitivity table below demonstrates how changes in a fund’s IRR impact total proceeds.
Larger funds are frequently harder to invest successfully than smaller funds so GPs must
consider optimal fund size carefully, especially since LPs are more likely to commit to the next
fund if the current one generates strong returns.
Illustrative Fund Economics5

Year
$ in millions 1 2 3 4 5 6 7 8 9 10 Total
Committed Capital 2,000 2,000 2,000 2,000 2,000
Cost Basis of Invested Capital 2,000 1,600 1,200 800 400
Management Fees % 2.0% 2.0% 2.0% 2.0% 2.0% 1.0% 1.0% 1.0% 1.0% 1.0%
Equity Principle Invested 400 400 400 400 400
Exit Returns Realized 995 995 995 995 995
Investment Capital Gains (Returns less Principle) 595 595 595 595 595
Management Fee Revenue 40 40 40 40 40 20 16 12 8 4 260
Carried Interest Revenue 119 119 119 119 119 595
Total Income 40 40 40 40 40 139 135 131 127 123 855
Sensitivity table: Total 10yr Fund Revenue by Comitted Capital vs. Gross IRR ($mm)
Fund's Comitted Capital ($mm)
855 1,000 1,250 1,500 1,750 2,000 2,250 2,500 2,750 3,000
10.0% 252 315 378 441 504 567 630 693 756
12.5% 290 363 436 508 581 653 726 799 871
15.0% 332 415 498 581 665 748 831 914 997
Fund's 17.5% 378 472 567 661 756 850 945 1,039 1,134
Gross 20.0% 428 535 641 748 855 962 1,069 1,176 1,283
IRR 22.5% 482 602 723 843 963 1,084 1,204 1,325 1,445
25.0% 540 675 811 946 1,081 1,216 1,351 1,486 1,621
27.5% 604 755 906 1,057 1,208 1,359 1,510 1,661 1,812
30.0% 673 841 1,009 1,177 1,345 1,513 1,681 1,850 2,018
5
This example assumes: $2 billion in committed capital, invested over 5 years in equal installments;
Management fees are paid on committed capital for the first five years at a 2% rate and on the cost basis of
remaining invested capital for the last five years; the gross IRR of each investment is 20%, and each investment
is exited after 5 years with carried interest being paid out immediately; no hurdle rate or “other revenue”.

Page 30

TITLES AND ROLES
Titles and their associated roles vary between PE firms. The following are the most common
titles, roles, and qualifications:
Analyst
- Role: Most PE firms don’t use the analyst title. Analysts at PE firms typically fall into one of
two categories: deal sourcing and deal support. Some large PE firms with proactive
sourcing models hire analysts to generate deal flow through cold-calling company CEOs.
Other large firms with reactive sourcing models hire analysts to work primarily on deal
support such as financial modeling, due diligence, and industry research. Most analysts are
hired for a 2 – 3 year program, after which they are expected to attend a top tier business
school in order to advance further. However, some PE firms do promote analysts to
associates without an MBA. Due to the lack of standardization of titles between PE firms,
some firms label associate-level positions as analysts, or vice versa.
- Prior experience: Most analysts are hired directly out of top undergraduate schools, while
some have 1 – 2 years of experience in analyst programs such as banking or consulting
- Technical skills: Since most analysts, as defined here, are hired directly out of
undergraduate programs, there is less focus on technical skills upon initial hire. Analyst
recruiters typically look for candidates with a strong quantitative academic background
(mathematics, finance, economics, engineering, accounting, physics, etc.) and a
demonstrated interest in finance (prior internships, finance clubs, etc.). Specific financial
and technical skills are learned during a formal training program or on-the-job.
Associate
- Role: Associates are the most junior investment professionals at most PE firms. At firms
with a proactive sourcing model, this role is often heavily focused on finding deals by
researching attractive industry sectors, cold-calling CEOs of potential target firms, and
attending industry conferences. At firms with a reactive sourcing model, associates typically
focus on helping to model potential deals, conducting due diligence and assisting with
portfolio company management. Many PE firms hire associates for 2 – 3 year programs,
after which they are expected to attend a top tier business schools in order to advance
further. However, some PE firms do promote associates without an MBA.

Page 31

- Prior experience: Most associates are hired after completing a traditional 2 – 3 year
analyst program at an investment bank or top tier management consulting company. A
small percentage of associates are hired after 2 or more years with a less traditional
program or employer.
- Technical skills: Associates often do the majority of the technical tasks at a PE firm.
Common technical skills vary somewhat but frequently include:
o LBO and cash flow modeling
o Acquisition due diligence and accounting
o Analysis of financial statements
o Industry and market research
o Expertise in Excel, PowerPoint and other common tools such as CapitalIQ
Senior Associate / Vice President (VP)

- Role: Sr. associates / VPs typically oversee the work of associates and play a larger role in
the structuring of the diligence process. Not all firms use both titles, but when both are
used, VP is more senior.
- Prior experience: Sr. associates / VPs are typically hired directly out of top business
schools, often after having completed a summer internship with a PE firm. Most senior
associates have investment banking or consulting backgrounds prior to business school
and most also have some pre-MBA PE experience. Some PE funds, however, promote
senior associates directly from their associate ranks without an MBA.
- Technical skills: Senior associates are typically required to have all of the skills of an
associate, along with a deeper understanding of the PE investment process that comes
with more experience.
Vice President (VP) / Principal

- Role: VPs / principals typically manage all of the day-to-day activities of deal teams and
work closely with partners on deal strategy and negotiation. They are often asked to
generate investment ideas and lead the more junior staff in pursuing these ideas. Not all
firms use both titles, but when both are used Principal is more senior.
- Prior experience: VP / Principals typically have at least 2 – 4 years of post-MBA PE
experience. Some Vice presidents and principals have 5 – 8 years of total PE experience
without an MBA.

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- Technical skills: VPs and Principals are typically required to be very familiar with the
associate / sr. associate skill set, but this is no longer their focus. While they must
understand all of the relevant financial, legal and accounting principles, they are typically
directing and supervising the technical work of associates rather than doing it personally.
Partner / Managing Director (MD)

- Role: Partners / MDs are the most senior members of a PE firm and are usually its co-
owners. Most partners / MDs have 8+ years of post-MBA level PE experience.
- Prior experience: Those who have been promoted to partner from vice president or
principal typically have at least 6 - 8 years of post-MBA PE experience. However, some
partners may have less PE experience if they are hired by a PE firm at the partner level
due to some special industry expertise or connections.
- Technical skills: Partners typically do little technical work and focus more on deal
origination, negotiation and strategic decision making
Non-Investment Professionals
Moving from a non IP role to an IP role can be difficult because IP roles are usually more
competitive and require specialized skills. Keep this in mind if you try to get your foot in the
door via a role in finance, operations or business development. The most common non-IP
positions are:
- Portfolio group: Improving performance of existing portfolio companies
- Administrative support: Schedules, copies, etc.
- Business development: Generating deal flow
- Executive in residence (EIR): Typically a former entrepreneur or executive who provides
industry expertise and sometimes takes over as CEO of a new acquisition
- Finance: Fund accounting and financial reporting
- Human resources: Recruiting, payroll, benefits, training, etc.
- Legal: Providing legal advice and negotiating of contracts
- Investor Relations: Brand-building and fundraising

Page 33

COMPENSATION
PE compensation for investment professionals is typically composed of a base salary, an
annual bonus and a share of the fund’s carried interest. The sum of the base salary and the
annual bonus are referred to as “cash compensation”. Larger funds tend to pay higher cash
compensation because they tend to generate more management fee revenue per investment
professional.
Trends in PE compensation depend heavily on the industry’s ability to raise capital as well as
on compensation levels at investment banks and hedge funds which compete with PE in the
hiring market. Prior to the ongoing credit crunch, PE compensation had been climbing steadily
due to record-setting fundraising levels and rising compensation at investment banks and
hedge funds. The credit crunch and economic downturn have dampened PE fundraising.
Investment banking compensation has taken a well-publicized fall. As a result, PE
compensation has also stagnated somewhat. Future trends depend heavily on how fundraising
and returns look over the next few years. The following compensation table provides rough
guidelines for average cash compensation by role and fund size. This data does not include
carried interest which accounts for the bulk of compensation at the more senior levels. Keep in
mind that the data on “All PE / VC funds” averages across many small VC and PE funds which
generally pay less than larger competitors.
“Show Me the Money!”

How to Find Relevant PE Compensation Data

Page 34

Average Cash Compensation by Role and Fund Size (Estimated)
$800K Avg. Cash Compensation 750
$700K (All PE / VC Funds)
Avg. Cash Compensation
$600K
(Large / Megafunds) 525
$500K
$400K 375
340
$300K 275
190
$200K 140
100
$100K
$0K
Pre-MBA Pre-MBA Post-MBA VP / Principal
Analyst Associate Associate

Page 35

Chapter 2: Industry Operations
In this chapter… This chapter describes how the PE

x Deal Process
industry chooses and analyzes
x Deal Selection
x Deal Funnel investments. It will help you to
x Deal Lifecycle understand what PE firms care
x Common Due
about most and how they generate
Diligence Topics
x How PE Makes their returns.
Money

Page 36

DEAL PROCESS
The deal process varies substantially in terms of steps and timeline as well as internally from
PE firm to PE firm, but there is a standard path that many deals follow. The following template
focuses on a typical LBO of a public company by a large PE firm, usually the most complex
type of deal with many steps and the longest time horizon. As a general rule, other types of
deals follow a subset of the steps outlined here:
A deal can come from several sources:

x A 2-3 page “teaser” from an investment bank representing the target
company. This source is increasingly common especially with larger targets
x The PE firm’s MDs may have an ongoing relationship with a CEO or owner
Source who suddenly wants to sell to you. This is a highly desirable and increasingly
deal rare deal source because it may mean less competition for the asset
(Timing x One of a PE firm’s existing portfolio companies finds a potential add-on

varies acquisition it wants the PE firm to negotiate and finance
greatly)
x The PE firm reaches out proactively to attractive targets. This method
sometimes involves MDs reaching out to select CEOs or sometimes involves
associates cold calling on hundreds of CEOs (a technique utilized most
prominently by Summit Partners and TA Associates)
If the asset is being sold via an auction by an investment bank (which is now nearly
universal for sales of large and even mid-sized companies), then teasers could go
out to 30–200+ potential bidders
Review An IP reads the teaser and decides whether it’s worth signing an NDA in order to
teaser & receive the full Confidential Information Memorandum (CIM)
Sign
When making the decision to sign the NDA, the PE firm considers several factors:
NDA to
get full x Does the proposed investment fit its investment criteria at a high level?
CIM x Does the firm have any conflicts which prevent it from pursuing the deal?
(2-3 days) x Is there much to learn from further participation in the process?
x Relationship issues (e.g. PE firms don’t want to develop a reputation for
saying yes to every teaser and never submitting a bid)
If the PE firm is intrigued by the deal, it executes an NDA and requests the CIM
If the PE firm doesn’t execute an NDA, it drops out of the process

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It is common for a bank to receive NDAs from and send CIMs to 10–100+ bidders
A junior IP reads the CIM, a 30–100+ page document, containing information about
the target’s business, industry, strategy, historical financials, projected financials, etc.
The junior IP builds a simple LBO model, frequently predicated on standard financing
terms and management’s financial projections from the CIM to determine roughly
Diligence
how much the PE firm could pay for the target while achieving its target IRR
phase 1:
The junior IP may also do some light diligence such as assembling public comps,
Review reviewing the target’s public filings and interviewing a few industry experts
CIM and
submit The IP assembles the findings into a 1 – 10 page summary document and presents it
IOI to an MD or group of MDs who may be interested in leading further diligence
If the MD/group likes the deal profile and thinks there is a reasonable chance of
(1-2
weeks) getting to a winning price, then the firm submits a non-binding bid with a range of
how much the firm expects to be able to pay for the asset. This non-binding bid is
sometimes referred to as an Indication of Interest (IOI)
If the firm decides not to submit an IOI, it drops out of the process
If the firm’s IOI is too low vs. competitors, the bank may drop it from the process
It is usual for a bank to get 5–20+ IOIs and grant data room access to 3–12 bidders
A team of 2 – 5 junior and mid-level IPs is assembled to perform further diligence
The team analyzes everything it can in the data room which is typically a secure
online repository of all of the target’s detailed financial, operational, and
administrative information
Diligence
The team performs as much diligence it can while minimizing spend because at this
phase 2:
stage winning the deal is still highly uncertain and expenses won’t be reimbursed
Data At some point during this stage the investment bank usually invites bidders to meet
room
review with management face to face for a few hours to discuss the company and its future
and The team solicits initial indications for financing packages from banks
“triage” The team builds a more detailed LBO model and its own operating/financial
diligence
projections to begin honing in on an actual price the firm could pay
(2-4 The team assembles its diligence, management meeting, and model output into a
weeks)
20-50 page summary presentation and presents it to an initial Investment Committee
(IC) of some or all of the firm’s MDs
If the Investment Committee likes the profile of the deal and thinks that it could
ultimately approve a competitive bid then the IC members provide the team with
further questions to answer and approve moving to phase 3 diligence
If the IC doesn’t like the deal profile then it can choose to drop out of the process

Page 38

The team shifts into high gear and employs the full PE diligence toolkit (as needed)
x 3rd party lawyers and accountants hired to review legal and accounting issues
x 3rd party consultants hired to perform a deep market study
x Industry experts hired to review the target’s technology, IP, operations, etc.
x The team visits and inspects the target’s stores, facilities, etc.
Diligence
phase 3: x Heavy utilization of “expert networks” such as GLG and Cognolink
x Etc.
Deep
diligence This stage of diligence can cost hundreds of thousands or millions of dollars
and Banks are asked to provide their best offers for financing
proffer of
The team updates its valuation model with any relevant new information and
an LOI
assembles a 40-100 page presentation for a final IC meeting
(2-4 The final IC decides whether to put in a binding bid commonly referred to as a Letter
weeks)
of Intent (LOI) and, if so, how much to bid
If the IC decides not to bid then the firm is out of the process
If the firm submits a binding bid then it waits to hear the target’s decision and moves
on to closing if its bid is accepted
Once a bid is accepted by the target’s management, the deal may still be far from
done
x Lawyers and accountants may still need to finish their diligence
x A purchase & sale (P&S) contract must be drawn up primarily by deal lawyers
x Final financing documents must be executed with the banks
x The target company’s management contracts must sometimes still be
Closing negotiated and executed
(4-12+ x Regulatory approval must be obtained

weeks) x Shareholder approval must be secured
Many deals have fallen apart closing due to unexpected regulatory issues or
shareholder dissent. Some buyers have also successfully backed out of deals by
invoking a Material Adverse Change (MAC) clause from their LOIs which stipulate
that the buyer can withdraw its bid if the target’s performance deteriorates
significantly during the closing period
If everything goes smoothly during closing, the PE firm buys its intended asset and
adds it to its portfolio

Page 39

The One Dirty Little Secret on Sourcing
3 Actual Examples of a Teaser, NDA, and CIM
Here is What an IOI Looks Like

Page 40

The Sacred Investment Committee Memo
Staple Financing 101: What is it and Why do Banks Offer it?
3 Material Adverse Changes (MACs) to Watch Out For

Page 41

DEAL SELECTION
Attractive PE deals come in all shapes and sizes, but most LBO firms look for deals which
have at least a few of the following characteristics:
- Strong competitive position: Highly levered LBOs can default and lose all invested equity
if the portfolio company’s performance deteriorates. Companies with strong competitive
positions are more likely to weather macroeconomic headwinds and industry upheaval
without losing profitability because they can take advantage of weaker rivals during tough
times. Strong competitive positions are often signaled by high market share, high margins,
rapid growth, valuable brand, high barriers to entry, and strong customer retention.
- Predictable cash flow: LBOs must usually make large ongoing cash interest payments, so
enough cash flow to cover them is essential. The cash flows of some business models tend
to be more predictable than others, even controlling for competitive position. For example,
the cash flow of a market-leading movie studio is less predictable than that of a 2nd tier
breakfast cereal manufacturer because the movie studio relies on unpredictable hit movies,
whereas the demand for breakfast cereal is very stable. Common characteristics of
predictable cash flow business models include: predictable customer demand, agnostic to
commodity and macroeconomic cycles, high percentage of recurring revenue.
- Long-term market tailwinds: PE firms like to invest in businesses which are positioned to
benefit from favorable market trends which are usually more stable and predictable than
the fortunes of a single company. For example, the US has seen a decades-long
movement toward healthy and organic foods. This trend played a large role in Leonard
Green’s investment in Whole Foods Market, Apollo’s investment in Sprouts Farmers
Market, and Oak Hill’s investment in Earth Fare.
- Concrete improvement opportunities: PE firms feel like they are getting a bargain when
they can identify several important operational issues that they can improve. Common
areas of potential improvement include: hiring better management, aligning employee
incentives, optimizing pricing, cutting unnecessary overhead, culling unprofitable

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customers, selling non-core assets, expanding geographically, rolling-up smaller
competitors, and upgrading IT infrastructure.
- Favorable deal dynamics: No matter how attractive the target, PE firms rarely feel
comfortable bidding aggressively for it unless they can identify a good reason why they are
particularly likely to win the deal at an attractive price. The following dynamics make PE
firms excited to compete for an asset: The seller is highly motivated, there are few natural
bidders for the asset, they have a particularly strong understanding of the industry, they
believe the seller prefers them as a buyer, or they are uniquely positioned to improve the
asset’s performance.
- Strong management team: Most PE firms cannot or do not want to operate the target
business day to day. For this reason it is important for the business to either already have a
terrific management team in place, or for the PE firm to have likely replacements in mind.

- “Fan of outcomes” upside: Every deal has a “base” expected outcome, as well as a
series of downside risks and upside opportunities. PE firms like a deal’s “fan of outcomes” if
the likely downsides aren’t fatal, and there are numerous potential scenarios to hit a home
run.

Investment Criteria: For most firms these days, the following are minimum criteria for being
interested in a deal:
o The deal fits the firm’s investment mandate as agreed to with LPs
o The deal generates at least a 20% equity IRR, the minimum rate of return most
LPs are looking for
o The deal generates least a 2.0x MoM equity return because carried interest is
paid on profit dollars rather than on IRR
o The equity check on the deal represents between ~2% and ~10% of the firm’s
latest fund size; anything less is not worth the bother while anything more is too
risky

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The 7 Traits of The Perfect Deal and…
One That Is More Important than All of Them Combined
DEAL FUNNEL
PE firms are highly selective in which deals they bid on and usually conservative with what
they are willing to pay because their LPs demand high rates of return on their capital (typically
20% or more). The PE industry is highly competitive, and firms which under-perform even over
a single cycle can face difficulty raising future funds. Consequently, PE firms typically evaluate
a large number of potential deals for every one which they ultimately close. As described in
previous section, there are a number of natural decision points during which a PE firm might
exit a deal process. The funnel chart below approximates how many deals make it to each
process stage in an average year at a typical PE firm which is investing a single fund.

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Deal Process Funnel (per year)

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DEAL LIFECYCLE
After a deal is closed, the PE firm holds and manages the investment as one of its portfolio
companies until exit. During this holding period, the PE firm usually stays involved with the
investment in many different ways. All deals are different, and PE firms choose to have
different levels of involvement with their portfolio companies, but the following is a list of
common PE activities during the holding period:
- Put MDs and sometimes more junior IPs on the portfolio company’s board
- Recruit new or supplemental company management
- Monitor the company’s performance and report quarterly to LPs
- Help the company set strategic direction
- Help the company look for and execute add-on acquisition
- Help the company manage its capital structure
- Help the company execute important initiatives (this is more common if the PE firm has a
dedicated in-house portfolio management group stocked with people with
operating/consulting experience)
- Decide when the time is right to exit the investment via IPO, strategic sale, or secondary
sale
Deal Lifecycle and PE Firm’s Cash In vs. Out
Sale / Exit
Deal
Hold Period • IPO
Lifecycle Closing
(~3 – 7 years) • Strategic sale
Chart
• Secondary sale
Cash Out: • Equity • Equity for add-on acquisitions (if

purchase needed)
• Additional equity infusions possible if
the company gets in financial trouble
Cash In: • Proceeds from special dividends or • Sale proceeds
refinancing
• Management fees paid by company to
PE sponsor

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COMMON DILIGENCE TOPICS
Due diligence is the process every PE firm undertakes to confirm its investment thesis before
any deal is struck. Diligence topics fall into four broad categories: commercial, valuation,
accounting, and legal. The following section describes each category and lists topics which are
commonly explored within each category:
Commercial Diligence
Commercial diligence centers on projecting the target’s operational and financial performance.
Commercial diligence includes investigation of: market growth, historical performance, the
target’s competitive position, the target’s business model, key performance drivers, supply
chain analysis, customer analysis, etc. Commercial diligence is usually executed by a
combination of the PE firm’s deal team alongside 3rd party advisors such as management
consultants. PE firms with an “industry diligence” philosophy like Bain Capital tend to do more
of the commercial diligence in-house, whereas firms with more of a “financial engineering”
philosophy like KKR tend to outsource more of it. Issues commonly addressed during
commercial diligence include:
- Market Issues:
o How fast is the industry growing and what are its primary drivers?
o How will these growth drivers evolve and how will that impact future growth?
o Which industry segments are likely to over/under perform?
o Is the industry consolidating? If so, what are the implications?
o How large is the target’s total addressable market (TAM)?
o How cyclical is the industry and where is it in its cycle?
- Competitive Position:
o How unique is the target’s value proposition and how essential is it to customers?
o How is share distributed among competitors and how/why is it shifting?
o How is the target’s brand positioned and how strong is it relative to competitors?
o What is the target’s bargaining power relative to customers and suppliers?
o How concentrated is the customer / supplier base?
o How high is the threat from new entrants? How strong are barriers to entry?

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- Business Model:
o What is the target’s margin structure? What % of costs is fixed vs. variable?
o How much of revenue is stable / recurring / locked into long-term contracts?
o What is the target’s free cash flow (FCF) generation profile?
What is the normalized FCF margin?
Capital intensive vs. light? Is Capex needed for maintenance or growth?
Positive or negative working capital requirements?
- Historical Performance
o How has the business grown over the past few years and what drove its growth?
Price growth vs. units sold growth?
New store growth vs. same-store-sales?
Growth in core business lines vs. line extensions?
Domestic vs. international growth?
Organic growth vs. acquisitions?
Industry growth vs. winning share?
o How much more runway is there for the most important growth drivers?
o What is happening with profit margins and why?
COGS: what is driving labor, material, transport cost, etc?
Opex: what is driving overheard, marketing, occupancy cost, etc?
Valuation Diligence
Valuation diligence centers on determining the current fair market price for the asset and the
multiple it could be sold for at exit. This analysis serves to assure the firm that it’s paying a fair
current price and helps to forecast its profits at exit. Valuation diligence is usually conducted by
the PE firm’s deal team, occasionally with some input from its investment bankers. Common
types of valuation diligence analyses include:
- Comparable (comps)
o At what multiples are the target’s most direct competitors or comparable
companies trading in the public market?
o What are the comps’ average trading multiples over a few years and
macroeconomic cycles?

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o Regression analysis to determine how historical growth rates have impacted
trading multiples for comps
- Precedent transactions
o What prices and multiples have been paid for recent transactions involving
competitors and comparables?
- Next Financial Buyer (NFB) analysis

o What would another PE firm be willing to pay for a secondary buyout of the target
in a few years if the target achieves its projected base case performance?
- Sum of the-Parts Analysis

o If the target is made up of distinct and separable divisions, then the above
analyses may be performed on individual divisions and added together
Accounting Diligence
Accounting diligence focuses on confirming that the target’s reported financials accurately
represent the fundamentals of the business. This work is important because valuation depends
on reported financials which are susceptible to mistakes as well as intentional manipulation.
Accounting diligence is highly detailed and specialized, usually executed by 3rd party
accountants during either the Deep Due Diligence or Closing Diligence phase, so we will cover
it here only at a high level. The most common topics of accounting diligence include:
- Acquisition / divestiture accounting: Are any reported pro-forma statements accurate

and reliable?
- Adjustments / non-recurring items: Have the target’s accountants or investment bankers

added back any questionable items to historical EBITDA?
- Debt vs. working capital: Accountants make sure that any outstanding liabilities are
categorized properly as debt or working capital. This is important because debt is
subtracted from the purchase price, so sellers have an incentive to classify iffy items as
working capital instead of debt.

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- Quality of earnings: Are historical reported earnings/profits reflective of the businesses’
true normalized level of profitability?
- Revenue and expense recognition: Has all reported revenue been truly earned? Have
the right cost items been expensed vs. capitalized?
- Tax issues: Is the target tax compliant? Are there any unmentioned tax liabilities lurking?
How can taxes related to the deal be minimized? Etc.
Legal Diligence
Legal diligence focuses on confirming that the target is not subject to any material unreported
legal liabilities. Legal diligence is highly detailed and specialized, usually executed by 3rd party
lawyers during either the Deep Due Diligence or Closing Diligence phase, so we will cover it
here only at a high level. The most common topics of legal diligence include:
- Pending litigation: Ensure that any liability from either pending or possible lawsuits is well
understood and manageable.
- Intellectual property (IP): Ensure that the target’s IP is valuable and unencumbered.
- Corporate structure: Ensure that the corporate structure (holding companies, operating
subsidiaries, off-shore subsidiaries, etc.) is well understood and legal.
- 3rd party contracts: Ensure that the target has lawful title to all material PP&E as well as
solid contracts with important customers, suppliers, and debt holders.
- Employee contracts: Ensure the target has solid contacts with key managers, especially
related to compensation and non-compete clauses. Also ensure any employee retirement
or health and welfare plan liability is well understood and adequately funded.

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Common Due Diligence – Why Does it Matter?
How PE Makes Money

Ever since its inception, PE has aimed for and usually achieved high returns. This section
discusses why PE needs to generate high returns to survive and describes common methods
PE firms use to achieve these returns.
Why PE Must Generate High Returns

- PE investments are illiquid. An average PE investment takes about 5 years to pay off, but
some PE investments have been held for ten years or longer. Unlike with the stock market
and even some hedge funds, LPs cannot easily get their money out of a PE fund when they
need it.
- PE has the reputation for being especially risky because it uses large amounts of leverage.
High leverage levels increases the likelihood that portfolio companies will default and wipe
out the invested equity.
- PE investments are “lumpy” and their timing is not predictable. When LPs commit to a new
PE fund, their capital may be “called” for a new investment at any time over the next
several years. There is little predictability to when new investments will happen or how
large they will be. In one year the fund might do zero deals and in the next year it might
invest half of its entire fund. This uncertainty is difficult for LPs to manage, especially for
pension funds and endowments which must make predictable cash distributions.

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Method #1: Buy Cheap
This is the most tried and true investment method of all time and is a hallmark of nearly every
kind of investing, not just PE. However, there are some unique reasons and situations where
PE is able to buy assets for less than other potential buyers:
- Better understanding of asset value: A core competence of most PE firms is having the
best estimates for the worth of the businesses they bid on. PE firms accomplish this by
constantly working to track and understand industry trends and valuation drivers. PE firms
are also experts at gleaning valuation information from the due diligence process because
they have more experience and frequently commit more resources than other types of
bidders. Comprehensive industry knowledge combined with differentiated diligence findings
sometimes allow PE firms to discover that the intrinsic value of an asset is actually much
higher than for what it is selling or where it is trading on the public market.
- Relationships with management and sellers: PE partners spend a lot of time getting to
know potential sellers and the management teams of potential targets. PE partners attend
many conferences, schmooze CEOs, sit on common boards, and continually maintain their
professional and business school networks. They are also proactive in promoting their
reputations both as experts in their investment areas and as value-added financial
sponsors. These efforts can help PE firms buy companies at a discount in two ways. First,
management teams sometimes have a lot of leverage over which buyer gets preferential
treatment based on which buyer they prefer to work with post buyout. For this reason PE
firms with close CEO relationships and good reputations sometimes get better deals.
Second, sellers don’t always sell their entire stake in a business when they transact with a
PE buyer. In order to maximize the value of any remaining stake in the business, referred
to as “roll-over equity”, some sellers are willing to sell companies at a discount to PE firms
who they believe will add the most value to the company going forward.
- Absence of other natural buyers: Some assets don’t have natural buyers other than PE,
so sellers of such assets have no choice but to accept the relatively high cost of PE money.
For example, distressed businesses (bankruptcies, loan defaults, etc.) and complex carve-
outs are common sources of deals with few bidders outside of PE because distressed
deals are very risky and require a lot of specialized legal and restructuring expertise.

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Distressed deals also frequently require tough/unpopular choices about layoffs and contract
renegotiations. Some PE firms such as Sun Capital and Cerberus Capital have the nerve
and the expertise to dive into deals nobody else will touch. Carve-outs/spinoffs also
sometimes have no bidders outside of PE because it is operationally difficult to turn a
former division of a large company into a functional, stand-alone entity. Carve-outs
frequently require finding new management, renegotiating contracts, and setting up internal
systems and processes which used to be handled by the corporate parent (IT, HR,
Accounting, Procurement, etc.). Few other buyers outside of PE have the risk appetite and
the expertise to support this process.
- Access to investment cash during downturns: PE firms’ funding commitments from LPs
are contractually guaranteed over periods of many years. This feature can be helpful during
economic downturns and stock market crashes when asset values plummet. At a time
when other investors are scrambling for safety and hoarding cash, some PE firms are able
to take advantage of the downturn and put money to work at attractive valuations.
- Faster deal closing: There are times when it’s important to a seller that the sale closes
quickly. This is commonly the case when the seller needs cash quickly for other purposes
or when having the asset “in play” for a long time could damage its value. The sale process
of a company can be highly distracting to management and can create a lot of uncertainty
for employees, customers, and suppliers. Businesses which are sensitive to uncertainty
can be damaged by sales processes which drag on too long. PE firms are uniquely
positioned to close deals quickly because they have a lot of experience doing deals and
because they usually require permission from only their internal investment committee (as
opposed to bureaucratic boards, diverse shareholders, lenders, etc.). Some sellers are
willing to accept less money for a faster close.
- More certain deal closing: Related to speed of close but somewhat distinct is certainty of
close. Many deals fall apart between signing and closing for various reasons including
regulatory hurdles, shareholder dissent, and adverse findings or developments during the
closing process. PE firms are less exposed to shareholder dissent than public company
bidders and tend to face less scrutiny about anti-trust issues than strategic bidders. In
addition, PE firms can credibly claim that they are less likely to try to back out of deals than

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strategic buyers because their entire business is built on their reputation as reliable deal
makers. Many assets would be damaged by a “broken” deal process, so some sellers are
willing to take less money in exchange for more certainty.
Method #2: Financial Engineering

Financial engineering is the practice of extracting value from an asset by optimizing the way it
is financed / capitalized. Financial engineering used to be the dominant driver of PE returns in
the 1980s, and many say financial engineering is still one of the dominant drivers. However, its
relative importance is waning because companies are more commonly employing PE-inspired
practices to optimize their own balance sheets. In addition, the term financial engineering has
acquired a pejorative connotation. Most PE firms deny that financial engineering is an
important driver of their returns. However, for the purposes of interviews, an understanding of
how financial engineering can drive returns, in theory, is important:
- Better balance sheet management (more debt): To make a complex issue simple: debt
financing (aka leverage) is “cheaper” than equity financing because equity is riskier than
debt. The interest rate debt providers charge is usually lower than the rate of return
demanded by equity investors. See the section on capital structure for more details. When
you finance a company with a higher % of debt and a lower % of equity during an LBO, its
cost of capital (WACC) decreases. Finance literature argues that this decrease in WACC
doesn’t increase the risk-adjusted return to equity (which is what PE firms are interested in)
because extra debt makes the underlying equity riskier. If this interpretation is correct, then
PE firms make higher returns by accepting more equity risk. It is possible, however, to
make the case that PE-owned companies are better able to manage high leverage levels
than public ownership. If this interpretation is correct, then PE companies can create equity
value by using more leverage. Some reasons PE firms may be better at utilizing leverage
include:
o PE firms have excellent long term relationships with many debt providers, making it
easier for PE companies to raise debt on better terms or refinance debt should a
levered portfolio company face financial distress.
o PE firms have more ready access to additional equity capital that could prevent
default should a levered portfolio company face financial distress.

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o Because they don’t have to answer to a diverse, fragmented group of public
shareholders, PE firms are able to make cost-cutting decisions faster in order to
forestall financial distress.
- Interest tax shield: A corollary to “more debt” is that interest paid on debt can be deducted
from a company’s taxable earnings. Adding more debt increases the interest tax shield
which raises a company’s cash flow and earnings, thereby increasing its value.
- Debt pay-down: PE firms use the cash flow generated by portfolio companies to pay down
the debt they used to finance their initial acquisition. Consequently, when the portfolio
company is ultimately sold, less of the proceeds go toward repaying any remaining net debt
and more of the proceeds accrue to the equity holders. Debt pay-down from cash flow is an
important source of returns for most LBOs. However, it is important to stress debt pay-
down does not create additional value. Debt pay-down is an important driver of returns
simply because LBO candidates are always profitable companies which create profits for
their owners every year. Imagine you buy a company for $100mm which produces $15mm
of cash flow every year. You will make a ~15% IRR on this investment even if the value of
the business stays flat. For this reason, debt pay-down is an important driver of returns but
is not a creator of value.
Method #3: Improve Operations

Most PE firms claim to be value-added investors because they can help the companies they
own become more valuable. How much value PE adds as an asset class is a difficult and open
question, but there are certainly many examples of PE firms adding exceptional value to
portfolio companies by using some of the following methods:
- Improve Management: PE firms frequently cultivate extensive networks of former and

current executives with varied skill sets, often leveraging these networks to find better
managers for their portfolio companies. There is some evidence that PE firms are willing to
give management a larger share of equity upside which may allow PE firms to attract more
talented management.

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- Optimize Incentives: Some companies have poorly aligned incentives prior to PE
ownership. Misalignments may stem from bureaucratic friction, political tension, inadequate
analytics, or simply good old mismanagement. PE firms can sometimes be more objective,
analytical, and dispassionate about incentives than previous ownership. Perhaps top
management needs more equity upside to take advantage of their entrepreneurial
capabilities. Perhaps the sales force needs to be compensated based on the profits rather
than the revenue their accounts generate. Perhaps separate divisions need to be given
reasons to cooperate rather than protect their own fiefdoms. Such changes are sometimes
easier to make for PE owners as opposed to founders / private family owners / public
companies.
- Fund and support accretive M&A: This is commonly referred to as the “roll-up” strategy.
There are many highly fragmented industries out there which are ripe for consolidation.
Some PE companies buy one of the leading competitors which they see as a “scalable
platform” and then help it to buy and integrate several smaller rivals. This strategy creates
value in a couple of ways. First, truly scalable businesses realize synergies when they
merge and become more profitable together. Second, larger companies with higher market
share are generally seen as stronger and more stable competitors that should trade at
higher multiples. For this reason, “tuck-in” acquisitions can frequently be done at multiples
which are lower than that of the “platform” business, a phenomenon known as “multiple
arbitrage”.
- Cut costs: Public companies and family-owned businesses are sometimes unwilling or
unable to cut costs which are economically suboptimal or outright wasteful. PE firms are
generally less skittish about cutting overheads, extravagant perks, and redundancies.
During the 1980s corporate raider days, PE firms sometimes made a lot of money simply
by cutting management’s excessive travel and “entertainment” budgets. These days most
public companies are under more judicious oversight, but prudent cost cutting opportunities
still abound.
- Restructure or turn around a business: Some businesses require difficult long term
changes to reposition them in changing markets. Such restructurings frequently require
short-term pain, investment, and patience to realize long-term success. PE is uniquely

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positioned to support such restructurings because its investment horizon can be several
years or longer and it does not have to keep up with the quarterly public markets earnings
treadmill.
- Professionalize a small or family business: Many middle market PE firms add value
simply by purchasing undermanaged family businesses or small companies who are
looking to grow to the next stage and introducing standard business practices. We’re
talking about “Management 101” stuff here such as investing in IT systems, standardizing
accounting practices, creating talent management systems, introducing activity-based
costing, optimizing pricing, etc. The trading multiple of a business can go up by quite a bit
simply by bringing the business up to professional standards.
- Drive synergies between portfolio companies: Some PE firms with large portfolios have
been able to drive value by getting their portfolio companies to collaborate. For example,
some of the mega funds have recently started an initiative to consolidate the massive
combined purchasing power of the companies they control. In this manner they have been
able to decrease the costs of some of the common goods and services their portfolios
companies buy. Another example is when a PE firm buys a company which is a natural
customer of or supplier to other existing portfolio companies. The PE firm can facilitate
these companies coming together (where it makes economic and strategic sense of
course) in order to make one or both better off.
Note: The list above is only a partial sample of some of the more common ways PE firms add
value to their portfolio companies. There are countless other ways PE firms have attempted to
improve the performance of their portfolio companies.
Method #4: Exit Right

PE firms can sometimes squeeze a little extra value out of portfolio companies when they
realize returns or make exits because firms are very flexible in terms of both the timing and the
method of the exit:
- Flexible exit timing: Some investors have limited choice for when to sell their holdings.
The capital which funds hedge funds is usually less patient than PE funds and monitors

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annual or even quarterly returns. Mutual funds have the same constraint, plus they’re under
strict regulations to invest in assets according to their prospectus and have to sell assets
which migrate outside of their mandate. Corporate owners sometimes have to sell assets
for non-financial “strategic” reasons. PE firms, on the other hand, are pretty flexible with the
timing of their realizations/exits because their primary concern is maximizing financial
returns and their funding is committed for several years or longer. Since markets are
cyclical, the flexibility to choose exit timing allows PE firms to practice patience and avoid
selling in downturns until the rebound arrives.
- Flexible exit method: PE firms frequently have several options on how to realize gains
from an investment. The most common options include selling to another financial sponsor
(secondary buyout), selling to a corporate/strategic buyer, selling to the public (IPO), or
deferring a final sale but taking out a dividend via a debt recapitalization. Different exit
markets are all cyclical, but not uniformly so. Sometimes the IPO window is “closed” while
the debt markets are hot and dividend recapitalizations are attractive. Sometimes strategic
buyers are hoarding cash while financial sponsors are hungry for new acquisitions. The
ability to realize returns via any of these methods gives PE firms flexibility to choose the
one which promises the best return at any given point in time.
What is the True Driver of Returns?

Financial Engineering vs Operational Improvement

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Chapter 3: Recruiting Overview
In this chapter… This chapter focuses on the details

x Common PE Career
of the PE recruiting process. It
Paths
x How to Build a PE teaches you where, when, and how
Background PE firms recruit so that you can
x Recruiting Cycle
position yourself for success well in
x How to Work with
Recruiters advance. It also teaches you
x How to Choose an important skills like working with
Offer
recruiters, writing your PE resume,
x How to Write Your
Resume as well as choosing an offer
intelligently.

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COMMON PE CAREER PATHS
Because PE firms want applicants who can hit the ground running on day one, they rely on
standard recruitment channels which consistently deliver qualified applicants. That is why the
most common PE career path is: Undergrad Æ Investment Banking Analyst Program Æ
PE Associate Æ MBA Æ PE Sr. Associate/VP Æ VP/Principal Æ Partner/MD. Other paths
into the industry are possible, including via consulting or a post-MBA career switch, but non-
traditional paths are much rarer and usually require a lot of personal networking to succeed.
Common PE Career Path Flow Chart
Legend Undergrad
University Note: this path is rare
because there are few PE
Rare Path “Analyst” roles available
Possible Path
~2-3yr pre- ~2-3yr pre-
Common Path Other MBA Mgmt. MBA I. Analyst
Consulting Banking
PE Role
~2yrs
Non-PE Step
Pre-MBA
Associate
~2yrs
~2yrs
Sr.
Full Time
Associate /
2yr MBA
VP
Post MBA 2-4yrs

Post MBA I.
Other Mgmt.
Banking
Consulting
VP /
Principal
3-5yrs
Partner / MD

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5 Examples of Where People Go After Their PE Career is Over
HOW TO BUILD A PE BACKGROUND

The single best thing that you can do to increase your odds of breaking into PE is plan ahead.
If you get yourself on the “common path” as early as possible, your odds increase dramatically.
This section is broken down by the stage of your education or career to help you figure out
your most direct path into PE.
High School Students

Is it crazy to worry about what steps you need to take in order to break into PE while you are
still at least 5 – 8 years way from a likely entry point? Perhaps it is. However, since breaking
into PE takes long-term planning, you might as well have the right information as early as
possible. The following accomplishments can dramatically increase your odds of eventually
breaking into PE, as well a host of other attractive careers:
1. Get into a target school: The most direct path into PE out of undergrad is via an analyst
program with a top investment bank or consulting firm. These programs are often as
selective as PE itself, and they typically select most of their hires from a few select “target”
institutions where they do on campus recruiting (OCR). Getting into one of these programs
can be difficult if you attend a non-target college. Before making a final decision on where
you go to school, you may wish to ask each school’s career center to provide you with a list

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of which analyst programs typically do OCR and how many graduates usually make it into
these programs. You can get into a top tier analyst program coming out of a non-target
school, but you will face longer odds and have to do more legwork.
o Caveat #1: I would NOT advise selecting your undergrad based primarily on its
investment banking and consulting career placement. The university you choose has
much more meaning and impact on your life than simply what job you get upon
graduation. The advice in this section should be taken into consideration only by
those very few who already know with certainty what career they want before
college.
o Caveat #2: Some people believe that doing an undergraduate business program
such as the ones at U. Penn and U. Michigan is the surest way to get into a top
analyst program. Such programs do matriculate many graduates into top analyst
programs, but they are no better in this regard than many other quantitative
programs at other target schools.
o Caveat #3: Most top analyst programs recruit candidates for multiple national and
international offices. Many regional offices focus on target schools in their vicinity.
You may find it easier to get an offer in your preferred location if you attend a target
school in the vicinity. For example, the same consulting firm may recruit most of its
NYC analysts from Columbia and Princeton, most of its San Francisco analysts from
Stanford, and most of its Chicago analysts from Northwestern and U. Chicago.
2. Ace the SATs: Believe it or not, your SAT score remains relevant after you’re accepted to
college. Many analyst programs encourage, and some even require, that you list your SAT
scores (or equivalents) on your resume. As a rough guide, a combined math and critical
reading score above 1400 can boost your odds, while a combined math and critical reading
score below 1300 may be a headwind.
Top Target Schools

The following undergraduate programs are known for attracting top tier investment banking
and consulting analyst programs to recruit students on campus, and for consistently placing at
least a few alumni into these programs each year. These rankings should be seen as
approximate and may not include all undergraduate programs which consistently place alumni
into top tier programs.

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US Undergrad Top Targets Table6
Target Strength Schools

Super Target U. Penn, Harvard, Princeton, Yale, Stanford
Strong Target Columbia, U. Chicago, Duke, Northwestern,
MIT, Dartmouth, Brown, Cornell
Semi Target U. Michigan, Berkeley, NYU, Notre Dame, UVA,
Georgetown, UCLA, Amherst, Williams, Johns
Hopkins, Washington U., U. Texas, Emory,
Wellesley
Big Fish in Small Pond of Swim with the Sharks?
Undergraduate Students
The most common path into PE out of undergrad is via an analyst program at a top tier
investment bank or consulting firm. Such programs hire only a few thousand undergrads per
year in the US. Hundreds of candidates submit a resume for each opening, and many qualified
candidates have trouble getting so much as an interview. Consequently, the most crucial step
to landing one of these spots is building a resume that is appealing to analyst program
recruiters. The following guidelines can help you build such a resume:
6
Blend of rankings from PEdatabase, Bankersball.com, WallStreetOasis.com, and US News & World Report
Note: These rankings may not list all target schools

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- Academics: Candidates with proven quantitative skills are preferred because analyst
programs involve quantitative and financial analysis. Examples of preferred majors include
finance, economics, engineering, physics, math, computer science, etc.
o Caveat: Whatever your choice of major, maintain a high GPA is helpful because top
analyst programs often have GPA minimums for granting interviews. A common
minimum is a GPA of 3.5 out of 4.0.
o Caveat: Some candidates get analyst program interviews without quantitative
majors and / or lower GPAs, but they usually still signal their quantitative aptitude
with relevant work experience and extracurricular activities.
- Extracurricular activities: Recruiters prize leadership qualities because leaders are often
high achievers who are driven to excel. You can increase your odds of getting interviews if
you can list several high-profile leadership positions in such organizations as student
government, athletic teams, community service groups, fraternities & sororities, financial
clubs, etc. Attaining leadership positions in one or two high profile organizations helps you
more than simply being a member of a dozen groups. In addition, recruiters prefer
candidates who have a demonstrated interest in business and finance. You can
demonstrate this interest by founding or being active in applicable organizations. Examples
of such organizations include investment clubs, consulting clubs, and business fraternities.
o Caveat: Recent graduates of your school now working for you intended employer
are frequently the first to screen resumes. They likely still have friends on campus,
so be careful not to earn a reputation as a shameless resume builder. Also be
careful not to make a position sound much more significant than it really is.
- Work experience: Analyst programs prefer candidates with relevant job experience.
Summer internships and part-time jobs are a great way to build experience and display
your interest in business. Seek out jobs where you can learn the basics of finance,
research, business, accounting, and economics, and where you can exercise quantitative
abilities, independent thinking, and teamwork. Work experience that allows you to learn to
use PowerPoint and Excel, both of which are essential in investment banking and
consulting, is especially helpful. Many consulting companies and investment banks offer
summer internships for undergrads between their junior and senior years. Getting one of

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these internships can be extremely helpful because many analyst programs extend full-time
offers to top performing interns.
Sample Resume Scoring Template

Top analyst programs often get hundreds of resume applications for each opening. Recruiters
often select which candidates to interview via a set of screening guidelines. One such set of
guidelines from a top tier consulting company is shown below. In order to have a chance for an
interview, resumes have to score a weighted minimum of 3.5 according to this template:
Sample Undergrad Resume Screening Template

Academics (35% weighting) Experience (30% weighting) Other (35% weighting)
5 out of 5 5 out of 5 5 out of 5
• “A” level GPA • Prior internship in consulting, • Elected role in important group,
• Challenging quantitative major investment banking, or another with evidence of large contribution
• Many academic honors demanding organization • Or, founder of significant group,
• Exceptional quantitative record • Evidence of team working ability with evidence of large contribution
• 1500+ combined math/reading SAT and excellent performance • Involved in 2+ other groups
3 out of 5 3 out of 5 3 out of 5

• “B” level GPA • Significant work experience in a • Significant contribution to one or
• Challenging major reputable business or academic more major campus organization
• Some academic honors environment • Involved an off campus group
• Good quantitative record • Some evidence of commendable • Some language and or applicable
performance software skills
• 1350+ combined math/verbal SAT
1 out of 5 1 out of 5
1 out of 5
• Little applicable work experience • Little outside involvement or
• “C” level GPA
• Easy major interests
• No academic honors • No significant software or language
skills
• Poor quantitative record
• <1200 combined math/verbal SAT
Do You Have What it Takes? Your Chances of Breaking into Private Equity
Based on Your Undergraduate Institution and Other Factors

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Undergrad Recruiting Cycle
The analyst program recruiting cycle is driven by the firms’ competition for talent, as well as the
school calendars of target universities. Since the school year typically ends in the spring, the
start date for most internships is in June, and most full time programs start in mid-summer or
early fall. Top tier firms want to have their pick of the elite candidates, so they kick off recruiting
for full time positions around October and November of the candidates’ senior year. Mid-tier
firms’ recruiting often overlaps the top tier firms, or follows soon thereafter. Some firms also
recruit undergraduate juniors (and occasionally sophomores) for summer internships around
January and February. Such internships tend to be offered by the larger and more prestigious
firms because they have the scale to consistently find work for interns and use the internship
programs to audition the best talent for full time positions. A small number of full time positions
are also occasionally filled off-cycle on an ad-hoc, as-needed basis throughout the course of
the year.
Typical Analyst Program Recruiting Cycle

On-cycle Summer Internship
Recruiting Begins
Most On-
cycle Full
Time Offers Most On-cycle
Made Summer Internship
Dec Jan Offers Made
Nov
Feb
Off-cycle full time
recruiting occurs
Oct year-round
Mar
On-Cycle Full
Time Sept
Recruiting
Begins Apr
Aug
May
Jul Jun
On-Cycle On-cycle Summer

Full Time Internship Start Date
Start Date

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Undergrad On-Campus Recruiting (OCR)
Students at target schools have a tremendous advantage because some PE firms and many
analyst programs that are feeders into PE recruit candidates every year through on campus
recruiting. If you are a student at a target school, you should talk to a counselor at your career
counseling office as soon as possible and find out which firms typically recruit at your school.
You should also find out the timing of their recruiting process, whether any of the firms recruit
for summer internships and what criteria candidates typically have to meet in order to get
interviews. Your career counseling office also probably has a schedule of events such as
career fairs and information sessions which are sponsored and attended by top firms and
analyst programs. I highly recommended that you attend these events in order to find out more
information about your target firms and meet some of their recruiters. When you attend these
events follow these guidelines:
- Wear a suit, unless expressly told not to by an event coordinator.
- Peruse the websites of attending firms so that when you talk to the recruiters you can ask
insightful questions which demonstrate your interest in their firm.
- Have copies of your resume on-hand in case a recruiter proactively asks you for a copy;
never force a recruiter to read it or take it.
- Many firms actively collect the resumes and names of all students who visit their
information sessions and career fair booths. Some firms interpret consistent attendance of
their events as interest in their firm. Demonstrated interest may occasionally influence
which candidates are selected for interviews.
- Politely ask every recruiter you meet for a business card and email them a very brief thank
you note the following day. If they respond, ask a few simple follow-up questions about
their firm to further demonstrate your interest.
- Treat everyone you meet as if they have sole discretion over the recruiting process.
- The recruiters you meet may or may not have some discretion over which candidates
ultimately get interviews and job offers. Some recruiters who attend campus events are
later charged with screening resumes and conducting interviews. In some cases, recruiters
may make a note of candidates who make either an exceptionally favorable or unfavorable
impression in person. These notes can sometimes influence whether the candidate is
selected for an interview. Keep this possibility in mind at all times when you are in the
presence of recruiters and other employees.

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Undergrad Non OCR Recruiting
It is difficult to get interviews for top tier analyst programs which do not recruit on your campus.
Most firms allow non-target school candidates to submit applications via their website, but such
applications face long odds. A referral from a current employee greatly increases your odds at
an interview. Non OCR opportunities also arise occasionally when analyst programs recruit off-
cycle. These opportunities arise when fewer analysts from target schools accept offers than
expected, when analysts leave the program unexpectedly, and when a firm has an unexpected
surge of work to do. This off-cycle recruiting is often open to non-target candidates and
horizontal transfers from other firms. Persistence, vigilance, personal connections, and
networking skills often determine the outcome of non OCR recruiting attempts.
Choosing an Offer a Post-Undergrad Analyst Program Offer

The following general guidelines can help you determine which jobs are most likely to give you
the most exit opportunities into PE:
- Investment banking, all else being equal, offers the best exit opportunities into PE because
it teaches the most common PE skills and provides exposure to the most PE firms
- Within investment banking, the groups with the most exit opportunities into PE are
transaction-oriented groups such as M&A, leveraged finance, and financial sponsors. The
same principal is also true within other professional services firms such as consulting and
accounting. Due diligence, financial services, private equity, M&A advisory, valuation, and
corporate finance are all examples of groups and practices which offer exit opportunities
into PE.
- PE firms are increasingly hiring management consultants, but they still make up only 15 –
20% of PE professionals, and most of them come from McKinsey, BCG, and Bain.
- Size and prestige matter. Larger firms tend to have more exit opportunities into PE than
smaller firms. However, a firm’s prestige often trumps size. For example, many people feel
that BCG offers better exit opportunities into PE than Accenture, and Lazard offers better
exit opportunities into PE than Citibank.
- The size, industry, type, and geography of the deals you work on strongly affect your exit
options into PE. A PE firm is much more likely to take interest in your resume if you can cite
transactions that you worked on that are similar to the PE firm’s investment mandate.
- The table on the next page shows the types of firms that often provide exit opportunities
into PE, and some guidelines about the kinds of exit opportunities they provide

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PE Exit Opportunities by Firm Type Table7
Firm Type Sample Firms Typical PE Exit Opportunities

Large Goldman, Morgan Candidates who work in M&A, financial sponsors, and leveraged finance
Investment Stanley, JP groups at these firms are actively recruited by all kinds of PE firms early in
Bank Morgan, Citi, BofA, the recruiting cycle. There is, however, significant difference in the relative
Credit Suisse, prestige and geographical footprint of the firms in this group. These
Deutsche Bank, differences affect the caliber and geographic distribution of the PE firms
Barcap, etc. which most heavily recruit at these banks.
Elite Lazard, Moelis, Candidates who work in restructuring practices of these firms are heavily
Boutique Evercore, PWP, recruited by distressed buyout firms. They are also competitive with bulge
Bank Centerview, bracket bankers for most other PE opportunities, except perhaps with
Greenhill, etc. mega buyout funds.
Tier I McKinsey, BCG, Candidates from these firms are actively recruited by most types of PE
Consulting Bain firms, especially if these candidates work in a financial or private equity
Firm practice. Most mega funds still prefer investment bankers, but some
industry-diligence minded firms prefer consultants.
Middle Houlihan Lokey, Candidates from these firms are heavily recruited by many PE firms,
Market Bank William Blair, Harris especially middle market firms. However, mega funds typically don’t
Williams, Baird, recruit here and large funds do so less frequently. Candidates from these
Rothschild, firms may need to rely more on the PE firms which do a lot of business
Jefferies, etc. with their bank. Recruiting at these firms usually happens later in the cycle
than at bulge bracket banks.
Tier II Oliver Wyman, Active PE recruiting at these firms is present, but inconsistent.
Consulting Monitor Group, Consultants from this group are eligible for many of the same
Firm8 Booz & Co. opportunities as their peers at Tier I consulting firms, but they usually have
to work a little harder. These candidates may have to reach out to
recruiters more proactively and sell their interest in and qualifications for
PE more aggressively.
Elite LEK, Parthenon, Candidates from these firms have skills that are similar to their peers at
Boutique OC&C, NERA, Tier I & II consulting firms, but their firms’ brands are less widely
Consulting Roland Berger, recognized. Candidates from these firms typically have to reach out to
Firm Cambridge recruiters aggressively and convince them of their qualifications. It may be
Associates, etc. necessary for these candidates to have worked on PE or finance-related
cases in order to make a strong case.
Tier I PWC, E&Y, Candidates from this pool are much more likely to be recruited for finance
Accounting Deloitte, KPMG, roles rather than investment roles. Their best chance is to work in an
Firm Grant Thornton, M&A-related group and to proactively target PE firms which have hired
BDO, etc. accountants for investment roles in the past.
IT / Ops Deloitte, AT These firms’ large size belies their weakness in PE recruiting. Very few
Consulting Kearney, IBM, PE funds recruit them actively. Candidates from this pool must
Firm Accenture, etc. aggressively network and reach out to recruiters. Their options may be
limited to early stage and tech focused PE funds.
Other Corporate M&A, These candidates are almost never actively recruited. It’s possible for
Finance and insurance, equity them to break directly into PE, but it usually takes a lot of networking,
M&A- research, ratings persistence, and luck. The best bet for these candidates is usually to
Related agency, retail access a more traditional pre-MBA recruiting channel such as investment
banking, etc. banking or consulting before breaking into PE.
7
Sample Firms are not exhaustive and are based on the presence of each firm’s alumni in PE
8
Monitor Group was recently bought by Deloitte and Booz & Co. by PWC; It is not yet clear how these
developments will affect these firms’ PE exit opportunities

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What firms and groups give you the best shot at PE?
Pre-MBA Investment Bankers

Investment banking analysts, especially in M&A-related groups at well-known banks are the
most heavily recruited pool of PE candidates. However, unless you are a star analyst at a
premier bank, a job in PE is not guaranteed. Whether you are a star candidate or not, there are
still several things you can do to increase your odds of getting the position you want most:
- Impress your MD: It should go without saying that impressing your supervisor has a great
deal of influence over your marketability, not only for PE, but also for most other
opportunities. Most PE recruiters will at least ask to speak with your MD as a reference.
Some recruiters may even contact your MD before they decide who to interview, in order to
identify the firm’s star analysts with interest in PE.
- Position yourself: The industries you work on and the types of deals you work on affect
your marketability to various PE firms. If you have a list of target firms in mind, then you
should try to find out what kind of deals they typically do, and try to work on as many similar
deals as possible.
- Get your name out early: Even if you expect to be contacted by recruiters at some point,
you may want to consider reaching out to them early to put yourself on their radar screen. If
you have a close relationship with your supervisors, it may be a good idea to make them
aware of your interest in PE early on. It’s possible that they can help you work on roles
which bolster your PE credentials. Many MDs fully expect some of their analysts to pursue
opportunities outside of banking after the completion of their program. Some banks are

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actually happy to place their analysts into top tier PE firms because it increases their
prestige and builds closer ties to the PE firms which can be a big source of investment
banking fees. You should, however, be extremely careful to never give the impression that
you’re not fully committed to your current job, or you see it primarily as a stepping stone.
- Develop your investment judgment: Many banking analysts are so focused on managing
their insane workload that they never take the time to consider the merits of a deal they’re
working on. While PE associates are still expected to build models and crank out
presentations, they are also asked to exercise investment judgment. When you are working
on a model or a pitch book, ask yourself why the deal makes sense and what the major
risks are. You are likely to be asked these questions during PE interviews and can
distinguish yourself if you are able give thoughtful answers. Take every opportunity to
further develop your investment judgment by discussing with your supervisors the logic
behind various deals and decisions.

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Pre-MBA Management Consultants
- Although PE is still heavily dominated by former investment bankers, the percentage of
consultants in the industry is rising because firms are taking more active roles in the
management of their portfolios. An increasing number of PE firms are hiring one or two
consultants for every few investment bankers to help round out their team’s overall skill set.
A small number of PE firms, mostly small or mid-sized, actually make much of their
associate hires from consulting programs. On the other hand, large and mega sized PE
firms, with the exception of Bain Capital, focus on ex bankers for IP roles. A consultant’s
best chance for breaking into PE is to target firms which routinely hire consultants.
Consultants should, of course, pay particular attention to PE firms which have hired alumni
from their firm in the past. The following are some factors that may make a PE firm more
likely to hire a consultant for a pre-MBA associate position:
- Early stage focus: Earlier stage deals typically don’t involve as much complex financial
modeling for which investment bankers are generally preferred
- Consulting firm affiliation: Some PE firms, such as Bain Capital, Monitor Clipper, and
Parthenon Capital, were founded by consultants and still hire many consultants
- Proactive sourcing model: The proactive sourcing role is heavy on research, cold-calling,
and networking where consultants are usually at no disadvantage to bankers. Prominent
PE firms that employ a proactive sourcing model include Summit Partners, TA Associates,
Spectrum Equity Investors, and Battery Ventures.
- Operational focus: PE firms which focus on assisting portfolio company management with
operations are more likely to hire consultants for their strategic planning, market research,
operational improvement, and management advisory skills.
o Caveat: Some large PE firms have captive operations groups that help to manage
and improve performance of portfolio companies. For example, KKR’s captive
consulting group is called Capstone. These groups are often filled with former
management consultants. While such positions are highly desirable to many
consultants, aspiring investment professionals should know that captive operations
consultants are not usually involved with investment decisions. There may not be a
clear path from a portfolio group role into an investment professional role.
- Special industry focus: A PE firm is more likely to be interested in a consultant who has
significant experience in an industry on which the PE firm focuses, especially if that
experience is transactional.

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Other Pre-MBA Backgrounds
Candidates from non-traditional backgrounds face an uphill battle. PE recruiters likely won’t
call you proactively with interview offers, and most job descriptions probably won’t include your
background under the requirements section. However, several hundred non-traditional
candidates do break into PE every year from such varied backgrounds as accounting,
corporate M&A, IT consulting, equity research, and credit rating. If you are trying to break into
PE from a non-traditional background, be wise and realistic about you options, and target the
firms where you have the best odds of success. Most successful non-traditional candidates
cite patience, tenacity, and creative networking as the keys to their success. The following
strategies have been employed by non-traditional candidates to successfully break into PE:
- Network aggressively with PE recruiters, alumni of your current employer who work in PE,
and other personal or family connections who are connected to PE
- Target smaller firms in less competitive geographies where candidates with a similar
background have been hired in the past and where associates don’t focus heavily on
financial modeling
- Leverage rare language skills or citizenships, special knowledge of or experience in a
particular industry, and special knowledge of or experience with one of a PE firms’ portfolio
companies
- Consider alternate stepping-stones into a PE investment professional role such as:
o MBA at target program
Pro: Chance to do OCR with PE firms
Con: Most post-MBA PE hires also have pre-MBA PE experience
o PE Fund-of-funds
Pro: More open to non-traditional backgrounds; Chance to learn more about
PE
Con: Easier to move from traditional PE into Fund of Funds than vice versa
o Non-investment professional PE role such as finance or operations
Pro: More open to non-traditional background; Chance to get foot in the door
Con: No guarantee of opportunity of transfer into investment professional role
o Horizontal transfer to analyst program in investment banking or consulting
Pro: Learn necessary PE skills and enter the traditional recruiting channel
Con: May be hard to enter from current position; May require a step down in
title or compensation

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MBA Students with Prior PE Experience
The majority of MBA students with pre-MBA experience in PE have historically found post-
MBA positions. However, this trend is faltering during the current industry downturn. Since fund
sizes are shrinking and the number of IP positions is stagnating, competition for partner-track
post-MBA positions has become a lot fiercer. The following guidelines can help you remain on
track to land your most desired post-MBA offer:
- Academic Concentration: Since it’s likely that you already have the common PE skills,
you can use your classes to broaden your horizons and become a more rounded
candidate. If you were primarily a deal execution associate, consider taking some
marketing or strategic planning classes. Above all, concentrate something you are
passionate about. When recruiters ask you about your choice of concentration, you can
impress them if you demonstrate your passion. Don’t forget, however, that whatever your
concentration, you need to maintain a strong academic performance if your school has
grade disclosure. You don’t want any red flags to ruin your candidacy.
- Summer: Once again, your prior experience in PE allows you some flexibility in your
summer internship choice. Feel free to explore options like hedge funds, consulting firms,
and operational positions with portfolio companies. However, if you wish to pursue a full
time position with a PE firm which is substantially different from your previous firm, you
should probably go for an internship with a PE firm closer to the kind you ultimately want to
target. The same is true if you worked at a very small or unheralded PE fund prior to your
MBA.
- Recruiting strategy: If you are a rock star associate from a brand name PE firm and are at
a top tier MBA program, then you shouldn’t have to do much more than apply for jobs
available through your school’s OCR. If, however, you’re nearer the middle of the pack, you
shouldn’t take anything for granted. Proactive networking with classmates, professors, and
recruiters is recommended. Join finance clubs and take leadership positions. Participate in
your school’s finance/PE conference if there is one. Go on treks to meet PE employers if
such events are available.

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MBA Students without Prior PE Experience
Candidates without previous PE experience face a daunting but not necessarily
insurmountable challenge. Most PE firms are hesitant to hire a post-MBA candidate without
prior experience since these firms typically have their pick of candidates already with PE
experience. Candidates with no prior experience likely need to be aggressive, persistent, and
creative in their approach to breaking into PE. The following guidelines can help you overcome
the odds:
- Academic Concentration: You should consider using your classes to fill any gaps in your
financial skill set and signal your strong desire to work in principal investing. If you lack
experience with PE staples such as accounting, financial modeling, strategic planning, etc.,
you can use your classes to fill the gaps and signal your aptitude by earning top grades.
- Summer: Your summer internship is your best chance to get on the right track because PE
firms are more likely to take a chance on a “risky” internship candidate than they are on a
full time candidate. You likely have little chance of interning with large, established PE firms
because they have too many other more proven applicants to consider. However, you can
greatly increase your odds of eventually getting a full time offer if you spend your internship
with a middle market or early stage firm. If you are unable to intern in PE, the next best
option is to intern with a brand name investment bank, hedge fund, or consulting firm. At
the very least, doing so will add an attractive name to your resume and signal your aptitude
for PE-type work.
- Recruiting strategy: In order to get a PE internship or full time offer, you likely face the
tough challenge of beating out someone with PE experience. Your best strategies for
success are aggressive networking and geographic flexibility. Other candidates in your
position have succeeded by getting leads and referrals from their classmates and well-
connected professors. Flexibility on offer location and firm type can also make the
difference. You may want to target middle market and early stage firms in less competitive
geographies. The most promising targets are firms with a history of hiring candidates with
your background, especially if the firm has alumni of your MBA program but isn’t
interviewing on campus because they are too small or too far away.

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RECRUITING CYCLE
Pre-MBA
The pre-MBA recruiting cycle is driven by PE firms’ competition for top tier talent, as well as
the recruiting cycle of the analyst programs from which PE firms select most of their
candidates. Most analyst programs conclude in late spring or summer, so most on-cycle pre-
MBA PE associate programs have start dates in the summer or early fall. The timing of when
on-cycle offers are made partially depends on how active and healthy the PE industry is in a
given year. When PE deal making activity is high and fundraising is strong, PE firms are
usually anxious to grow and thus compete for the best candidates earlier in the cycle. On the
other hand, when deal making activity is low or fundraising is weak, PE firms are cautious
about making new hires and make on-cycle offers later in the year. For example, during the
peak year of 2007 some firms made on-cycle offers in April (16 months prior to start), whereas
during the current, ongoing credit crunch, few on-cycle offers are being made prior to July.
On-cycle PE recruiting typically occurs in three stages. During the first stage, the mega and
large buyout firms compete over top ranked analysts at the most prestigious investment banks.
Such firms often proactively reach out to managing directors at top tier banks and inquire
about recruiting their top ranked analysts. The banks are sometimes receptive to these
requests because having alumni at top buyout firms increases their prestige and helps ensure
that they maintain a close relationship with the buyout firms which often pay them large fees
for arranging deals. In addition to contacting managing directors, some PE firms also reach out
to targeted candidates directly via recruiters and headhunters. Candidates who are eligible for
this stage are usually aware of it because they are being proactively recruited as early as half
way through the first year of their analyst program.
The second stage is when the majority of middle market firms make their on-cycle offers. The
duration of this stage varies considerably because there are more middle market PE firms than
large ones. During this stage, offers may be made anywhere from late summer all the way
through the winter. As with the first stage, PE firms and their recruiters actively reach out to
their top candidates. However, this stage allows for a greater range of candidates to break into
the process because smaller firms are more open to candidates of various backgrounds.

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During this stage, many candidates from lower profile programs and non-traditional
backgrounds are able to break into PE alongside the more traditional candidates.
The third stage occurs in the spring, when many early stage firms do their recruiting. Such
firms are often most open to candidates with non-traditional backgrounds. These firms’ have a
much larger pool of candidates who do not need to be locked up a year in advance.
Typical Pre-MBA PE Recruiting Cycle9
Dec Jan Most Early

Most Middle Stage Firms
Market Firms Nov Have Begun
Have Made On- Feb On-cycle
cycle Offers Recruiting
Off-cycle full time
recruiting occurs
Oct year-round for
candidates who Mar
can start
immediately
Sept
Apr
Most Early
Most Middle Market Aug Stage Firms
Firms Have Begun On- Have Made On-
cycle Recruiting May
cycle Offers
Jul Jun
Most Large and Mega
Firms Have Made On-cycle
Offers
Most Large and Mega Firms Have On-cycle Start
Begun On-cycle Recruiting Dates Begin
9
The pre-MBA recruiting cycle typically begins a few month earlier when the PE industry is doing particularly well,
and a few months later when the PE industry is struggling; other factors may also change the timing year to year

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Post-MBA
The post-MBA recruiting cycle is driven by PE firms’ competition for scarce talent, as well as
the school calendar of the MBA programs from which PE firms select many of their candidates.
Most MBA programs last for two regular academic years, with one summer in the middle.
Therefore, most post-MBA full time positions have start dates in the summer. In addition, some
PE firms recruit first year MBA students for summer internships in order to audition them for full
time positions after graduation. The timing of when on-cycle offers are made partially depends
on how active and healthy the PE industry is in a given year. When PE deal making activity is
high, and fundraising is strong, PE firms are usually anxious to grow, so they compete for the
best candidates earlier in the cycle. On the other hand, when deal making activity is low, or
fundraising is weak, PE firms are cautious about making new hires and make on-cycle offers
later in the year. For example, during the peak years of 2006 and 2007, many PE firms began
their on-cycle recruiting near the beginning of the school year. However, during the current
environment, many processes are being pushed back closer to winter.
As with pre-MBA recruiting, the larger and more established firms are usually out of the gate
first. These funds aggressively pursue the most pedigreed candidates at the most prestigious
MBA programs. In a robust hiring environment, top tier candidates are likely to be actively
contacted by recruiters from premier PE and hedge fund firms for on-cycle interviews as early
as September. Since this pool of employers and candidates is relatively small, this phase of
on-cycle recruiting can be over in just one or two months.
Middle market buyout firms and early stage firms typically conduct their recruiting a little later in
the cycle and over a longer period of time. These firms, especially early stage firms, are
typically a little more open to candidates without top tier pre-MBA experience, and even
without pre-MBA PE experience altogether. Due to the large number of small and mid-sized
firms, this phase can easily stretch through the winter. Some early stage firms even hand out
offers as late as the spring.
PE firms also do off-cycle recruiting year-round for post-MBA positions when they have an
unexpected vacancy. For example, off-cycle opportunities arise when firms experience
unexpected turnover, fail to sign up enough candidates via on-cycle channels, or raise more
capital than anticipated. PE firms typically fill these opportunities by reaching out to their

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network, or by employing recruiters. These opportunities may be open to MBA students as well
as lateral hires. The best way to access off-cycle opportunities is to always stay on recruiters’
radar screen and keep in touch with as many professional in the industry as possible.
Typical Post-MBA PE Recruiting Cycle10

Most Other
Firms Have
Begun On-cycle Most Middle
Recruiting Market Buyout
Dec Jan Firms Have
Most
Large and Made On-cycle
Mega
Nov Offers
Firms Feb
Have Off-cycle full time
Made On- recruiting occurs
cycle Oct year-round for
Offers candidates who Mar
can start Early
immediately Stage
Firms
Sept Make
Final On-
Apr cycle
Offers
Most Large
and Mega Aug
Firms Have
May
Begun On-
cycle Jul
Recruiting Jun
On-cycle Full Time and

Summer Internship Start
Dates Begin
10
The post-MBA recruiting cycle typically begins a few month earlier when the PE industry is doing particularly
well, and a few months later when the PE industry is struggling; other factors may also change the timing year to
year

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PE Recruiting Timing: Game Theory In Action
HOW TO WORK WITH RECRUITERS
For most PE candidates, working with recruiters is an essential part of their job search. Most
PE firms have limited internal recruiting personnel and don’t have time to sift through hundreds
of resumes. As such, most PE firms rely on outside recruiters, also known as executive search
firms and headhunters, to help source and filter qualified candidates. The following frequently
asked questions section summarizes what you need to know in order to get the most traction
with PE recruiters:
What do recruiters do?

- Find candidates who meet their client’s requirements.
- Screen qualified candidates and make sure they are interested in the available position.
- Present CVs of qualified and interested candidates to the client for interviewee selection.
- Act as liaison between the candidate and the client during the interview process, if needed.
- Recruiters DO NOT decide which candidates are selected for interviews or get offers.
These decisions are in the hands their clients. However, if recruiters have a particularly
close relationship with their client, they may have some influence on these decisions.
How do recruiting firms differ?

- Size: Some boutique firms have only a single or a handful of recruiters. Larger recruiting
firms often have several dozen or even several hundred recruiters.

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- Geographic focus: Some recruiters focus on individual cities or regions. Other typically
larger recruiters focus on entire countries or multiple countries.
- Industry focus: Some recruiters focus on a niche market such as PE firms and hedge
funds. Other recruiters focus on entire industries such as finance. Some large recruiters
service many diverse industries.
- Role focus: Different recruiters sometimes focus on filling different corporate roles such as
investment professionals, finance, and marketing. Some recruiters also specialize in filling
positions of different seniority levels such as junior level, mid-level, and senior level.
- Search type: Some recruiters work primarily on a retained basis, while others work
primarily on a contingency basis. Some recruiters work on both a retained and a
contingency basis depending on their client. Retained recruiters are given an exclusive
mandate to fill a certain position for a client and are paid a retainer fee in addition to a
success fee once the position is filled. Contingency recruiters typically don’t have a
mandate to fill a position. Instead, they opportunistically introduce qualified candidates to
the client and are paid a success fee if the candidate is hired.
Whose side are recruiters on?

Recruiters are good at sounding like they are on your side. While this may very well be true,
keep in mind that recruiters don’t work for you; they are paid by their clients. When recruiters
work on retainer, they get paid regardless of who gets the job. They want to make clients
happy by helping them find and sign the most qualified candidate as quickly as possible. It may
be in their best interest to steer you toward taking their clients’ offer even if you might find
better opportunities. When recruiters work on contingency, their financial incentive is to place
as many candidates as possible as quickly as possible. They may just be playing a matching
game where they try to line up their most promising candidates with the most imminent
opportunities. They may push you toward whichever opportunity they feel is likely to generate
a quick offer. Recruiters can be very useful in your search, but you should always keep their
motivations in mind when they offer you advice.
Should I work with recruiters?

The only potential downside to working with recruiters is that it makes you a more expensive
hire. Recruiters are paid a success fee, 25 – 33% of your cash compensation on average, for
every new hire they introduce to a PE firm. Given a choice between two equally attractive

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candidates, a PE firm might possibly pick the candidate that doesn’t come with having to pay
an additional commission fee. As such, if you have a great personal connection to your target
employer, you may wish to contact them directly. However, most PE funds, especially the
more established ones, fully expect to pay hiring commissions as a normal part of doing
business. In addition, most candidates cannot possibly establish a relationship with as many
potential employers as recruiters can on their behalf. For these reasons it is highly advisable
for most candidates to make recruiters an important part of their job search.
How do I contact recruiters?

If you work for a top tier investment banking or consulting program, PE recruiters will likely
reach out to you or your supervisor. If recruiters aren’t reaching out to you proactively, or if you
want to work with a larger number of them, then you should follow these steps:
- Update your resume: It’s crucial that your resume clearly and concisely summarizes your
qualifications for PE. Recruiters are much more likely to respond to you if they can quickly
determine that you are a qualified candidate. If you already have contacts with experience
in financial recruiting, you would be wise to ask their assistance.
- Build an initial target list: Refer to the appendix for a list of PE recruiting firms. These
firms’ websites typically contain the firm’s main contact information, individual recruiter
contact information, and resume submission information. If possible, augment this list with
recruiters you find on your own or hear about from your contacts. Depending on how strong
your qualifications are and how robust the hiring environment is, determine how wide to
cast your net. If you have a strong background and the hiring environment is good, you
may wish to limit your recruiter contacts to a smaller set most likely to have the best
opportunities. If you have a non-traditional background, or if the hiring environment is slow,
you may wish to initially reach out to as many recruiters as possible because opportunities
for you may be scarce.
- Ask for referrals: Many recruiters are overwhelmed with candidates, and getting their
attention can be difficult. Your response rate will increase if you can get one of your
contacts to send a referral email to their recruiter contacts. Another good approach is to ask
your contacts if you can reference them when you reach out to recruiters with whom they
have a relationship. If you get permission, make the subject line of your introductory email
something descriptive like “M&A group referral from <name of your contact>”. Recruiters

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are more likely to read your email if the subject line includes attractive buzz words, the
word referral, and the name of someone they recognize.
- Send introductory email: Some recruiting firms have a specific resume submission email
addresses or resume submission form on their website. Feel free to use these submission
channels because they can help you make sure your resume is sent to the right recruiter,
especially within larger firms. However, contacting recruiters directly, if possible, is a good
idea. Your initial email to any recruiter should include your resume, a summary of the types
of opportunities you are interested in, and a summary of what makes you qualified for such
opportunities. Your message should also request a 10 minute introductory phone call at the
recruiter’s convenience. Many recruiting firms have information about their firm and
biographies of their recruiters on their website. Your odds of a response increase if you find
a way to use this information to make your email sound more personal and thoughtful.
Keep this message to fewer than 250 words.
- Follow up: If you don’t get a response within a week, follow up with another email or phone
call. When you follow up, acknowledge that the recruiter must be very busy and avoid
sounding whiny or entitled. If you include some sort of update about your job search in your
follow up, you can lend it an element of news instead of coming off as demanding or
complaining. Reiterate your desire to schedule a 10 minute introductory phone call at the
recruiter’s convenience. If your follow up fails to generate a response, you may wish to
move on and focus your time on other recruiters.
How do I get the most out of recruiters?

The following guidelines can help you ensure that recruiters work hard to match you with the
right opportunity and strongly advocate your candidacy.
- Impress them: Recruiters look for candidates that have a desirable background and a
presentable demeanor because such candidates are the easiest to place. If you have a
desirable background, you are already a step ahead but can still damage your chances if
you do not impress on the phone or in person. If you have a non-traditional background,
then you may have to convince recruiters to take you seriously. The following guidelines
can help you come across as an impressive candidate:
o Be 100% thoughtful and professional in all interactions, including email.
o Have a clear 3 minute response to the “please walk me through your resume”
question.

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o Be able to summarize exactly what types of positions interest you and what
makes you qualified.
o When speaking with a recruiter on the phone, pretend that it’s an interview.
Convey your confidence and excitement about PE through both your words and
your voice. Speak at a calm pace.
o Ask for an in-person meeting whenever possible. This is especially critical for
candidates who need to overcome a weaker background by making a great
impression. Treat meetings with recruiters as interviews. They are asking
themselves whether they can picture you impressing a PE interviewer. Wear a
sharp conservative suit (grey or blue).
- Communicate what you want: Be clear and specific about the opportunities that interest
you. If possible, provide recruiters with preferences about the size, location, industry focus,
and investment type of your desired employer. Doing so creates the impression that you
have thought carefully about what you want to do and ensures that you hear about all
opportunities that fit your interests.
- Stay in touch: Periodic check-ins help keep your name near the top of recruiters’ minds.
Recruiters also appreciate when you keep them updated about the status of your search so
that they don’t waste their time and their clients’ time.
- Drop the attitude: Are you God’s gift to finance? Great. Keep it to yourself. Most recruiters
have seen it all before. Avoid acting entitled, arrogant, or impatient. Diva-like behavior won’t
impress anyone and may cost you a recruiter’s fulsome support.
- Be discreet: Recruiters often consider the names of their clients and the status of their
searches as confidential. Don’t be loose with this information, especially when working with
more than one recruiter at a time. If you spill confidential information, recruiters may fear
you will spill their confidential information to others.
- Be honest: Recruiters appreciate candidates who are always honest about their
background, the status of their search, and their interests. Be careful not to give them the
impression that you would take an interview for practice rather than out of genuine interest.
During the interview process, be as honest as possible about how you think the process is
going and whether you would strongly consider an offer if it were given. Recruiters may
lose faith in a candidate who professes to be excited about an opportunity but turns down
the offer if it comes.

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- Control your resume: Make sure that recruiters never send your resume to a firm without
your permission. Also, keep a list of all firms your resume is sent to. You don’t want your
resume to end up in the hands of an unexpected person or to be sent to a firm from
multiple recruiters.
- Do them favors: If you decline a potential opportunity or are eliminated from a process,
consider referring another qualified candidate to the recruiter. If you hear about a new, non-
confidential search within their area of focus, let them know about it. The more you are able
to help your recruiters, the more they will like you and want to help you.
3 Crucial Tips When Dealing with PE Recruiters/Headhunters

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HOW TO CHOOSE AN OFFER
When PE professional evaluate an offer, they most commonly consider the upward mobility,
job security, and exit opportunities of their new position. Of course, they also consider how
much they would personally enjoy their new role, but in this guide we focus only on the first
three categories.
Topic 1: Upward mobility

PE is a destination industry. Many people use consulting and investment banking as stepping
stones into a long term career in PE. In fact, most PE professionals who go to business school
return to PE, which is a retention rate few industries can match. The goal for most
professionals in PE is to work their way up to a partnership position where the bulk of the
decision making power and financial rewards reside. Therefore, one of the most important
elements of an offer is how quickly it can lead to a partnership position. The following factors
can help you evaluate this criterion:
- MBA requirement: If you are considering a pre-MBA role, then you may wish to know
whether an MBA is required to advance past the associate level. If an MBA is required, you
may wish to know whether the firm sponsors its associates for business school (pays their
tuition) with the intent of bringing them back for a career track position. If so, you should
find out what criteria associates must meet in order to be considered for sponsorship or to
be brought back for a career track position without formal sponsorship. If an MBA is not
required, which is increasingly common, then you may wish to find out what percentage of
associates typically make it further up the ladder and what criteria are used to make those
decisions.
- Partnership opportunity: The following guidelines can help you determine how much
opportunity an offer gives you to attain partnership:
o Past precedent: How long it took current and former members to advance up
the ladder may be a useful proxy for how long you could expect it to take you,
especially if your firm is a larger, mature organization with well-defined roles and
career progressions.
o Growth opportunity: The fastest way to make partner is usually by joining a
growing firm where new partnership opportunities are created rather than waiting

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until a partner leaves or retires. Partnership opportunities are typically created
when a PE firm raises new funds, increases the size of its AUM and expands into
new geographies or new investment foci.
o Current partners’ plans: Another source of partnership opportunities is when
current partners retire or move on. If you can glean any information on current
partners’ career plans, this information can help you assess your own partnership
opportunity. You should, of course, be extremely careful and discreet when
gathering this information.
Topic 2: Job Security

As with any new job, most applicants care very much about the stability of their employer and
their own job security. This concern is especially relevant in PE because not only is finding a
similar job if you are laid off difficult, your personal reputation is partially tied to the
performance and reputation of your firm. The following factors can help you evaluate the
stability of your prospective employer:
- Turnover: Partnership positions in PE are extremely lucrative and scarce. If any partners
have left recently it raises a host of possible questions. Did they retire, leave PE, defect to a
competitor, or were they fired? Is there discord or any other drama amongst the
partnership? Is the firm’s target market slowing down? Is fundraising going badly? Are
there any major negative surprises in the company’s portfolio? Likewise, if any junior staff
have left recently during an odd time (i.e. before their program naturally concluded), it’s
wise to discover why. Did they under-perform? Did they jump ship for a better opportunity?
Did they dislike the culture?
- Funding: A PE firm’s funding is its lifeblood. If funding dries up, then the firm stops making
investments, partners leave, bonuses shrink, and junior staff gets laid off. There are a
number of ways to assess a firm’s financial health:
o Fundraising cycle: How much dry powder does the firm have remaining and
when will it need to raise its next fund? Have the firm’s most recent funds
exceeded or fallen short of target funding levels? If the firm needs to raise capital
soon, is the fundraising environment weak or strong?
o Recent track record: Is there any recent positive or negative news about the
firm’s portfolio companies or the sectors in which its portfolio companies
operate? Has the firm made any recent successful exits? Have any of its portfolio

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companies declared bankruptcy, been written down, or been downgraded by a
ratings agency?
o Deal activity: Has the firm been making deals at a healthy pace? Is it actively
pursuing new deals? Does it have a healthy pipeline of new deals? Are there any
deals currently under letter of intent (LOI)? Have any recently announced deals
failed to close?
o Limited partner base: How diversified is the firm’s LP base? How longstanding
is the firm’s relationship with its biggest LPs? Has there been any recent
troubling news about the firm’s LPs or the sectors in which they operate? Have
any of the LPs recently attempted to reduce or sell their stakes?
Topic 3: Exit Opportunities

Although PE is a destination industry, many candidates still care very much about how
marketable their new position makes them should they ever choose to go to graduate school,
leave PE, or pursue a position with a different PE firm. The following guidelines can help you
evaluate how a particular position is likely to affect your future options:
- Experience: The nature of your role and experience strongly affects the exit opportunities
for which you are seen as qualified. Consider how the following factors will affect you if you
ever move on from your firm:
o Deal activity: One of the first questions you are asked during interviews is, “Tell
me about the deals you worked on?” If you can point to a number of completed
deals on which you played a significant role, future recruiters will see it as proof
that you have what it takes to bring a deal across the finish line. Having a lot of
completed deals on your resume also allows you to showcase your investment
judgment when you discuss the merits and challenges of each deal.
o Deal size: Working on a $10 billion dollar deal is a very different from a $1 billion
deal, which is very different from a $100 million deal or a $10 million deal. Larger
deals often mean larger deal teams, more legal and accounting issues, a more
complex capital structure, and more operating units, in addition to other
differences. As a general rule, individuals who work on smaller deals are
responsible for a greater portion of the overall deal, but may not get the
opportunity to tackle additional complexity. For this reason, professionals who

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have successfully overseen large deals find it easier to transition to doing smaller
deals than vice versa
o Deal stage: Another experience differentiator is whether you work on primarily
early stage, mid stage, late stage, or distressed deals. The more that you
specialize in one particular stage, the more attractive you become to other firms
that focus on that stage. On the other hand, it may be difficult to transition
between stages. For example, someone who has worked primarily on early stage
deals may have to work hard to convince a late stage firm that he or she can
handle the additional complexity of late stage deals. Someone who has worked
primarily on late stage deals might have to work hard to convince an early stage
firm that he or she has the requisite breadth of industry knowledge and passion
for startups.
o Industry focus: If you work for a generalist fund it may be difficult for you to
transition to a more sector or industry-focused fund in the future. On the other
hand, if you work for a highly specialized fund, you may find it difficult to break
out of that niche. As a general rule, you should look to specialize in an industry
only if you are passionate about it and want to work in it for a long time.
o Role: The final major experience differentiator is which parts of the deal process
you are responsible for. If you focus on sourcing, investment theme
development, execution, due diligence, or portfolio management, then you are
more marketable for positions which focus on your area of expertise. The general
rule is, the more roles you play, especially in an oversight capacity, the greater
your range of exit opportunities.
- Brand: A strong brand can be helpful if you ever leave the firm to go to graduate school,
transition to another PE fund, or look for a job outside of PE. A firm’s brand is a
combination of some of the following factors:
o Size: Larger firms tend to be more prestigious for two reasons: First, they tend to
work on a larger number and higher profile deals, so more people are likely to
have heard of them. Second, LPs tend to give PE firms larger capital
commitments when the PE firms perform well and hire reputable partners. It is
common to see partners from larger firms moving to smaller firms, but it is less
common to see professionals from smaller firms moving to larger firms.

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o Performance: Strong historical performance often goes hand-in-hand with larger
firm size and is a big component of a firm’s brand. Being associated with a strong
performer enhances the cachet of your resume. Strong performance is especially
important for more senior positions because they are the ones with the ultimate
decision making power.
o History: PE is a relatively young industry, one in which succeeding consistently
is difficult. Funds that have a long track record are more likely to be well known
and respected.
o Team pedigree: It’s a mistake to read too much into the biographical details of a
PE firm’s partners and team members. However, there is truth in the notion that
people with prestigious backgrounds tend to seek prestigious positions and
attract other people with similar backgrounds. If most of a firm’s team members
hail from prestigious firms and universities, and if most of its alumni transition to
other prestigious institutions, then that’s a signal the firm’s brand is well
regarded.
How do I evaluate these topics?

As a PE professional, your job is to do your due diligence before you make an important
decision. Since choosing your employer is one of the most important decisions you will ever
make, get as many of your questions answered as possible. You should be able to get
answers to many of these questions by asking your interviewers and by researching
information available on the firm’s website. You will find that a firm’s junior staff is often more
candid than its partners and HR staff. A firm’s recent alumni are another great source of
information. Any associates who have recently entered business school or transitioned to a
different firm are often more candid than current employees. You should always ask to speak
with as many current employees as possible and ask for the names of any recent alumni
before accepting an offer. Finally, finance message boards, blogs, and news wires can be a
goldmine of information. Refer to the appendix for a list of websites you should visit.

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3 Ways to Find the Dirt and Get a Good Grasp of Private Equity Firms

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HOW TO WRITE YOUR RESUME
A recruiter will take no more than a minute to scan your CV out of a pile of hundreds, so every
word has to count and there can be no errors.
What your CV Must Say About You

Your CV should make it obvious that you possess to a superior degree the following
characteristics which PE recruiters look for:
- Analytical skills
o Any jobs or roles which required quantitative analysis
o Academic credentials in quantitative courses
o Examples of completed projects which required analysis of large data sets
o Examples of academic or work-related studies which followed a hypothesis-
driven investigative approach
o Examples of a time you discovered a problem and fixed it or figured out a way to
make an existing process even better
o Examples of building complicated operating or projection models
- Attention to detail
o Zero grammar and formatting errors on your CV
o Not a single comma out of place; standardized abbreviations; aligned margins;
consistent fonts, etc.
- Exceptional work ethic

o Examples where you went above and beyond your assigned responsibilities
o Achieved particularly strong academic, personal, or professional results
Exceptional grades in tough courses
Major athletic accomplishments
Rapid promotion in a demanding job
- Exceptional communication skills

o Written communication experience

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Slide presentations, articles, academic papers, memos, etc.
o Verbal communication experience
Oral presentations, speeches, leading meetings, leading negotiations, etc.
- Financial modeling proficiency

o Examples of jobs or roles which involve financial modeling
o Examples of times you have built financial models like LBOs, DCFs, valuations,
comparable analysis, etc.
o Examples of finance classes you have taken either in school or via specialized
training programs like WallStreetPrep
o Any financial certificates you have like the CFA
- Independence
o Examples of times you took initiative or structured your own work
- Leadership and teamwork skills

o Membership or leadership positions in collaborative activities like boards, sports
teams, fraternities/sororities, clubs, community service organizations, etc.
o Experience working on deal teams, project teams, case teams, etc.
o Experience working on academic group projects
o Examples of times you led or influenced a group of people to accomplish a goal
CV Tips
- Use the resume template which comes with this guide or borrow one from a friend who
works in investment banking. PE recruiters expect this format. There is no up-side in this
case to getting creative.
- Keep your CV at no longer than 1 page.
- Have your colleagues and career mentors check your CV for content, grammar, and
formatting.
- Tailor your resume to individual firms (e.g. if you have particular domain experience that
you know they are looking for).
- Quantify the results of your work whenever possible; estimate when necessary (e.g. “saved
my deal time ~50 hours of work by …”).

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- Use common industry lingo where appropriate because recruiters sometimes look for
certain buzz words as they scan a CV (e.g. “LBO”, “restructuring”, “deal”, “due diligence”,
“IPO”, “benchmarking”, “M&A”, etc.).
- Start role, task, and project descriptions with past tense verbs like “led”, “developed”,
“performed”, “designed”, “presented,” etc.
Standard PE Resume Template

Investment banking analysts are the most common PE recruits, and junior investment bankers
use a near-universal template for their resumes. Consequently, this template, with minor
variations, has become the industry standard for PE recruiting. It is highly advisable that you
use this template for your CV and refer to the sample CVs in the appendix as a guide:
Standard PE Resume Template

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Note: As part of the PE Prep Package, we have linked you to our latest private equity resume
template for professionals with deal experience. The bullets in the template are placeholders
only and not considered “good bullets”, so this template should only be used for formatting /
layout purposes.
5 Common Mistakes on PE Resumes that Can Hurt You

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Chapter 4: Interview Preparation
In this chapter… This chapter focuses on helping you

x Interview Process
succeed in PE interviews. This
x Key Technical
Concepts section covers the most important
x Top 30 Technical PE-related finance and accounting
Questions
topics, as well as the most common
x Top Fit 15 Questions
x Top 10 Brainteasers technical, fit, and brainteaser
interview questions and how to
answer them.

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INTERVIEW PROCESS
The PE interview process for pre-MBA and MBA OCR varies from firm to firm. Some firms do
all or only some of the following steps, and the order can vary somewhat (especially if there is
a modeling test), but the following process is common:
While less than half of firms employ the phone screen stage, some especially smaller
firms, which aren’t located in the same city as you, do.
~30 minute phone call with an HR representative or a junior IP.
The purpose of this screen is to make sure you have a strong interest in the job and
a passion for the industry, plus meet the minimum qualification standards.
Quantitative and technical questions are unlikely at this stage.
The types of questions you are likely to face include:
Phone
Screen x Walk me through your resume / tell me about yourself
x Tell me about your experience with your previous employer. What did you like
or not like? What did you learn?
x Why do you want to go into PE? / Why are you interested in our firm?
x Do you have any questions about our firm?
Relatively few candidates are cut during this stage as long as they can convince the
interviewer of their genuine interest in PE and the interviewer’s firm in particular. It
also helps to be personable on the phone and fluent in “talking your CV”.
Early round interviews are usually conducted by mid-level IPs like VPs. They last 30-
60 minutes each. You will commonly have 1-5 of interviews back-to- back either at
the firm’s office or in your own city if you don’t live in the same city as the firm.
These interviews will likely focus on technical questions, brief case questions, and
possibly brainteasers (see further details in the Interview Preparation section). You
Early might face a few fit questions, but the focus of this round is to test your
Rounds understanding of the PE industry, finance skills, and investment judgment.
The subsequent phases of the process involve busy senior IPs so a lot of candidates
don’t make it past the early rounds. A PE firm may interview 50 or more candidates
for every offer it gives out, and most of the cuts happen at this stage.
In order to make it past this stage you must demonstrate your mastery of relevant
accounting / finance, PE investment theses/returns drivers, structuring of analysis,
and your previous deal-related experience.

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Less than half of PE firms do full-blown modeling tests, and those that do put it in
different parts of the process. This test commonly happens as part of early round
interviews or as a stand-alone phase following early rounds. The modeling tests are
possibly the final phase of the interview process, as sometimes practiced by KKR.
The modeling test is meant to simulate an abbreviated deal diligence experience and
is intentionally stressful to gauge your ability to work under pressure with a deadline.
It lasts 2-5 hours, depending on level of detail, and is conducted at a PE firm’s office.
Candidates are provided with a laptop with basic Excel / PowerPoint (cannot use
your own) and an abbreviated CIM about a hypothetical or real potential deal.
Modeling The candidate is required to do some or all of the following:
Test
x Triage available data and focus what is needed to build an investment thesis
x Project the target’s operating/financial performance for ~5 years using
assumptions supported by available evidence or at least sound general logic
x Build a valuation model either from scratch or from a partially pre-populated
template. Simpler tests may require only Sources & Uses, Income Statement
projection, and Exit assumptions, but more complicated tests may require a
full 3-statement model with multiple operating cases and returns sensitivities
x Determine the right structure and price for a deal with this profile
x Present your findings orally or in slide format to one or more senior IPs
See the Modeling Test section for more details and advice.
Late rounds are almost always conducted by senior IPs at the PE firm’s offices
Interviews last 30-60+ minutes and may be conducted by every senior IP.
Senior IPs’ time is limited so this stage is typically reserved for candidates whose
odds of getting an offer are 50% or better.
At this stage your qualifications are proven, so the focus typically turns to fit. The
partners want to make sure you align with the firm’s culture and share its goals,
Late /
Decision values, and work style. Technical questions are rare, but some partners throw in a
Rounds case question to get a feel for how you think, communicate, and structure analysis.
You are likely to be asked about your personal history, career goals, personal goals,
work style, likes/dislikes etc. Partners may also ask about what you look for in a deal,
what diligence techniques you find most valuable, and which industries you’re most
excited to invest in, etc.
At this stage an offer is yours to lose. See the Fit section for more details and advice
Note: Late rounds may take place over multiple visits if the PE firm’s partners’
schedules don’t line up or if they need time to ponder their hiring options.

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WHAT IS AN LBO?
Definition of an LBO and why it uses leverage

An LBO is the acquisition of a company where the buyer contributes some of its own money
(equity) along with a lot of borrowed money (“debt” or “leverage”) to fund the purchase. Debt
makes up 50 – 80% of the purchase price of a typical LBO. The buyer uses the cash flow of
the target company to make interest payments on the debt and pay down the principal over
time. If the buyer is a PE firm, it will hold (own) the target for ~5 years and then look to sell it for
a profit. By using debt to fund the acquisition, the PE firm risks only a fraction of the purchase
price and increases the return on its equity. Consider the following simplified example:
Example PE Acquisition without Debt

Assum ptions Year: 0 1 2 3 4 5
Target purchase price 1,000 Free cash flow (FCF) of target company 70 74 77 81 85
Target initial FCF 70 Less: interest on debt - - - - -
FCF Grow th Rate 5.0% FCF remaining to repay debt principle or pay out as dividend 70 74 77 81 85
Target value at exit 1,500
Debt % of acquisition 0% Beginning debt - - - - -
Debt annual interest rate 8.0% Less: debt principle repayment - - - - -
Ending debt - - - - -
Sources of acquisition funding Proceeds from sale of target 1,500

Debt - Less: debt remaining at exit -
Equity 1,000 Proceeds to PE ow ner 1,500
PE ow ner cash in vs. cash out

Equity out at purchase of target (1,000)
Return on equity Dividends 70 74 77 81 85
Equity MoM return 1.6x Proceeds from sale of target 1,500
Equity IRR 15% Total cash proceeds (1,000) 70 74 77 81 1,585
Example PE Acquisition with Debt

Assum ptions Year: 0 1 2 3 4 5
Target purchase price 1,000 Free cash flow (FCF) of target company 70 74 77 81 85
Target initial FCF 70 Less: interest on debt (60) (59) (58) (57) (55)
FCF Grow th Rate 5.0% FCF remaining to repay debt principle or pay out as dividend 10 14 19 25 31
Target value at exit 1,500
Debt % of acquisition 75% Beginning debt 750 740 726 707 682
Debt annual interest rate 8.0% Less: debt principle repayment (10) (14) (19) (25) (31)
Ending debt 740 726 707 682 652
Sources of acquisition funding Proceeds from sale of target 1,500

Debt 750 Less: debt remaining at exit (652)
Equity 250 Proceeds to PE ow ner 848
PE ow ner cash in vs. cash out

Equity out at purchase of target (250)
Return on equity Dividends - - - - -
Equity MoM return 3.4x Proceeds from sale of target 848
Equity IRR 28% Total cash proceeds (250) - - - - 848

Page 99

Why LBOs Use Leverage and 3 Other Ways to Boost Returns
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INCOME STATEMENT OVERVIEW
The income statement presents a company’s sales over a period of time (usually a fiscal year
or quarter) along with the expenses which were incurred to generate these sales. The purpose
of the income statement is to match sales up with their associated expenses as closely as
possible in order to show how profitable the company is during a particular period.
Sales (aka Revenue): Sales measures how much goods or services a company sells during a
particular period. Simply put, sales is the number of units of goods or services the company
has sold multiplied by the average price per unit
Sample Income Statement (in $)
customers agreed to pay. One caveat is that sales
Sales 1,000
made are not the same thing as cash actually Cost of goods sold (COGS) 500
received. In order to be recognized as sales on the Gross profit 500
Income Statement, a particular transaction must meet
Operating expenses 300
an accounting standard of being both “earned” and Other income 50
“realized,” but no cash necessarily needs to change EBITDA 250
hands. For example, if a manufacturer sells a widget
Depreciation & amortization 50
to a customer and delivers said widget, the EBIT 200
manufacturer may recognize the sale on its income
Net interest (50)
statement before the customer actually pays for it as
EBT 150
long as the customer is considered credit-worthy.
Income tax 60
Net income 90
Cost of Goods Sold (COGS): COGS measures
what expenses the company incurred in the direct Diluted shares outstanding 10
production and/or delivery of the goods and services Diluted earnings per share 9
recognized as sales. Different businesses classify different expense categories as COGS, but
the most common categories are the cost of materials and direct labor. Some companies also
classify other expense categories such as transportation and commissions paid to sales
people under COGS. COGS are usually relatively variable with sales. For example, if a
company sells 1,000 fewer units of its product, it won’t need to procure as much raw materials
and might not need to employ as many hourly laborers during the income statement period.
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Gross Profit (aka gross margin): Gross profit equals sales less COGS. Gross profit as a %
of sales is a metric which is commonly tracked as an indicator of a company’s profitability.
Operating expenses (aka Opex or sometimes simply SG&A): Opex measures the
expenses a company incurs during the income statement period but are not directly incurred in
the production and/or delivery of specific goods or services. Expense categories which fall
under Opex are typically those which are relatively fixed from period to period regardless of
how many units of its products the company sells. Common Opex categories include
administrative overhead, occupancy costs, advertising and marketing, and R&D.
Other income: Other income refers to profits the company receives from non-core operations
or minority interest in other companies. Other income is rarely at issue during PE interviews. If
you ever need to model it you can usually just keep it constant from period to period because it
is by definition not a core part of whatever company you are looking at.
EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization): IBITDA is Gross
profit less Opex plus Other Income. EBITDA is critically important in PE because it is
frequently a quick proxy for a company’s cash generating capability. The Total Enterprise
Value (TEV) of a company is frequently calculated and quotes as a multiple of EBITDA. How
much debt a company could take on as part of an LBO is also commonly calculated and
quoted as a multiple of its EBITDA. Note that for the purposes of EBITDA Opex must not
include depreciation and amortization.
Depreciation and Amortization (D&A): D&A are non-cash expenses which are meant to
proxy the aging and decay of a company’s capital plant and intangible assets. At a high level,
not all expenses companies incur show up on their income statements right away. Some
expenses are instead categorized as Capital Expenditures (or Capex) and appear on the Cash
Flow Statement instead because they support the generation of revenue far into the future
instead of just during the current period. Examples of such expenses may include the
construction of a factory, the purchase of patents and trademarks, and even some forms of
R&D. Such assets tend to become less valuable over time as factories break down and
patents become obsolete. D&A captures this process of obsolescence as a percentage of the
initial cost of these long-term assets.
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EBIT (aka Operating Income or Operating Profit): IBIT is EBITDA less D&A. Note that some
companies include D&A as part of Opex. For such companies EBIT and EBITDA essentially
switch places in the income statement. In order to get to EBITDA, D&A has to be added back
to EBIT. Company valuations and debt levels are frequently calculated and quoted as a
multiple of its EBIT, either instead of or in addition to EBITDA multiples.
Net Interest: Companies pay interest on their debts to others and receive interest payments
on their loans to others. Net interest is simply the sum of interest payments and receipts.
Interest is not counted as an operating expense (and therefore isn’t taken out of EBIT)
because it typically depends on how a business is capitalized rather than how inherently
profitable it is. Net interest can be positive or negative, but is almost always negative for
companies which become highly levered via an LBO.
EBT (aka Earnings Before Tax): EBT is EBIT less Net Interest. EBT is important only insofar
as corporate taxes are calculated based on a percentage of EBT.
Income Tax: These are all of the taxes a company pays on its taxable profits. Tax rates vary
dramatically across geographies and industries due to different tax regimes and corporate
structures. Taxes also depend on whether the company has any Net Operating Losses (NOLs)
to offset current-period taxes due to operating losses in the past.
Net Income (aka Earnings): Net Income is EBT less taxes. Net Income is meant to be the
most accurate measure of a company’s real profitability and is the most common basis for
measuring the equity value of a company. Note that Net Income accrues only to the equity
holders of a company because debt holders have already taken their pound of flesh in the form
of interest.
Diluted Shares Outstanding (DSO) and EPS: DSO refers to the number of shares, or pieces,
a company’s total equity is broken up into if all outstanding equity-granting instruments (like
options, stock grants, warrants, etc.) were exercised. Earnings per share (EPS) is the quotient
of Net Income over DSO. EPS is the most common basis for valuing a single share of a
company’s stock.
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BALANCE SHEET OVERVIEW
The balance sheet is a snapshot of a company’s financial condition and book value on a
particular date (usually the last date of a fiscal year or quarter). Items in the balance sheet all
fall under the categories of Assets, Liabilities, and Shareholder Equity. The balance sheet gets
its name from the fact that Total Assets must always equal Total Liabilities plus Shareholder
Equity. Assets are defined as resources which are controlled by the company and are useful
for generating an economic benefit. Liabilities are monetary obligations that the company owes
to outside parties. Shareholder Equity is the difference of Assets less Liabilities.
Sample Balance Sheet (in $)

Assets Description
Current Assets Assets which will be economically exploited within one year
Cash and equivalents 1,000 Highly liquid assets like currency, money market, commercial paper, etc.
Accounts receivable (AR) 500 Goods/services the company delivered but has not yet been paid for
Goods ready for sale and the raw materials that finished goods are made
Inventory 300
of in various stages of processing
Expenses which have been paid ahead of coming due, such as when
Prepaid expenses 200
taxes or rent are paid ahead of schedule
Noncurrent Assets Assets which will be economically useful for more than one year
Net Property, plant, & equipment 2,000 Factories, buildings, machines, vehicles, etc. (aka PP&E)
Net non tangible assets 200 Trademarks, copyrights, patents, etc. (Net of accumulated amortization)
The difference between the book value of an asset and the price the
Goodwill 300
company paid to acquire it
Total Assets 4,500 Current assets plus noncurrent assets
Liabilities
Current Liabilities Liabilities which are scheduled to be paid within one year
Accounts payable (AP) 400 The price of goods the company has received but not yet paid for
Expenses which have been incurred but have not yet been invoiced (such
Accrued expenses 200
as accrued wages, accrued taxes, and accrued rent)
Current / short-term debt 250 Debt which will mature or must be repaid within one year
Noncurrent Liabilities Liabilities which are scheduled to be paid after one year
Long-term debt 2,000 Debt which will mature or must be repaid after one year
A liability arising from timing differences between GAAP accounting and
Deferred taxes 250
tax accounting. Deferred taxes can also sometimes be assets.
This liability arises when the company is paid for goods or services it has
Deferred (or Unearned) revenue 100
not fully delivered (e.g. a 2-year magazine subscription paid up-front)
Total Liabilities 3,200 Current liabilities plus noncurrent liabilities
Shareholder Equity 1,300 Total Assets less Total Liabilities
Balance Check: PASS 4,500 = 3,200 + 1,300
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CASH FLOW STATEMENT OVERVIEW
The cash flow statement (CFS) tracks how much cold hard cash a company generates within a
given timeframe (usually a fiscal year or quarter). The CFS is essential because companies
need enough cash to perform their daily operations. No matter how profitable a company is on
its income statement how well capitalized it is on its balance sheet, losing sight of the cash
flow statement can lead to bankruptcy. The cash flow statement is broken down by three
different categories of sources (and uses) of
cash: operating activities, investing activities, Sample Cash Flow Statement (in $)
and financing activities. Cash at beginning of period 900
Cash from Operating Activities
Net Income (NI) 90
The cash flow statement looks complex but
Depreciation & amortization (D&A) 50
its governing principles are simple: Deferred taxes 10
- Operating activities: Adjusts net income Equity compensation 10
Inventories (5)
from the income statement for any items Accounts receivable (AR) (5)
where actual cash paid or received does Accounts payable (AP) 10
Deferred revenue (10)
not match its corresponding income
Net cash from Operating Activities 150
statement value.
Cash from Investing Activities
- Investing activities: Sums up the cash Capital expenditure (PP&E) (50)
which the company spent or received Other investing activities 20
Net cash from Investing Activities (30)
related to changes in balance sheet
Cash from Financing Activities
items such as PP&E and various Cash from debt 100
securities. This section also tracks cash Cash from equity (100)
Shareholder dividends (20)
spent on acquiring other
Net cash from Financing Activities (20)
companies/divisions and cash received
Total cash generated (spent) 100
from divesting the company’s own Cash at end of period 1,000
divisions. The most important rules to
remember about this section are:
How Changes in Assets / Liabilities Impact the CFS
When… Impact on cash… Why?
Assets increase Use of cash (goes down) Assets acquired for cash (e.g. a factory is built)
Assets decrease Source of cash (goes up) Assets sold or used for cash (e.g. inventory is sold)
Liabilities increase Source of cash (goes up) Liabilities added for cash (e.g. $ is borrowed from bank)
Liabilities decrease Use of cash (goes down) Liabilities are paid off for cash (e.g. a loan is repaid)
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- Financing activities: Tracks the cash received or spent related to the purchase or sale of
equity or debt. This section also tracks cash spent on payments of shareholders’ dividends.
- Net income: Comes directly from the income statement for the same period as the cash
flow statement to give us a starting point to make our cash adjustments.
- Depreciation & amortization (D&A): We add these non-cash expenses from the income
statement back in the cash flow statement because they have no current-period impact on
cash. These expenses stem from the obsolescence and decay of tangible and non-tangible
assets which were acquired from previous periods.
- Deferred taxes: Deferred taxes are usually an asset on the balance sheet. Therefore,
when they increase, cash decreases and must be subtracted from Net Income on the CFS.
When deferred taxes decrease, cash increases and must be added back to Net Income on
the CFS.
- Equity compensation (aka stock-based compensation): Some companies pay their
employees (especially senior managers) with equity such as stock options or grants instead
of cash (salaries and bonuses). This form of compensation is expensed on the income
statement as part of operating expenses, but no cash is actually paid during the current
period, so equity compensation is added back to Net Income in the CFS.
- Inventories: Inventories are an asset. Refer to the table above for their impact on the CFS.
- Accounts receivable (AR): AR is an asset. Refer to the table above for its impact on the
CFS.
- Accounts payable (AP): AR is a liability. Refer to the table above for its impact on the
CFS.
- Deferred revenue: Deferred revenue is a liability. Refer to the table above for its impact on
the CFS.
- Capital expenditure (Capex): Capex (aka payment for PP&E) is cash spent on the
acquisition of assets (usually long-term noncurrent assets) that will benefit the company in
future periods. Since capex expense does not support the company’s generation of sales
or profits in the current period, it is not included as an expense on the current period
Income Statement. However, since capex is a real cash expense in the current period, it
must be treated as a use of cash on the CFS.
- Other investing activities: Most CFSs break out Other Investing activities into such line
items as the purchases and sales of securities, investments, and corporate
divisions/entities. These items are rarely an important part of an LBO model so we won’t
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dive deeply into them here. Just remember that when a company sells items of this nature
cash from Investing Activities goes up, but when the company buys items of nature cash
from Investing Activities goes down.
- Cash from debt: When a company issues debt (borrows), its debt liabilities go up on the
balance sheet and cash from Financing Activities on the CFS increases from the debt
proceeds. When a company repays its outstanding debt principal, its debt liabilities go
down, and its cash from Financing Activities also goes down since the repayment is made
in cash.
- Cash from equity: When a company issues new equity (shares), its shareholder equity
liability on the balance sheet goes up and cash from Financing Activities goes up from the
equity issuance proceeds. Shareholder equity decreases when a company buys back its
shares with cash, while cash from Financing Activities decreases.
- Shareholder dividends: When a company pays cash dividends to its shareholders, cash
from Financing Activities decreases.
Why You Should Care About Changes in Net Working Capital
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FINANCIAL STATEMENT CONNECTIONS
Understanding how the major financial statements connect is critical for modeling a company’s
financial performance and for answering common PE interview questions. This section
highlights the high level links, and the LBO modeling section delves into more detail.
Income Statement and Balance Sheet Links
Sample Income Statement (in $) Sample Balance Sheet (in $)

Assets
Sales 1,000 Current Assets
Cost of goods sold (COGS) 500 Cash and equivalents 1,000
Gross profit 500 Accounts receivable (AR) 500
Inventory 300
Operating expenses 300 Prepaid expenses 200
Other income 50 Noncurrent Assets
EBITDA 250 Net Property, plant, & equipment 2,000
Net non tangible assets 200
Depreciation & amortization 50 Goodwill 300
EBIT 200 Total Assets 4,500
Net interest (50) Liabilities

EBT 150 Current Liabilities
Accounts payable (AP) 400
Income tax 60 Accrued expenses 200
Net income 90 Current / short-term debt 250
Noncurrent Liabilities
Diluted shares outstanding 10 Long-term debt 2,000
Diluted earnings per share 9 Deferred taxes 250
Deferred (or Unearned) revenue 100
Total Liabilities 3,200
Shareholder Equity 1,300
Notes:
- Depreciation reduces Net PP&E and amortization reduces non tangible assets. More of
these assets on the balance sheet usually leads to more D&A on the income statement
- Current and long-term debt is what generates interest expense. More debt on the balance
sheet usually leads to higher net interest on the Income Statement.
- Net Income from the income statement is added directly to Shareholder Equity
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Income Statement and Cash Flow Statement Links
Sample Income Statement (in $) Sample Cash Flow Statement (in $)

Cash at beginning of period 900
Sales 1,000
Cost of goods sold (COGS) 500 Cash from Operating Activities
Gross profit 500 Net Income (NI) 90
Depreciation & amortization (D&A) 50
Operating expenses 300 Deferred taxes 10
Other income 50 Equity compensation 10
EBITDA 250 Inventories (5)
Accounts receivable (AR) (5)
Depreciation & amortization 50 Accounts payable (AP) 10
EBIT 200 Deferred revenue (10)
Net interest (50)
EBT 150 Cash from Investing Activities
Capital expenditure (PP&E) (50)
Income tax 60 Other investing activities 20
Net income 90 Net cash from Investing Activities (30)
Diluted shares outstanding 10 Cash from Financing Activities

Diluted earnings per share 9 Cash from debt 100
Cash from equity (100)
Shareholder dividends (20)
Cash at end of period 1,000
Notes:
- The only major direct connections between the income statement and the cash flow
statement are that the Net Income and the D&A portions of the Cash from Operating
Activities come from the income statement.
- The rest of the connections between the income statement and the balance sheet go
through the balance sheet.
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Balance Sheet and Cash Flow Statement Links
Sample Balance Sheet (in $) Sample Cash Flow Statement (in $)

Assets Cash at beginning of period 900
Current Assets
Cash and equivalents 1,000 Cash from Operating Activities
Accounts receivable (AR) 500 Net Income (NI) 90
Inventory 300 Depreciation & amortization (D&A) 50
Prepaid expenses 200 Deferred taxes 10
Noncurrent Assets Equity compensation 10
Net Property, plant, & equipment 2,000 Inventories (5)
Net non tangible assets 200 Accounts receivable (AR) (5)
Goodwill 300 Accounts payable (AP) 10
Total Assets 4,500 Deferred revenue (10)
Liabilities
Current Liabilities Cash from Investing Activities
Accounts payable (AP) 400 Capital expenditure (PP&E) (50)
Accrued expenses 200 Other investing activities 20
Current / short-term debt 250 Net cash from Investing Activities (30)
Noncurrent Liabilities
Long-term debt 2,000 Cash from Financing Activities
Deferred taxes 250 Cash from debt 100
Deferred (or Unearned) revenue 100 Cash from equity (100)
Total Liabilities 3,200 Shareholder dividends (20)
Shareholder Equity 1,300
Cash at end of period 1,000
Notes:
- Purple: Balance sheet cash is the beginning cash of one CFS period and the ending cash
of another CFS period
- Yellow: D&A decreases PP&E, non-tangible assets, and goodwill; capex and some other
investing activities increases PP&E, non-tangible assets, and goodwill.
- Green: Increases in these assets on the balance sheet decreases cash from operating
activities; decreases in these assets increase cash from operating activities.
- Red: Increases in these liabilities on the balance sheet increase cash from operating
activities; decreases in these liabilities decrease cash from operating activities.
- Blue: Increases in debt increase cash from debt, and decreases in debt reduce cash from
debt; increases in cash from equity increase shareholder equity, and decreases in cash
from equity reduce shareholder equity; shareholder dividends reduce shareholder equity.
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CAPITAL STRUCTURE
The capital structure of a company refers to how the company is financed, who has an
ownership claim on the company and its assets, and the seniority of those claims. Every
company needs some form of financing to get off the ground and to fund daily operations
because every company needs to buy raw materials, pay employees, etc. A company may be
financed through equity or debt or a combination of both. There are many different types of
equity and debt, and each of them has different characteristics including riskiness, expected
rate of return, and seniority. Understanding capital structure is important because LBOs
usually radically change the target’s capital structure and derive a great deal of their returns
from these changes.
Equity
Equity holders are investors who have provided the company with cash financing in exchange
for a direct ownership stake in the company. Equity holders own shares of the company and
can usually vote on important matters such as who sits on the company’s board and who
should be the company’s CEO, CFO, etc. Equity holders control the company’s strategic
direction and investment decisions through the people they appoint to run the company. In
addition, equity holders are the direct beneficiaries of a company’s net income profits. Equity
holders can decide whether the company pays its net income out to them via dividends/share
repurchases or re-invests its net income to grow the business and generate more net income
in the future. Equity holders have a lot of control over the company and benefit from nearly all
of the financial upside when the company grows.
On the other hand, equity holders own the most junior/least senior claim on the company’s
profits and assets. Equity holders do not get paid until the company has paid any interest and
principal owed to debt holders. If the company fails to make any scheduled payments to debt
holders, the company is in default, and the equity holders can lose their entire ownership
claim. In the event of default, debt holders can take all of the equity away from the original
equity holders and take control of the company. In the event of bankruptcy, equity holders do
not get a penny until debt holders have been repaid in full. If the company does not have
enough asset value to repay the debt holders in full, then all residual value goes to debt
holders while the equity holders get nothing. For these reasons, owning the equity of a
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company is the riskiest investment you can make in a company, so equity holders usually
demand high expected returns relative to more senior investors. Since equity investors tend to
to tolerate higher risk in exchange for higher reward, they also frequently want to take an
active role in the management of the company. There are several common ways investors
might become equity holders of a company:
- Provide bootstrap / angel / VC funding during start-up in exchange for shares
- Buy stock shares during an IPO or on the open market once the company goes public
- Buy options, warrants, or other equity-granting instruments, and exercise them for stock
- Be granted stock, options, or warrants in lieu of cash compensation (common for
executives and board members)
- Provide some or all of the equity portion of the financing of an LBO of the company
Debt
Debt holders are investors who provide the company with cash financing in exchange for a
contractual promise to be repaid over a set period of time with a set amount of interest (yield).
Any investor that lends money to a company becomes one of its debt holders. Debt holders
typically have little or no say over the company’s strategy or daily operations with the exception
of certain contractual covenant rights (explained later). As long as debt holders are paid their
stipulated interest and principal on time they are generally happy to sit back and watch the
money trickle in. As long as the company avoids default, debt holders have no claim to a
financial upside beyond their contractual interest payments when the company grows.
Excepting special distressed debt situations, debt holders have only downside if the company
defaults or goes bankrupt.
On the other hand, debt is more senior than equity in the capital structure. Debt holders gain a
massive amount of power if the company ever defaults on its debt payments. In case of
default, debt holders may force the equity holders to do their bidding or take over control of the
company directly. In case of bankruptcy, debt holders are repaid in full before equity holders
get any of the remaining scraps (if there are any). For these reasons, owning a company’s
debt is the safest investment you can make in a company. Since debt is less risky than equity,
the interest rate (yield) that debt holders receive is lower than the rate of return equity holders
expect. Debt investors are generally risk averse and want to minimize the odds of losing any of
their principal. Characteristics of different types of debt are listed in the table below.
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LBO Capital Hierarchy
LBOs are typically executed with a mixture of capital sources, many of which fall in different
levels of seniority. The following tables lists the most common types of LBO capital sources
along with their associated characteristics and annual return expectations:
LBO Capital Hierarchy Table (higher = more senior)

High % of Annual
Level Avg. Returns
Capital Capital Sub- LBO / Cost of
Type Types Typical Characteristics Capital Capital
- The most senior of all debt and secured by both the assets
- Revolving
and the cash flow of the company
credit facility
- Must be repaid in full with interest over 5 – 8 years and
(“Revolver”)
typically includes amortization (annual repayment of some
- Term Loan A
principal in addition to interest) 30 – 50%
- Term Loan B LIBOR +
Bank Debt - Term Loan A’s typically have shorter terms (5-6 years), and
- Secured Bond 200 – 400
higher levels of annual amortization) (2.0x-4.0x
(The most bps
(aka Bank LTM
- Term Loan B’s typically have longer terms (7-8 years), and no
Loans, senior bonds EBITDA,
principal amortization prior to full repayment at end of the term (usually
Senior are hard to variable
- Revolvers are like corporate credit cards, which may be drawn equals to
Debt) categorize with
down and repaid as needed to fund daily operations 4 – 8%)
industry)
between
- Bank debt principal may typically be repaid early by the
senior and
company with no pre-payment penalty
subordinated
- Frequently contain maintenance covenants and may contain
debt)
incurrence covenants (see covenant section)
- Junior to bank debt and usually unsecured by assets 8 – 12%
- Senior
- Longer term length than bank debt (7 – 12+ years), with no 15 – 25%
Subordin- Unsecured
principal amortization prior to full repayment at end of term (fixed
ated Debt Bond
- Principal cannot be pre-paid early (1.0x-2.0x coupon
- Senior LTM payments
(aka - Must usually be at least $100 - $200 million in total size
Subordinated EBITDA, (i.e. not
Sub-debt - Frequently publicly traded, with a highly fragmented investor
Bond variable tied to
or High base
- Subordinated with LIBOR
Yield Debt)
- No maintenance covenants; do have incurrence covenants industry) like Bank
Bond
Debt)
- Junior to all other types of debt and always unsecured
- Contains debt-like qualities because it usually entails the
15 – 20%
payment of interest / coupons
Mezzanine - Mezzanine
- Also contains equity-like upside because it frequently contains 5 – 15%
Debt / Debt (blended
Preferred provisions for conversion to common equity all-in rate
- Warrants (if used,
Equity - Term length is highly variable or even indefinite of return
- Preferred but may
- Sometimes used instead of High Yield Bonds if the total dollar including
Equity be 0%)
(aka Mezz.) size is too small equity
convert)
- Interest / coupons are paid either in cash or in-kind (PIK)
- No covenants
- Most junior capital with the highest risk, but most of the upside 10 – 50% 20 – 30%
Common - Controls the company as long as debt covenant and payment
Equity / requirements are met (20-30% (depends
Shares - 5 – 15% of common equity is usually reserved in an option most on deal
pool to incentivize key management (CEO, CFO, etc.) common) riskiness)
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4 Capital Structure Tiers to Know Well
Covenants
Covenants are contractual agreements between lenders and borrowers. Lenders typically have
little control over a company’s strategy and the utilization of its capital as long as the company
is current on its debt payments. However, debt holders are risk averse and want extra
protections to ensure they get their due payments in the future. Covenants give lenders certain
rights and protections. The two main types of covenants are incurrence and maintenance.
Incurrence covenants are common for both bank debt and subordinated debt (bonds). The
objective of such covenants is to prevent the company from taking actions which would harm
the covenant holder, unless the covenant holder agrees to such actions action after negotiating
appropriate compensation with the company. Common types of incurrence covenants:
- The company may not incur debt which is more senior in the capital structure than that of
the covenant holder. This type of covenant is crucial to debt holders because, as explained
above, the security of their investments depends on being senior in the capital structure.
- The company may not incur more debt of any kind which would cause it to exceed a total
leverage ratio or total debt quantum
- The company may not spend its cash on certain types of capital investments or acquisitions
or shareholder dividends without the lenders’ approval
- There are no periodic tests for incurrence covenants, unlike maintenance covenants below
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Maintenance covenants are common for bank loans. The objective of such covenants is to
ensure the company maintains a sufficient cash and profitability cushion to never even
approach default. If the company ever fail (or “trips”) one of these covenants, then the
company may be declared in default and the lenders could take control of it or force the equity
holders into negotiated concessions. The following are common maintenance covenants:
- The company must always keep its debt ratio below a certain ceiling (e.g. Debt / EBITDA
must never exceed 4.0x or Debt / Equity must never exceed 2.0x)
- The company must always maintain an interest coverage ratio above a certain floor (e.g.
EBIT / Total Annual Interest expense must never be below 3.0x)
- Maintenance covenants are subject to periodic (usually quarterly) tests, a crucial distinction
between maintenance covenants and incurrence covenants. The company must routinely
prove its compliance with its maintenance covenants after every period to avoid default.
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COMMON VALUATION TECHNIQUES
There are several ways to value a company, different situations call for different techniques. It
is important to understand the most commonly used techniques as well as their pros and cons.
Comparable Multiples
Multiples are the most commonly used type of valuation (and metric) in PE. A multiple is simply
the ratio of the value of a company relative to some quantitative measure of its performance.
The most common multiple in PE is Total Enterprise Value (TEV) / LTM EBITDA. For example,
a 7.0x EBITDA multiple for a company which generated $100 million of EBITDA over the past
twelve months implies that the Total Enterprise Value of that company is 7x * $100 million =
$700 million.
Investors are willing to pay higher multiples for companies which they expect will perform
better in the future. For example, all else being equal, investors willing to pay higher multiples
for companies with stronger competitive positions and exposed to more attractive industries
because such companies are likely to become larger and more profitable in the future.
Investors are willing to pay more today for companies which will be more profitable in the
future. For example: Companies A and B each currently have $100 million of EBITDA, but
Company A’s EBITDA will grow by 10% per year while company B’s EBITDA will decline by
10% per year. All else being equal, any sane investor would pay a much larger multiple of
company A’s current EBITDA compared to company B.
You can use multiples to value a company by comparing it to a group of companies which
have similar characteristics (often referred to as “comparables”, or “comps” for short). For
example, let’s say we need to value car manufacturer “A” that has $100 million of LTM EBITDA
and is projected to grow at 10% per year. Let’s say we found the following list of publicly traded
comparable car manufactures:
Public Car LTM EBITDA Projected Annual Total Enterprise

Manufacturer ($mm) Growth Value ($mm) EBITDA Multiple
B $300mm 11% $3,150mm 10.0x
C $150mm 8% $1,275mm 8.5x
D $80mm 15% $990mm 11.0x
Average $177mm 11% $1,805mm 9.8x
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From this list you could conclude that a valuation range of 8.5x – 11.0x LTM EBITDA is
reasonable and that 10.0x is a good estimate. These comps would lead you to conclude that
company A is worth roughly $100mm * 8.5x-11.0x = $850mm – $1,100mm with an estimate
around $100mm * 10.0x = $1,000mm.
Good comps are frequently competitors or companies in the same industry, companies that
perform similar functions, or companies that have similar profiles as the target. Choosing the
closest comps is sometimes as much an art as it is a science. The trick is to find companies
which most closely mirror the characteristics of the target that investors care about most, such
as growth, profitability, and competitive position.
In addition to TEV / EBITDA, other common multiples include:

o TEV / EBIT
EBIT is a better metric than EBITDA when comparing companies with
different levels of D&A which EBITDA doesn’t capture. Different levels of D&A
are commonly found in companies which have different levels of capital
intensity (i.e. different levels of capital investment into PP&E).
o Price / Earnings (aka P/E Ratio)
This metric typically equals the market value (market capitalization) of the
equity of a publically traded company over its LTM Net Income. This is the
most common valuation multiple for publically traded stocks. Keep in mind
that this metric applies only to the equity value of the company rather than its
TEV. This is because net income belongs to a company’s equity holders
since debt holders are paid interest before any money flows to equity holders.
o TEV / Revenue
This metric is used for companies which aren’t profitable or have highly
cyclical levels of profitability (such as commodity businesses).
There are many other useful multiples, but the above should cover you in the vast majority of
interview situations.
- Pros of multiples:
o Multiples are a quick way to gauge the relative value of companies of different sizes.
They scale in a way which makes it possible to glean valuation information about a
company from the valuation of other companies which are both larger and smaller.
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o Multiples are less volatile and less prone to assumption-driven swings than bottoms-
up valuation methodologies such as the Discounted Cash Flow.
- Cons of multiples:
o If the market’s valuation of the comps is wrong, then your valuation of your target will
be equally wrong.
o No single comp is a perfect proxy for a different target company. Finding enough
solid comps to average out the idiosyncratic differences can be difficult.
Precedent Transactions
Comparable multiples can be used with precedent transactions data just as effectively as with
publicly traded stock data. Companies and investors are constantly making deals to purchase
either entire companies or divisions of companies. During such transactions, buyers are paying
some price for assets which have certain performance characteristics (revenue, EBITDA,
EBIT, earnings, etc.). When the right data is available, comparable multiples may be based
just as easily on precedent transactions as on public markets trading data. For example, let’s
say it is 2014, and we are trying to value a women’s apparel retailer which has $100mm of
EBITDA. We have assembled a list of the following precedent transactions of women’s apparel
retailers over the past 5 years:
Women’s Apparel Total Purchas

Retailer Year EBITDA ($mm) Price ($mm) EBITDA Multiple
B 2013 250 2,125 8.5x
C 2013 120 1,320 11.0x
D 2012 130 975 7.5x
E 2011 50 600 12.0x
F 2011 220 2,310 10.5x
G 2010 75 938 12.5x
H 2009 110 1,265 11.5x
Average 136 1,362 10.5x
From this data you might conclude that the value of your target women’s apparel retailer is
~7.5x – 12.5x its EBITDA, or ~$750mm - $1,250mm, with an estimate around $1,050mm
- Pros of precedent transactions:
o Precedent transactions include the premium buyers sometimes pay to gain control of
a target in order to make operating improvements, exploit its cash generating
capacity, and take advantage of any synergies.
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o Precedent transactions data is sometimes available on private companies where
public market trading information is not available.
- Cons of precedent transactions:
o Precedent transactions have all the same cons as comparable multiples.
o In addition, precedent transaction data is frequently sparse and spread over many
years. Precedent transactions data from previous years may be less relevant if the
industry has undergone significant change and/or the market has passed through
various cycles.
Market Value
If your target is publicly traded, estimating its value is easy because the market does the work
for you. The total market capitalization of a company is the market’s estimate of the value of its
equity. As long as the company is not in financial distress, then the face value of its long term
debt less its excess cash equals the market’s estimate of the value of its net debt. If you add
market capitalization value to the value of net debt you will get the market’s valuation of the
target’s TEV. These values fluctuate daily along with the target’s stock price. As a general rule,
the larger the company, the more heavily it is covered by stock analysts and traded by
sophisticated investors. Therefore, as a general rule, larger companies are more efficiently
valued by the market than are smaller companies.
- Pros of market value:
o Market value is always up-to-date and is instantly available for public companies.
o Market value is determined by the individual decisions of many investors so it
reflects the collective work and judgment of many people.
- Cons of market value:
o The market can be wrong … sometimes by a lot … if it wasn’t then hedge funds and
other public market investors would almost never beat the market.
LBO Model
An LBO model may be used to value both public and private companies if you can project their
ability to generate free cash flow. The details of LBO modeling are covered in the next chapter.
- Pros of LBO modeling:
o LBO models are built from the ground up and do not depend as much on trusting the
wisdom of the public markets (which can be very wrong).
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o LBO models can capture the value of optimizing a company’s capital structure (often
by using more debt than the public market is comfortable with).
o LBO models can capture the value of operational improvements private owners
could enable that would otherwise be difficult for a public company to execute.
- Cons of LBO modeling:
o LBO modeling requires making many uncertain assumptions about a company’s
operating and financial performance at least 3-5 years into the future.
o LBO modeling requires access to more data and entails a lot more work than
valuations based on comparable multiples, precedent transactions, or market
values.
Discounted Cash Flow (DCF)

The DCF model relies on two assumptions. First, the financial value of any company depends
solely on what cash profits or dividends it can generate for its owners over time. This
assumption implies that any two companies which will produce equivalent cash profits for their
owners at all times and in all scenarios in the future must have equal financial value. Second,
the value of cash profits today is different from (and almost always more than) the value of
cash in the future. This assumption is made because if you have cash today you can invest it
and have more cash in the future. Therefore, $100 today is worth more than $100 in the future
(assuming you have investment options with positive nominal returns). For this reason,
expected future cash flows in a DCF must be “discounted” to reflect the “time value of cash”.
The first step in a DCF is to project a company’s FCF for ~5 years forward. See the section on
FCF for details of how FCF is calculated and why it is a good proxy for DCF profits. The
second step in a DCF is to calculate an appropriate discount rate for the profits projected in the
first step. There are different ways of calculating an appropriate discount rate, but the most
common is called Weighted Average Cost of Capital (WACC). See the section on WACC for
details on how to calculate it and what it means. The third step in a DCF is to project the
target’s Terminal Value (TV) after the last year of projected FCF. See the section on Terminal
Value for details. The final step is to apply the following formula to discount the value of all
future cash flows back to the present day to calculate the present total value of the enterprise:
FCFyear1 FCFyear2 FCFyear3 FCFyear4 (FCFyear5 +TV)

Present TEV = + + + +
(1 + WACC) (1 + WACC)2 (1 + WACC)3 (1 + WACC)4 (1 + WACC)5
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- Pros of DCF:
o DCF is the most ground-up valuation methodology available. All other valuation
methodologies rely on it either implicitly or explicitly. The market value of securities
is predicated on the cash value investors expect to receive from them in the future in
the form of dividends and capital gains (stock price appreciation). Multiples also
implicitly rely on DCF principles. Investors are willing to pay higher multiples for
companies which they expect will become more profitable in the future and lead to
more dividends and capital gains.
- Cons of DCF:
o Despite being theoretically sound, DCF is used less frequently in PE than multiples,
LBO, and precedent transaction analysis because the assumptions which drive a
DCF are very sensitive and can lead to wildly different valuations. In addition, most
of the value in many DCFs lies in the TV which is frequently estimated using
comparable multiples analysis anyway.
Sum-of-the-Parts
If the target is made up of distinct and separable divisions, then all of the above valuation
methods may be performed on individual divisions and added together. This technique is most
commonly applied if a partial or total break-up of the target is being contemplated.
- Pros of sum-of-the-parts:
o This analysis can capture the value of breaking the business apart either partially or
entirely. Sometimes certain parts of a business are more valuable as a stand-alone
entity than as part of a larger business. For example, Carl Icahn recently asserted
that Ebay should spin off Paypal because Paypal would be worth more as a stand-
alone company than as a subsidiary of Ebay.
- Cons of sum-of-the-parts:
o This analysis has all of the same cons as the other valuation techniques.
o Moreover, how much breaking up a business will cost and how the resultant pieces
are likely to perform can often be very difficult estimate.
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COMMON CALCULATIONS
Total Enterprise Value (TEV)

TEV is the measure of the financial value of a company to all financial stakeholders, the
investors who have an ownership claim on the company. The universe of investors who have
an ownership claim on the company encompasses all equity holders in the company as well as
all debt holders. Equity holders are obviously owners because they control the company, but
debt holders are also owners in a sense because they could gain ownership/control of the
company if it fails to make interest payments or repay principal on time. Therefore, TEV =
Value of Equity + Value of Debt – Excess Cash. The value of equity is typically calculated
using the market value (market capitalization) of a company. The Value of Debt is typically
calculated as the total face value of outstanding debt on the balance sheet. Excess cash is
defined as cash on the balance sheet which is not needed for the ongoing operation of the
business. Excess cash is subtracted from TEV because in the event of an LBO the sellers will
usually keep any excess cash. Another way to look at excess cash is that it doesn’t reflect the
value of the underlying business operations. Imagine a company which does nothing, has no
revenues or profits, but has $100 on its balance sheet. Such a company would nominally be
worth $100, but the value of the underlying operations is zero.
Free Cash Flow (FCF)

FCF is the lifeblood on an LBO because FCF determines how much debt a company can
service which then determines how much leverage an LBO can use. The conceptual
explanation of FCF is that it is the total amount of cash profits that a company can pay out to
its owners, be they equity holders or debt holders. Equity holders are generally paid with
dividends, whereas debt holders generally get interest payments. The fastest way to get to
FCF is as follows:
- Start with EBIT on the income statement.
- Multiply EBIT by (1 – Tax Rate) because taxes are a cash expense.
o Note: for the purposes of FCF do not subtract interest expense from EBIT. FCF is
calculated on an unlevered basis (i.e. disregarding any debt or interest expense the
company has).
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- Add back depreciation & amortization (D&A) because these are expenses which are
captured on the income statement but do not impact cash.
- Subtract capital expenditures because these are cash expenses that are not captured on
the income statement.
- Subtract change in working capital (this can increase FCF if change in NWC is negative)
because changes in working capital can be sources or uses of cash but don’t get captured
on the income statement. See the NWC section for more details.
- The full FCF formula is:
FCF = EBIT (1 – Tax Rate) + D&A – Capex – Change in NWC
Weighted Average Cost of Capital (WACC)

A lot can be said about WACC. However, to keep things simple, the only thing you need to
understand for PE interviews is that WACC is a measure of the riskiness of investing in a
company. It is used as the discount rate in the denominators of the DCF equation. The TEV of
every company is made up of some percentage equity and some percentage debt. Therefore,
the WACC is the sum of the cost of equity and the cost of debt, each weighted by the
percentage of TEV they constitute. The only wrinkle is that interest payments on debt are tax
deductible (this is referred to as an Interest Tax Shield or ITS), so the cost of debt must be
adjusted by multiplying it by one minus the tax rate. The simplest way to estimate the cost of
equity is to apply the CAPM model (see the section on Cost of Equity). The simplest way to
estimate the cost of debt is to use the yield on the company’s debt (i.e. what % interest the
company pays on its debt). The WACC formula is as follows:
Market Cap. Cost of Face Value

of Equity of Debt Yield on
WACC = Equity from + 1 – Tax Rate
Debt
TEV CAPM TEV
Cost of Equity (Via CAPM)

The Capital Asset Pricing Model (CAPM) is a model which describes the relationship between
the riskiness of assets and the rate of return investors should expect in order to willingly bear
those risks. While CAPM is a foundational theory in finance, because it isn’t used much in PE
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aside from using it to estimate the cost of equity, we won’t dive into the details. Just remember
the following equation:
Cost of Equity = Risk Free Rate + Beta (Equity Risk Premium)
- The Risk Free Rate is usually equal to the yield on safe government bonds (2-4% is a safe
assumption in developed markets like the US).
- The Equity Risk Premium is the premium return over the Risk Free Rate investors demand
in order to take the risk of investing in a diversified “Market Portfolio” of equities. It has
historically been estimated to be 5-6% in developed markets like the US.
- Beta is a measure of how levered a particular stock’s returns are to the diversified Market
Portfolio of equities. A Beta of exactly 1 signifies the stock is exactly as risky as the
diversified Market Portfolio. A Beta between 0 and 1 signifies the stock is somewhat less
risky than the Market Portfolio. A Beta above 1 signifies the stock is more risky than the
Market Portfolio. Common examples of stocks with low Betas are utilities and consumer
staples companies because such companies produce essential goods consumers need
regardless of whether the economy is doing well. Common examples of high Beta stocks
include semiconductors and durable assets (like cars) because demand for them soars
when the economy is doing well but plummets during recessions.
How Would You Calculate a Firms WACC and How Would You Use it?
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“Walk Me Through a DCF”
Net Working Capital (NWC)

There are several conceptual ways of thinking about NWC. The one I find most useful for PE
interviews is that NWC is a proxy for how much cash/liquidity a company needs to fund its
daily business operations. The most basic formula for NWC is “current assets minus current
liabilities” on the balance sheet. However, cash and cash equivalents are usually excluded
from the calculation, so the most common formula for NWC is:
NWC = Accounts Receivable + Inventory + Prepaid Expenses – Accounts Payable – Accrued Expenses
Many practitioners prefer to exclude Prepaid and Accrued Expenses such that the formula is:
NWC = Accounts Receivable + Inventory – Accounts Payable
It is up to your judgment to decide which current assets and liabilities to exclude from the
calculation. Your guiding principle should be to ask yourself whether each particular current
asset or liability is necessary for funding daily operations. If the item is necessary and is likely
to continue to be necessary then it should be included in NWC. Note that NWC can be either
positive or negative. Positive NWC businesses tend to be ones which have to pay cash to their
suppliers faster on average than they get paid by their customers.
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However, there is a caveat. Balance sheets are snapshots for only a single date, while in
reality NWC fluctuates daily. Let’s say NWC is $0 on the last fiscal date of Q1 and remains $0
on the last fiscal date of Q2. If the company bought $500 of inventory on the first day of Q2
and sold it all two days prior to the end of Q2, you would miss that the NWC for most of Q2 is
actually close to $500 rather than $0.
Change in NWC
Change in NWC is simply the difference between the current period NWC and the prior period
NWC. To calculate change in NWC, we usually subtract the prior fiscal year’s (or quarter’s)
NWC from the current year’s (or quarter’s) NWC so the formula is:
Change in NWC = NWCCurrent Period – NWCPrior Period
If change in NWC is positive it means that the company spent additional cash to fund its
operations over the current period. If the change in NWC is negative it means that the
operations were actually self-funding and produced excess cash in addition to the company’s
regular profits. Companies with consistently positive NWC usually need more and more cash
to fund their operations as they grow, which is a drag on FCF and debt capacity. Companies
with consistently negative NWC, on the other hand, generate more and more cash from NWC
as they grow, which is a boon to FCF and debt capacity.
Calculating Returns (IRR & MoM)

PE firms typically use two metrics to gauge returns, Internal Rate of Return (IRR) and Multiple
of Money (MoM) return. MoM is also frequently referred to as Cash on Cash, or Multiple of
Cash.
IRR: Unlike the definition of IRR found in text books, IRR as used in PE is not defined as the
rate of return at which the present value of a proposed project is zero. In PE, IRR is simply the
non-discounted, annualized rate of return on invested equity over the lifetime of a deal. To
avoid confusing yourself you can think of IRR simply as rate of return. The formula for IRR with
more than one return cash flow is complicated. We won’t worry about it here because you will
unlikely have to calculate it in an interview without access to Excel (which calculates it for you
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as you can see in the LBO modeling section). On the other hand, the formula for IRR with a
single return cash flow is simple, and you have to know it:
1
Cash ^ # Years before
Returned Return Realized
IRR = – 1
Cash
Invested
For example, let’s say a PE firm invested $1 million in a deal and realized a return of $3 million
after five years. Its IRR would be (3/1) ^ (1/5) – 1 = 24.6%. IRR is very important to PE firms
because their LPs usually demand cumulative rates of return of 20% or better. PE firms also
frequently have to exceed an IRR threshold called a Hurdle Rate (usually 7 – 10%) before
receiving any carried interest. IRR depends not only on how much total profit a deal generates,
but also how long it takes to realize these profits. All else being equal, IRR goes down the
longer it takes to exit a deal.
Here is How You Do IRR Quickly in Your Head
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MoM: MoM is very easy to calculate. Add up all of the net projected equity returns generated
by a deal and divide it by how much equity the PE firm has to invest to originally win the deal:
Sum of all
Net Returns
MoM =
Cash
Invested
For example, let’s say a PE firm invested $1 million in a deal and realized a return of $3 million
after any number of years. Its MoM would be 3 / 1 = 3.0x. PE firms care about MoM just as
much as IRR because total carried interest dollars are paid based on total MoM rather than
IRR as long as the IRR hurdle rate is met. A deal which generates a 10% total return (a 1.1x
MoM) over a couple of months would have an extremely high IRR (~77%), but the total carried
interest dollars paid to the PE firm would be very low. As one of my classmates in a PE
Finance class once said, “You can’t take IRR to the Ferrari dealership.” Sad, but true.
Terminal Value (TV)

The TV is a necessary calculation to complete a DCF analysis. Let’s say you have projected
FCF 5 years forward in a DCF. You still need to account for the value of the enterprise for all
subsequent years, assuming it is the sort of enterprise which is meant to remain a going
concern indefinitely. This remaining value is called Terminal Value (TV). The most common
way to calculate TV is called a perpetuity equation and the formula is as follows:
FCF(t+1)
WACC - g
TV =
(1 + WACC)
- FCF(t+1) is your forecast for FCF one period (year) after your last year of projected DCF
periods. If you made your DCF forecast for 5 years, then FCF(t+1) would be your FCF
forecast for year 6.
- See the section on WACC for instructions on how to calculate it.
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- The variable g is called a perpetuity growth rate. This is the average annual rate of growth
you expect the company’s FCFs to achieve in the long run. Most of the time g is estimated
to be something close to the long-run annual growth rate of either the company’s industry
or the broader economy. For mature markets like the US, 2-3% is a common range for g. If
you estimate g to be significantly higher than the long-term industry or country growth rate,
you should have a really good reason, because any company which forever grows faster
than the broader economy would mathematically eventually take over the entire economy.
- Many people forget to divide the numerator of the TV by (1 + WACC). This step is
necessary because the TV is calculated based on the FCF of the period subsequent to
your last projected DCF period. Therefore, the TV must be discounted by one year in order
to match the time-value of your last projected DCF period.
- Another common mistake with the TV is forgetting to discount it all the way back to present
day. Remember that in a DCF both the final year cash flow and the TV must be discounted
back to present day. See the formula for DCF.
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Debt Coverage and Leverage Ratios
There are two principle types of ratios which measure a company’s ability to meet debt
obligations. Coverage ratios measure a company’s ability meet its annual debt payment
obligations, and Total Leverage ratios measure a company’s total indebtedness. Both types
of ratios may be found in debt covenants in various formulations.
Common Total Leverage Ratios

- Total Debt / LTM EBITDA or LTM EBIT or LTM EBITDA less Capex
- Total Debt / Book Equity or Market Equity
Common Coverage Ratios

- Interest coverage: Can the company meet annual interest obligations?
EBITDA or EBIT or EBITDA – Capex
Annual Interest Due
- Debt service coverage: Can the company meet total annual debt payment obligations?
EBITDA – Required Capex – Taxes
Annual Interest + Principle Payments Due
- Fixed expense coverage: Can the company meet its annual contracted expenses?
EBITDA or EBIT or EBITDA – Capex
Annual Interest + Leases, rent, etc.
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TOP 30 TECHNICAL QUESTIONS AND ANSWERS
Technical questions in PE interviews test your understanding of accounting, finance, valuation,
LBO modeling, and the drivers of LBO returns. PE technical questions tend to be similar to but
more advanced than investment banking technical questions because most PE interviews
assume you understand at least the basics of accounting, finance, and valuation. If you need
to brush up on the basics, the WSO Technical Interview Guide is a good resource. The
following questions are common technical PE questions as determined by the WSO Company
database and the Harvard Business School Venture Capital & Private Equity club members:
1. Walk me through one of the deals on your resume

This is one of the most common questions in a PE interview if you come from a deal-oriented
background. The interviewer might let you choose a deal to discuss or pick one at random
from your CV. The interviewer might ask you anything from a simple high level overview all the
way down to a detailed discussion of the investment thesis, purchase price, operating forecast,
and expected returns. This type of question is used to gauge the following:
- Your investment judgment
- Your knowledge of the PE investment process
- Your ability to focus on the most important issues
- Your knowledge of PE financing, accounting, and modeling
- Your deal memory for deal facts and context
Before you walk into any PE interview, you should reacquaint yourself with the following facts
about every deal on your CV:
- Purchase price, including the multiples of EBITDA and EBIT it represented
- Sources and uses of capital
- The investment thesis and its primary drivers
- The key diligence issues and findings
- The base operating case/projection
- Key risks and upsides
- Projected returns (IRR & MoM)
- Key members of the management team
- What your role was and what value you added to the team
- Whether you personally thought it was a good deal and why
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Sample Deal Walk Through
2. How would a $100 decrease in depreciation expense on the Income Statement

impact all three major financial statements?
This is a common interview question in both banking and PE and comes in many forms (e.g.
what happens when A/R increases, Inventory decreases, tax rate increases, capex decreases,
etc.) so you need to familiarize yourself with how the financial statements connect in the
Financial Statement Connections section.
- Income Statement
o When depreciation decreases by $100, EBIT and EBT increase by $100.
o When EBT increases by $100m, net income increases by ~$60 (assuming a ~40%
corporate tax rate which means an extra $40 is paid in taxes).
- Balance Sheet
o Since net income increased by $60, shareholder equity also increases by $60.
o Since an extra $40 is paid in cash taxes, cash decreases by $40.
o Since depreciation decreased by $100, net PP&E increases by $100.
o The balance sheet remains in balance since liabilities went up by $60 and assets
went up by $60.
- Cash Flow Statement
o Net income increased by $60 which increases cash from operations, but PP&E
increased by $100 which decreases cash from operations.
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o The net impact is that cash from operations declines by $40 which happens to match
both the only cash expense incurred by the drop in depreciation (taxes) as well as
the drop in cash on the balance sheet.
3. Tell me why each of the financial statements by itself is inadequate for evaluating a
company?
- Income Statement
o The income statement alone won’t tell you whether a company generates enough
cash to stay afloat or whether it is solvent. You need the balance sheet to tell you
whether the company can meet its future liabilities, and you need the cash flow
statement to ensure it is generating enough cash to fund its operations and growth.
- Balance Sheet
o The balance sheet alone won’t tell you whether the company is profitable because it
is only a snapshot on a particular date. A company with few liabilities and many
valuable assets could actually be losing a lot of money every year.
- Cash Flow Statement
o The cash flow statement won’t tell you whether a company is solvent because it
could have massive long-term liabilities which dwarf its cash generating capabilities.
o The cash flow statement won’t tell you whether the company’s ongoing operations
are actually profitable because cash flows in any given period could look strong or
weak due to timing rather than the underlying strength of the company’s business.
What if you can’t value a company using DCF or multiples?
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4. If you could choose two of the three financial statements in order to evaluate a
company which would you choose and why?
Choose the income statement and the balance sheet because if you have them, you can
actually build the CFS yourself. Remember that cash flow is basically equal to Net Income,
plus/minus non-cash items on the income statement, plus rise in liabilities on the balance
sheet, minus rise in assets on the balance sheet.
5. What are common ways of valuing a company and what are their pros and cons?
See the Common Valuation Techniques section.
6. In what way is deferred revenue different from accounts receivable?

- Deferred revenue is a liability because the company has already collected money from
customers for goods or services it has not yet fully delivered. Accounts receivable is an
asset because the company has delivered goods or services for customers and has not yet
been paid.
7. What might cause two companies with identical financial statements to be valued
differently?
The financial statements do a good job of describing a company’s historical performance, but
they do not necessarily tell us everything we need to know about a company’s future
performance. Since the value of a company depends primarily on its expected future
performance, the financial statements are insufficient. Some important things financial
statements don’t tell us include, but are not limited to:
o The future growth of the company’s industry
o The company’s competitive position including share, relationships, patents, etc.
o The reputation and capabilities of the company’s management team
o The quality of the company’s future strategy
8. Why does PE generate higher returns than public markets?

See the section on How PE Makes Money. The short answer is that PE LPs demand higher
returns than public market investors which causes PE investors to price their deals to an IRR
of 20% or higher. PE LPs demand these high returns for two main reasons:
o LBOs are highly levered thus making PE investments riskier than public stocks.
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o PE investments are much less liquid than public stocks; it can take up to ten years to
realize returns.
9. Why does PE use leverage? Or how does leverage increase PE returns?

Refer to the section What is an LBO? The short answer is that PE returns are calculated
based on return on their invested equity. Using leverage to do deals allows you to use less
equity which means the ultimate returns are larger in comparison to the amount of equity
initially invested. Another way to look at it is that the cost of leverage (debt) is lower than the
cost of equity because equity is priced to an IRR of 20%+, whereas the annual interest
expense on debt is usually below 10%. Yet another way to look at it is using a lot of debt
makes the return on equity much more volatile and much riskier because the debt must be
repaid before the equity gets any return. The high returns on PE equity may be seen as the fair
return associated with the extra risk associated with high leverage.
10. How would you determine an appropriate exit multiple on a PE deal?

There are a few common way to do this. See the sections Comparable Multiples, Precedent
Transactions, and LBO Model. Comparable multiples analysis will tell you what multiples
similar public companies are trading for on the stock market. Precedent transactions will tell
you what the multiples were on deals involving similar targets. An LBO analysis (in this case
referred to as a Next Financial Buyer analysis) will tell you what multiple a financial sponsor
would be willing to pay in the future.
11. Walk me through a Discounted Cash Flow (DCF) analysis

This question may come as a stand-alone question, part of a case question, or as part of a
discussion on one of your past deals. See the section and video on DCF for how it’s done.
12. Walk me through an LBO model at a high level

See the LBO Model section for more details. This question may come as a stand-alone
question, as part of a case question, or as part of a question about one of your past deals. At a
high level, there are 5 steps to an LBO:
1) Calculate the total acquisition price, including acquisition of the target’s equity, repayment
of any outstanding debt, and any transaction fees (such as the fees paid to investment
banks and deal lawyers, accountants, consultants, etc.).
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2) Determine how that total price will be paid including: equity from the PE sponsor, roll-over
equity from existing owners or managers, debt, seller financing, etc.
3) Project the target’s operating performance over ~5 years and determine how much of the
debt principal used to acquire the target can be paid down using the target’s FCF over that
time.
4) Project how much the target could be sold for after ~5 years in light of its projected
operating performance; Subtract any remaining net debt from this total to determine
projected returns for equity holders.
5) Calculate the projected IRR and MoM return on equity based on the amount of equity
originally used to acquire the target and the projected equity returns upon exit
13. How might you still close a deal if you and the seller disagree on the price of the
asset due to different projections of its future operating performance?
- The classic PE solution to this common problem is called an “Earn-out”. Sellers are
frequently more optimistic about the future performance of a business than PE investors
are willing to underwrite. In such cases either party may propose that the sellers are paid a
portion of the total acquisition price up-front, while a portion is held back (frequently in an
escrow account) until the business’ actual future performance is determined. If the business
performs like the seller expects then the seller is paid the remainder of the purchase price
some months or years after the close of the deal. If the business under-performs the
seller’s expectations then the buyer keeps some or all of the Earn-out money. This type of
structure is a common way of bridging valuation gaps between buyers and sellers.
14. How would you calculate change in Net Working Capital (NWC)?
The classic formula for NWC is current assets (excluding cash) less current liabilities. For a lot
of businesses, it is sufficient to define NWC as: NWC = Accounts Receivable + Inventory –
Accounts Payable. Change in NWC is simply the difference between NWC in the current
period less NWC during the previous period. See the section Net Working Capital for more
details and to learn why NWC is important.
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Why You Should Care About Changes in Net Working Capital (Repeat)
15. What are some common areas of due diligence?

- This question may be asked broadly as above, or it may be asked specifically about a
particular deal (e.g. what would you most want to diligence before buying company X?)
- See the section Common Diligence Topics. If the question is asked broadly, you can
describe the high level categories (commercial, valuation, accounting, and legal) and give a
few examples from each category. If the question is asked about a specific company, you
will need to use your best judgment to decide which issues from the common diligence
topics section (in addition to any personal experience you have) are most relevant.
16. Walk me through the PE investment process

See the sections Deal process, Deal Selection, and Deal Funnel. Walk the interviewer
through the process from sourcing to closing at a high level in ~2 minutes. No need to touch on
every detail. If the interviewer wants more details he/she will ask.
17. Would you rather achieve a high IRR or a high MoM on a deal? What are the
tradeoffs? What factors might influence your answer?
PE firms try to achieve high IRRs and high MoMs on deals, but sometimes tradeoff choices
between these two common returns metrics do arise. For example, let’s say a PE firm bought
a company for $100 and, three years later, has a choice to either sell it immediately for $180 or
wait another year and sell it for $200. In this scenario the PE firm would achieve a 22% IRR
and a 1.8x MoM by selling after year three versus a 19% IRR and 2.0x MoM by selling after
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year four. This tradeoff exists because a longer hold period counts against IRR but does not
count against MoM.
Two common reasons to prefer a higher IRR are:

1. IRR is the most important single metric by which many LPs judge the performance of
PE firms because LPs such as pension funds and endowments need to hit certain
return rate thresholds in order to meet their commitments to their constituents. An LP
won’t be impressed with a 2.0x MoM if it take 10 years to materialize, because the IRR
on that return would be far below the LPs requirements for the PE portion of its portfolio.
Funds which achieve “top quartile” IRRs usually have little trouble raising subsequent
funds, whereas funds with low IRRs struggle to raise future funds. Therefore, PE funds
are careful not to let IRRs drift below the level their LPs expect.
2. Most PE funds don’t get their carried interest unless their IRR exceeds a certain “hurdle
rate”. Hurdle rates and the mechanics of hurdle rate accounting are varied and
complicated, but most funds must clear a 6 – 17% IRR in order to receive their full
carried interest percentage. Therefore, if a fund’s IRR is below or near its hurdle rate,
PE funds are especially financially incentivized to boost IRR.
Two common reasons to prefer a higher MoM are:

1. Assuming the hurdle rate has been exceeded, GPs are paid carry dollars based on
MoM, not IRR. If a GP buys a company for $100 and sells it for $140 one year later, that
translates to a terrific 40% IRR, but the GP would earn only ~20% * $40 = $8 in carried
interest. On the other hand, if a GP buys a company for $100 and sells it for $250 after
four years, the IRR falls to 25% but the carried interest earned is ~20% * $150 = $30.
2. PE firms (and by proxy their LP investors) incur transaction costs when they buy and
sell companies. If a PE firm sells portfolio companies too quickly in order to juice IRR,
then it has to spend more money to find and close additional deals. In addition, once a
PE firm fully invests its existing fund, it must raise another fund, which also has
fundraising costs associated with it.
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As you can see, the choice between MoM and IRR can be complicated and involves several
considerations. As a general rule PE firms prefer to hold on to portfolio companies and grow
MoM as long as the annual rate of return the portfolio companies are generating meets or
exceeds the rate expected by the PE firm’s LPs.
18. Which valuation techniques usually produce the highest vs. lowest values? Why?
There is a great deal of variability among the outcomes of different valuation techniques for
different industries and companies. Some banker interview guides state that there is a
commonly accepted order of valuations with precedent transactions at the top and market
valuation at the bottom. However, the reality is that it is difficult to predict which techniques will
yield higher or lower valuations. The most I would say is as follows:
o The cost of PE equity is higher than nearly any other form of capital, so in an
efficient market, PE-backed LBO valuations should tend to be on the lower side on
average. Of course there are times when this is not the case, especially when a
company is under-levered or poorly managed.
o Precedent transactions tend to be on the higher side, especially when the buyer is
“strategic” because such buyers frequently pay both a control premium and a
synergy premium.
o Public comps / market valuations tend to be roughly in the middle of the pack
depending on whether the market is hot or cold.
o DCF analyses are also middle of the pack on average, but there is a wild variability
in DCF analyses on both the high side and the low side because DCF analyses are
extremely sensitive to input assumptions.
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DCF vs. Trading Multiples vs. Transaction Multiples…
Which provides the Highest Valuations?
19. How would you estimate roughly how much debt capacity is available for an LBO?
- Debt capacity for an LBO is typically constrained by three primary ratios, total leverage
ratio, interest coverage ratio, and minimum equity ratio. Any one of these ratios could be
the governing constraint for a particular deal. To estimate debt capacity for an LBO, you
could estimate debt capacity under each of those ratios and take the lowest of the three.
See the Debt coverage and Leverage Ratios section for further details.
- Total Leverage Ratio: The most common method for estimating this ratio is Total Debt /
LTM EBITDA. During normal times, Maximum Debt = ~5.0x(LTM EBITDA). During hot debt
markets this ratio can go up to ~6.0x, and during cold debt markets it can fall to ~4.0x. This
ratio can also be higher or lower based on the nature of the target’s business. Highly
cyclical or risky businesses with few tangible assets are on the lower end of the range,
while stable business with a lot of tangible assets (which can be liquidated to repay debt
holders in the event of default) are on the higher end of the range.
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- Interest Coverage Ratio: The most common method for estimating this ratio is LTM EBIT /
Annual Interest Expense. The floor for this ratio is usually around 1.5x. Therefore, the
maximum debt this ratio will allow is roughly:
LTM EBIT
Maximum Debt =
1.5(Blended Interest Rate)
The blended interest rate depends on prevailing interest rates and how the overall LBO
debt package is structured, but roughly 8-9% is a safe assumption.
- Minimum Equity Ratio: Long gone are the days when PE firms could routinely buy targets
for 5 – 10% Equity and 90 – 95% debt as a percentage of the total acquisition price. These
days lenders demand that about 20 – 30% of the total acquisition price be equity. As such,
you could estimate:
Maximum Debt = 0.75(Total Acquisition Price)
20. What constitutes a good LBO target?

See the Deal Selection section for the common boilerplate answer. The truth is that there
have been many good deals done with targets which failed most of the criteria in the section.
They key is price. Almost any target would make a good buyout candidate at a low enough
price. Is there any company you wouldn’t buy for a dollar? I caveat my answers to questions
like these by asserting that “deals which check all the boxes are usually very expensive” and
“all problems may be overcome with price.”
The 7 Traits of The Perfect Deal and…

One That Is More Important Than All of Them Combined (Repeat)

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21. What is an acquisition / control premium and why is it paid?
When a PE buyer (or any investor) acquires a majority share of a publicly traded company, it
nearly always pays more per share than the company was trading at prior to acquisition. The
percentage by which the acquisition price per share exceeds the pre-acquisition trading price
per share is called a control premium (aka acquisition premium). The trading price per share
prior to acquisition is commonly calculated as a 30 to 90-day trailing Volume Weighted
Average Price (VWAP) prior to the day news of the pending acquisition becomed public. For
example, if the 30-day VWAP of a stock is $20 on the day an acquisition is announced for $25
per share, then the acquisition premium is $25/$20-1 = 25%. The size of control premiums
varies, but they are usually between 10% and 50%.
There are several reasons why investors might be willing to pay acquisition premiums:
o Some buyers, especially strategic buyers, expect to realize synergies with the
acquired asset which makes the asset more valuable to the acquirer than to
previous shareholders.
o Majority control of a company allows the new owners to choose how to spend the
company’s capital, including how and when to take dividends or exit the
investment. Unlike public shareholders, PE owners have a great deal of influence
over how and when they will get cash out of their investment.
o Buyers of public assets frequently believe that the company will be worth more
under their control than its public valuation. They believe they can add value by
getting better management, setting a better strategic direction, fixing operating
problems, etc. Majority control is what gives buyers the power to execute such
plans.
Another way to look at control premiums is from the perspective of the sellers. A public stock
has a very fragmented ownership base. Thousands or more individuals or entities may be
owners of a single stock, and the top ten largest owners frequently own less than 50% of
outstanding shares. In order to consummate an LBO, the buyer has to convince at least a
majority of shareholders to approve the transaction. Many of these owners own the stock
precisely because they think it is undervalued by the market. Such owners would not be willing
to sell the stock at its market price. There are of course zero (or nearly zero) owners who
would sell the stock below its trading price. Therefore, by virtue of pure math, a new buyer will
need to pay more than the trading price to acquire a majority of shares.
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22. How would you gauge how attractive an industry is?
The three most important measures of an industry’s attractiveness are its growth rate, stability,
and profitability. The most attractive industries are predictable/stable, high growth, and high
profitability. However, keep in mind that attractive companies can exist in unattractive
industries if they have a strong competitive advantage. For example, the airline industry is low
growth, cyclical, and unprofitable, but Southwest Airlines has been successful for many
decades due to their differentiated business model. Even unattractive companies in
unattractive industries might sometimes make good investments if you can buy them at the
right price and/or remedy some of what ails them.
- Gauging stability
o The stability and predictability of an industry is usually easy to gauge by
determining its growth drivers and examining its performance over a few
business cycles.
o If the growth drivers depend on entrenched secular trends (e.g. the healthcare
industry in a country with a demographically aging population) then the industry
will be more predictable than one which depends on taste/trends/fads (e.g.
fashion brands).
o If the products the industry produces are “must haves” for customers (e.g.
electricity or food staples), then the industry will be more resistant to recessions
than an industry which produces luxuries (e.g. cruise lines or expensive cars).
o If the products the industry produces are commoditized, then its fortunes tend to
oscillate with the business cycles of its customers (e.g. mining or
semiconductors), whereas industries with strong intellectual capital/differentiation
tend to be less cyclical (e.g. enterprise software or medical devices).
- Gauging growth rate
o Estimate the industry’s historical growth rate from industry reports or from the
aggregate revenue growth rates of participant companies.
o Discover the primary drivers of historical growth (e.g. technology improvement,
untapped market penetration, growing product/service adoption, price growth,
etc.) from industry reports, participant’s public disclosures, or calls with industry
experts.
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o Discover how growth drivers are trending and project future growth from
educated assumptions about the main drivers.
- Gauging profitability
o Discover the historical profit margins of industry participants and then utilize the
5-forces framework to gauge whether industry-wide profit margins are likely to
shrink, grow, or remain steady. The 5-forces framework is as follows:
Bargaining power of suppliers: The relative level of consolidation
between industry participants and the industry’s suppliers frequently
determines which side is likely to capture most of the profits. If industry
participants are more consolidated than the industry’s suppliers that is a
good sign for future profitability. If not, the reverse may be true.
Bargaining power of customer: Similar logic applies as Suppliers’
Bargaining power. If industry participants are more consolidated than their
customers it’s a good sign for profitability.
Threat from new entrants: How strong are the industry’s Barriers to
Entry (BTEs)? Strong BTEs include essential/exclusive intellectual
property, high fixed capital investment requirements, high minimum
efficient scale thresholds, and high value placed on brand and existing
relationships. Highly profitable industries with low BTEs are likely to lose
profitability over time as new competitors pile in.
Threat from substitute products: A good signal is when the industry’s
products or services meet essential customer needs which cannot be met
other different ways.
Existing competitive rivalry: It’s a good sign if the existing competitors
have established a pattern of competing on factors other than price and on
focusing on growing the industry rather than taking market share from
each other.
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Quick Primer: Porter’s 5 Forces
23. Which industry would you invest in and why?

This is another common way to ask the previous question about how attractive an industry is.
The trick to this question is that it’s not simply about identifying a good industry, but rather is
about identifying an industry which is improving. If an industry is already high-growth and
profitable, the valuations of acquisition targets are also likely sky high. Investing is about
buying undervalued assets rather than simply good assets. If you identify a bad/mediocre
industry which is about to improve, you could probably find a lot of undervalued acquisition
targets in it. Therefore, look for industries which are experiencing some of the following:
o Acceleration in long-term growth: Driven by new technology, an inflection
point in adoption, changing consumer preferences, etc.
o A shift in competitive rivalry: E.g. competitors are beginning to compete on
brand, quality, service, technology, etc. instead of price. E.g. a major competitor
is exiting the industry.
o A shift in supply chain dynamics: E.g. the industry is consolidating. This could
lead to both add-on acquisition opportunities as well as better bargaining power
relative to suppliers and customers.
o Barriers to entry increasing: E.g. patents, proprietary technology, brand,
minimum efficient scale, etc. are becoming more important
o Threat from substitutes declining: E.g. the products and services the industry
provides are becoming more unique and essential to customers.
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24. How would you gauge a company’s competitive position?
- Market share: High market share relative to competitors is usually a sign of competitive
strength. Firms with higher market share are more likely to enjoy brand awareness, close
relationships with key customers/suppliers, economies of scale, etc. Recent share trends
also matter. Companies which are gaining share tend to be better positioned competitively.
- Profit margins: High profit margins (such as Gross Margin, EBIT Margin, Net Income %,
etc.) are frequently a sign of competitive strength. Companies with higher margins are
usually more cost efficient and/or able to charge premium prices due to a superior product
offering. Recent expansion of margins is also frequently a positive signal.
- Brand perception: Brand awareness can be a very important competitive strength
indicator, especially for consumer-facing businesses. Equally important is how customers
perceive the brand when they are aware of it. The best signal of competitive strength is
high unaided customer awareness, associations with positive attributes customers care
about most, and a high willingness to recommend the brand to friends and family.
- Product breadth and quality: In many industries it is important for competitors to carry a
full line-up of products that can meet all or most of customers’ needs. For example, a farm
equipment manufacturer should probably manufacture not only tractors, but also tillers,
harvesters, and many other things a farm equipment wholesaler/retailer is likely to carry. It
is equally important, of course, that the products and services a company offers are well
designed, well manufactured, and highly regarded by customers.
- Management team quality: A bad management team can ruin the best business. A good
management team can sometimes work miracles. Assessing management team strength is
highly subjective, but it’s something PE professionals spend a lot of time discussing.
- Other signs of competitive strength:
o Lowest-cost product / service delivery model
o Strong intellectual property (IP) such as patents
o Low levels of customer “churn” (customers rarely stop being customers)
o Excellent physical locations (important for retail companies)
o Diversified customer and supplier base
o Diversified revenue sources
o High levels of recurring revenue
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25. What are some common ways PE firms increase portfolio company value?
How much value PE firms actually add is an open question, but the following methods are
frequently mentioned :
o Recruit better management and board members
o Provide more aligned management incentives (usually via stock option pool)
o Identify and finance new organic growth opportunities (new geographies, new
product lines, adjacent market verticals, etc.)
o Find, finance, and execute add-on acquisitions
o Foster stronger relationships with key customers, suppliers, and Wall Street
o Support investment in better IT systems, financial reporting and control, research
& development, etc.
26. What company would be a good LBO candidate today and why?
You always want to have one or two good pitches in your back pocket in case you get asked
this question. Before selecting a candidate, refer back to the sections on the common
attributes of LBO candidates and how PE firms make money. Try to find candidates which fit at
least some of the following criteria:
o Has a lot of stable and predictable free cash flow to pay down debt relative to
how much you would have to pay to acquire it. A free cash flow yield (FCF /
purchase price) of 10+% is a solid benchmark
o Could benefit from a strategic overhaul which would be difficult to execute as a
public company
o Is having significant operational difficulties which would require a lot of time,
patience, and capital to address
o Has a bad management team or governance structure which a PE firm could
improve
o Has a lot of room to grow either organically or via acquisition if backed with
enough patient long-term capital
27. If I gave you $X, how would you invest it?

There is no right answer to this question, but a good answer demonstrates your passion for
investing, understanding of risk vs. reward, and understanding of investment time horizons. I
usually answer this question by following these steps:
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1. Discuss a few of the investment options available to you
2. State what your investment goal, risk appetite, and time horizon is
3. Compare and contrast the risks, rewards, and time horizons of these options
4. Pick the investment options which best fits these criteria
- A sample answer might sound like this:
o “The investments options with which I am most familiar are private equity co-
invest, bonds, and equities, so I would limit my investments to those areas
because I would not invest in something I do not understand well. I have a long
way to go before retirement, so my main investment goal is a high rate of return.
However, I would also like to purchase a home in about five years, so I will
require liquidity around that time. In order to meet my goals, I would invest 10%
of my assets in PE co-invest because historically it offers the highest long-run
return. I would not invest more than 10% because co-invest is highly illiquid and
too correlated with the fortunes of my employer. I would invest 60% of my assets
in passive equities funds, split evenly between domestic and international stocks
to take advantage of equity’s historically solid returns while increasing
diversification. I would then invest the final 30% of my assets in a low-cost
medium-maturity bond fund because such bonds are relatively uncorrelated with
equity investments and ensure I will be able to buy a home in five years.”
If I gave you $1 Million, How Would You Invest?
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28. What are some different types of debt covenants and what are they used for?
Debt covenants are contractual agreements between lenders and borrowers (such as
companies which have been bought via an LBO) that give lenders certain rights to help protect
their investment. Maintenance covenants require the borrower to maintain a certain equity
cushion or debt service coverage cushion to maintain their ability to repay its debt. Incurrence
covenants prevent the borrower from taking certain actions which could be detrimental to
existing lenders such as taking on more debt or paying out cash dividends to equity holders.
Strict covenants can make an investment much riskier to a PE investor because a default on a
covenant can result in the loss of the entire equity investment even if the portfolio company
remains solvent. See the section on covenants for details.
29. What is free cash flow, how do you calculate it, and why does it matter in an LBO?
See the Free Cash Flow (FCF) section for more details.
30. If you had to value a company based on a single number from its financial
statements, what would that number be?
- The single most important value determinant for most companies is its free cash flow
(FCF) because FCF is how owners pay themselves dividends and pay down debt. If you
could know a second fact about the company before estimating its value you would want to
know how quickly its FCF is growing.
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TOP 15 FIT QUESTIONS & ANSWERS
Fit or “behavioral” questions are used to assess whether you have the right attitude, work
ethic, personality, and values to fit in with a PE firm’s culture. Most PE firms take fit extremely
seriously because most firms usually have only a handful of investment professionals who
must collaborate over long hours and under tight deadlines. This section discusses the
personal traits PE firms commonly look for in candidates so you can highlight these attributes
when you answer fit questions. This section also walks you through the most common types of
fit questions and suggests approaches for answering them. The suggested approaches and
sample answers are meant to be illustrative. You need to adapt your answers to be true to
yourself and your own words. Don’t make the mistake of reading from these samples because
this guide is read by a lot of people, and the PE universe is very small.
Show (Don’t Tell) With These 7 Stories
Personal attributes PE firms look for
- Confidence: As an investment professional, you will be asked to form opinions about

potential investments. It will not be enough to simply execute perfect analyses and build
flawless models. You will need to make decisions about what matters most and how to
interpret ambiguous data. You must be able to form an opinion without having all of the
facts. You must be able to defend your opinions in the face of skepticism. Deal teams work
best when members challenge each other (respectfully) and push each other’s thinking.
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Therefore, interviewers are looking for you to demonstrate that you believe in yourself and
your abilities enough to take a stand when appropriate.
- Humility: The evil twin brother of confidence is arrogance. It can be hard to tell them apart.
No doubt there are quite a few successful, arrogant PE professionals. However, for the
most part they succeed in spite of their arrogance rather than because of it. Arrogant
people are hard to work with. Arrogant people tend to ignore good advice and disregard
evidence that contradicts their existing beliefs. These traits are corrosive to teamwork and
lead to bad investment decisions. Confidence is good, but only when quenched in a pool of
deep humility. None of us have all the right answers. The markets will make fools of us all
from time to time. It is important that you demonstrate that you know your limits and respect
the opinions and experiences of others.
- Work ethic: PE works hour are long, deadlines are tight, and stress can be high. Deal
teams are only as strong as their weakest link. A PE professional must be willing to put in
long hours without losing engagement or focus. A PE professional must also be willing to
make some trade-offs with respect to their life outside of work. Deal processes often work
on deadlines set by sellers and investment banks. In order to win a deal firms must be able
to execute their diligence process on time. Sometimes deal deadlines conflict with other
commitments. A PE professional has to accept that they won’t always be home for dinner
and that weekend plans are written in pencil rather than in pen.
- Attention to detail: PE partners live in a world of numbers. Sometimes it feels like

numbers are the air they breathe. Numbers are their reality. PE partners see the world like
the Matrix, replete with ratios, multiples, margins, and growth rates. Partners are partners
because they can take numbers and turn them into decisions. When you screw up a
number or a calculation, you alter reality. If a partner can’t trust your numbers with 100%
confidence then he or she can’t make decisions. Therefore, you must demonstrate your
ability avoid mistakes at all costs.
- Intellectual honesty: PE professionals make a lot of judgment calls based on limited or

ambiguous information. Credit committee decisions may be swayed one way or another
based on which modeling assumptions you make and what information you choose to
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present or exclude. When you make a recommendation, your team needs to trust that it’s
based on a balanced and thoughtful analysis of all sides of an issue. Therefore, PE firms
looks for candidates who demonstrate the ability to see issues from several points of view
and avoid being influenced by personal biases.
- Passion for investing: PE is a difficult profession which requires long hours and a
commitment to ongoing learning. People who get into it for the wrong reasons tend to
become unmotivated and unhappy over time. Therefore, PE firms look for candidates who
enjoy the investment process and want to be in the industry for the long haul.
- Curiosity: As the PE industry matures, it’s getting harder and harder to make money by
doing what has been done before. Firms need to innovate and find new ways to source
deals and value to existing portfolio companies. The most successful agents of such
innovation are those who aren’t blinded by the status quo. PE firms want candidates who
will ask unconventional questions, pursue unexplored opportunities, and never stop
pushing the envelope of what’s possible.
- Self-awareness: Every PE professional has areas of strengths and weakness. We all have
certain domains of expertise and ignorance. A deal team functions best when each
member contributes where they are strong and asks for help where they are weak. No
single person ever has all of the answers, so it’s important to demonstrate both your
expertise as well as your ability understand and admit your limitations.
Fit Questions and Answer Approaches
1. Walk me through your resume

This is the most common fit question. It comes in other open-ended forms such as “tell me
about yourself.” This question is asked in practically every interview process, but it’s amazing
how many people don’t have a ready answer. If asked, this question almost always comes first
because the interviewer want to get comfortable with you and set the stage for more specific
probing questions.
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There are many creative ways to answer this question and we can’t discuss all of them here.
What we will focus on is how to give a good “standard” answer. A good standard answer is
your professional life story which highlights every major stop, explains the reasons for the
transitions, and ends with why you are now having the current interview. The entire answer
should be three minutes or less. You don’t need to give too many details. The interviewer will
probe on anything you skipped over or summarized. The most common error in answering this
question is droning on too long. You answer must be tight.
I usually follow a structure like this:

o Where I grew up
o What personal interests led me to choose my undergrad college and major
It’s good if you can already set the scene here for your ultimate interest in
business, investing, etc.
o What I learned in college which made me take my first job out of undergrad
o What skills I learned on my first job, what I liked about it, and what I didn’t like
about it
The what I learned section is a chance to highlight skills and attributes
which PE recruiters are looking for
I try to pick my “likes” to be things which are still true in PE
I try to pick my “dislikes” to be things which are less present in PE
o Why I’ve decided to move on from this job and switch to PE
- Sample Answer
o “I was born and raised in XXX until my family moved to XXX at age XX. When I
was in high school I took a class in XXX which got me interested in studying XXX
in college. I chose to go to XXX University because I discovered that they have a
particularly strong XXX program. While at school I discovered that I have a real
passion for XXX, which led me to pursue a career in [INDUSTRY]. I chose to
work at [OLD FIRM] because I knew I would learn XXX and gain exposure to
XXX. I spent XXX years at [OLD FIRM] and learned a lot while I was there. I think
the most valuable skills I learned at [OLD FIRM] are XXX, XXX, and XXX. I
enjoyed my time at [OLD FIRM] very much because I really liked XXX. However,
as time passed I began to recognize that there are additional thing that I want to
do and learn in my career. Specifically, I’ve decided that I would really enjoy
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XXX, which is why I have decided to make the switch to PE. I was really excited
to have the chance to interview with [New FIRM] in particular because I know it
has a great reputation for XXX, so I’m glad to be here. I realize that was a pretty
brief summary. Is there anything I could tell you a bit more about?”
Note: In addition to a 3-minute version of this answer you should also have a 30-second
version of this answer. Sometimes interviewers ask this question as a total formality and don’t
want your life story. If the interviewer asks this question in a perfunctory way or if you notice
they are getting impatient flip to your 30 second answer. The 30-second answer could be as
simple as:
o “I went into [Industry] after college because XXX. I enjoyed it very much and
learned a lot about XXX, but ultimately I’m interested in becoming an investor
and feeling a real ownership stake in my work so I have decided to transition to
PE. I’m especially excited to be interviewing with [Your Fund] because XXX.”
Samples: 30 second and 3 minute version of

“Walk me through your resume”
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2. Why did you choose your current industry or employer?
Interviewers ask this question to get a sense for what drives you and to understand the path
which led you to PE. The goal of your answer should be to give clear and concise reasons that
highlight your personal attributes which PE firms like. Refer to the list of desirable personal
attributes above and brainstorm truthful answers that highlight those qualities.
Here are some sample answers that accomplish your mission:

o “I’ve been interested in business and investing since [high school / college / etc.]
because I believe smart investors allocate capital where it is needed and help
grow our economy. I went into investment banking in order to learn to be an
investor and learn the skills I need to eventually transition to the buy side.”
o “I’m the type of person who really enjoys working on teams to solve interesting
problems. I went into [Industry] because it offered the chance to work with really
smart people and create a lot of value by solving XXX.”
o “I have been planning to break into PE for a long time and I knew that in order to
have that opportunity I would need to learn [skills]. I went into [Industry] in order
to learn those skills. Now I am ready to apply these skills on the buy side.”
o “I’m the type of person who thrives when the stakes are high and my team is
fighting against the clock. When I was [member / captain / whatever] of my
college [sports team], some of the most exciting moments of my life were when I
led my team from behind to victory. I went into [Industry/Firm] because I knew I
would have the opportunity to be on teams facing analogous circumstances.”
There are many honest ways to answer this question. Find answers you really believe in
because making things up is both risky and unethical. Almost as important as what you say is
what you DO NOT say. Avoid the following mistakes:
o Many people go into finance because it pays well. However, for whatever reason,
mentioning this as a motivator in an interview is a death sentence. Mention
compensation and it’s curtains. Thanks for stopping by, don’t let the door hit you
on the way out. I have no idea why the industry isn’t willing to be honest with
itself on this point, but it’s just a fact. You can still give honest answers without
mentioning compensation. If you have no other honest answers … maybe look
for different work because you’ll eventually burn out and hate your day to day job.
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o Don’t sound arrogant and don’t brag. I’ve seen candidates I’ve interviewed
answer this question by saying they are hyper competitive and went into banking
because they knew they would beat their competition. This type of response
doesn’t make an interviewer want to work with you.
o Avoid obvious clichés that sound contrived and fail the smell test. “I love working
80hr weeks” is not a good answer because nobody likes working 80hr weeks.
3. Why do you want to transition to PE?

Once again the interviewer is looking to understand what drives you and whether you’re
getting into PE for the right reasons. A good answer does the following:
o Describes what you like about your current job and what skills you’ve learned on
your previous job, especially if both are applicable to PE
o Describes what it is about your current job that isn’t satisfying or could be more
satisfying in PE
o Makes the case for why a transition to PE makes sense now
- Here are a couple of sample answers:
o “I have been working as a consultant for X years and for the most part I have
enjoyed it very much. Solving challenging problems alongside smart team
members has been exciting. I’ve learned a lot about analyzing the competitive
position of a business and about figuring out ways to improve its operations.
However, now that I’ve completed several projects I find that I’m wishing for of an
ownership stake in the outcome of my work. I’m also excited about the prospect
of seeing a company through from origination to closing to operational
improvement. I feel that PE would give me both an ownership stake as well as
the chance to engage with companies for the long run and witness the fruits of
my labor rather than always transitioning to the next case.”
o “Investment banking has taught me a lot about how to value a company and how
to think about different types of deals and financings. However, I feel that at the
higher levels of investment banking my job would become more and more a
salesmanship role. My true passion lies in learning to apply my investor’s
judgment and discovering ways to add value to companies. PE offers the perfect
blend of analysis and judgment that I want to continue to cultivate in my career.”
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Once again as above do not mention compensation as a motivator, don’t brag or over-sell
yourself, and keep your answers truthful.
4. Why are you interested in our firm in particular?

The interviewer wants to make sure that you are truly serious about their firm and that there is
likely to be a good fit between you and the firm. Your goal should be to demonstrate your clear
interest by showing you’ve spent time researching the firm and have specific reasons to be
interested in it.
Before you go into an interview, dig up some of the basic information about it:
o Its origin, age, fund size, office locations, industry focus, investment criteria, etc.
o Bios of some of it investment professionals, especially those likely to interview
you
o Existing and past deals / portfolio companies
o How they describe themselves / how they see themselves / what makes their
investment process or culture unique
Great resources for learning the above include:
o The firm’s website first and foremost. It frequently has an “about the firm” section,
IP bios, investment criteria, existing portfolio and past deal examples or case
studies
o CapIQ and other similar data providers also frequently have some of the above
data
o Google the company’s name for news article, especially press releases on new
investments and exits
o Search for WSO threads about the company and read the WSO database entries
on the company
o If you have friends who work there or have worked there they can of course be a
great resource
It’s not enough to offer vague praise about brand name and prestige. Make your reasons as
specific as possible and tailor them to your own background where possible. Sample reasons
for being interested in a particular firm include but are not limited to:
o Focus or strong track record in a particular industry vertical, especially if you
have demonstrable personal interest or experience in that vertical (e.g. “I have a
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lot of interest and experience in the healthcare vertical and I know that you have
done several successful deals in that space such as X, Y, Z)
o Affinity for a particular sourcing model (e.g. “I appreciate that many of your deals
are proprietary and I believe a great way to generate strong returns is to avoid
competitive auctions”)
o Focus on a particular deal stage (e.g. I really enjoy investing in growth
businesses rather than trying to optimize capital structures so I’m excited by your
focus on growth equity deals such as X, Y, Z)
o Focus on how the firm drives returns (e.g. “I believe that PE firms should drive
returns by adding a lot of value to their portfolio companies. [Your firm] has a
large portfolio group and several high profile operating partners such as X,Y,Z,
which reinforces your claims to being a value-added sponsor”)
o Focus on a geography (e.g. “I know that [your firm] has done several deals in
[geography] such as X,Y,Z. As a native (or native speaker of) [geography /
language], I am highly interested in looking at deals in this region.
3 Great Sample Answers:

“Why do you want to work at our fund in particular?”
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5. What do you think the job of a PE associate is / what makes a good PE associate?
The interviewer is trying to assess whether you really understand the job you are interviewing
for. Make sure to read the portions of this guide relating to PE roles, the PE investment
process, and personal attributes PE firms look for. Your goal should be not only to answer the
question, but also to subtly make your case for why you would be good at it. You should tailor
your answer to each particular firm instead of giving one standard answer. If a firm like TA or
Summit require a lot of proactive sourcing work from associates you need to mention that and
describe what makes someone good at sourcing (positive attitude, a lot of energy, curiosity
and gregariousness, ability to handle rejection, creativity, etc.). If a firm requires associates to
deeply engage with portfolio companies and help with operations you need to mention the
requisite consulting toolkit.
Some sample answers are:

o “The role of an associate can vary a lot from deal to deal, but I understand there are
some common elements. At various points in the deal process and associate may be
called on to develop investment themes, triage incoming deals, support deal diligence
and execution, and engage with portfolio companies. Some common tasks associates
execute include reading incoming CIMs, building LBO models, doing trading multiples
analysis, competitive position analysis, and industry growth forecasting.
o “A good associate is first and foremost highly diligent and detail oriented in order to
prevent having any mistakes in their numbers. In order to accomplish this good
associates make it a habit to double check their work and learn techniques for spotting
error red flags. A great associate is someone who doesn’t make mistakes and
understands the purpose of their work so that they can use their initiative and judgment
to add more value to their deal team. In addition to delivering the product their manager
requested, a great associate will offer interpretations for what their product implies for
an investment thesis, appraise their manager of any uncertainties in the analysis, and
suggest useful next steps.
6. What is your long-term career goal / where would you like to be in 5 years?
The interviewer is trying to make sure that you see PE as a meaningful phase of your career
and that you have reasonable expectations for what the role you’re interviewing can offer you.
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PE requires a lot of hard work and dedication; it is not a job for someone to try out on a whim.
PE firms spend a lot of time interviewing candidates and make their decisions very carefully.
They don’t want to hire someone who might not be fully committed.
You do not need to pretend to know with certainty that you will be in PE for the rest of your life,
but it helps if you think PE at least factors prominently in your future. On the other hand it’s
also important to have reasonable expectations. If you’re sure that you’re going to go from new
associate to full partner in five years you might end up disappointed by a longer climb up the
ladder. Be honest if you’re not 100% sure you will definitely stay in PE. That’s not a deal-
breaker, especially at firms with pre-MBA associate programs which don’t necessarily give
offers to all “graduating” associates for partner-track positions. It helps, however, if your
alternate plans include options which will be enhanced by your PE experience because then
the PE firm remains comfortable you will remain committed to your work for the duration of
your employment. For example, a PE firm would be more likely to hire someone who’s career
alternatives include public markets investing, entrepreneurship, or general management than
they are to hire someone who’s real dream is to be an engineer, or doctor, or journalist.
A good sample answer is:

o “I have been working toward a career in principal investing for many years and
am strongly committed to this path. Of course it’s hard to be 100% certain, but I
expect that I will enjoy this job very much and will look to turn it into my long-term
career. If things go well I would love to either come back here after an MBA or
simply rise through the ranks if that is an option. If, for whatever reason, my
career has to go in another direction, I expect that I would remain involved with
investing, if perhaps in a different role or asset class.”
7. What other opportunities are you considering / what other firms are you interviewing
with?
This question is tricky because, as always, you want to be honest but you don’t want to
necessarily reveal your entire hand or have to answer even more awkward questions like
“what is your first choice if you had your pick”. I usually try to keep my answer to such
questions vague in hopes that my interviewer will drop the subject, and frequently they do. If
I’m interviewing with some direct competitors and I don’t want to go into details I usually say
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something like, “I’m involved with some other processes, but I’m not under any time pressure
and I’m most excited about seeing where the process with [your firm] leads first.”
PE Firms Get Jealous Too: Here is Proof
In the rare case that my interviewer presses me to reveal names, I try to just reveal a couple
which I suspect the firm will respect but won’t feel like they’ll definitely lose me if I get a
competing offer. I then try to give one or two credible reasons for why I am most interested in
the firm with which I’m interviewing. PE firms really hate it when their offers get turned down,
so you’re less likely to get an offer if the firm doesn’t think it has a great chance to sign you.
Maybe this approach will strike some as dishonest, and I respect that, but I find this question a
little unfair so I’m not above playing games. It’s kind of like when you’re on a first date, your
date asks for the names of other people you’ve gone out with recently. Caveat: If you already
have an offer with another firm (especially one which you would strongly consider taking) don’t
be shy about disclosing it. I have no numerical proof, but in my experience PE firms get more
serious about you when they know you’re already wanted by a competitor they respect. If you
already have a good offer then revealing it can sometimes get other processes moving along
quicker so that you don’t have to twist in the wind for too long. Any downside is limited
because you always have your good offer to fall back on. Just don’t be tempted to make up
phantom offers … the PE world is small. It’s rare that professionals have more than one or two
degrees of separation. I’ve seen candidates get caught lying, and it’s not pretty.
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8. How would your peers, friends, or manager describe you / how would you describe
yourself / give me 3 adjectives that describe you?
When faced with this question some candidates find it difficult to praise themselves and fail to
highlight their best qualities. Other candidates go overboard and describe themselves in
absurdly glowing terms. Remember that a PE firm is looking for confidence mixed with some
humility. The sweet spot for this question is to describe yourself in a few reasonable positive
terms that you hope are present in you or that others see in you.
Refer back to the attributes PE firms are looking for and select a few which you honestly feel
apply to you. You don’t need to feel pressure to balance positives with negatives with this
question unless explicitly asked to list weaknesses. Look at this question as an opportunity to
sell yourself to the interviewer. In order to drive the point home feel free to bring up stories or
examples about some praise you have received.
A good sample response is:

o ”I would like to think my peers would describe me the same way I would describe
myself, which is an intelligent and honest person who is passionate about his
work and loyal to his friends. Honesty, loyalty, and hard work are common
themes in the feedback I’ve gotten from friends and supervisors. In my last
review, my supervisor made special note of my readiness to work extra hours to
help newer members of my team and my willingness to state my direct and
honest opinion whether popular or not.”
9. What are you best and worst at / give me three strengths and weaknesses?
This question is similar to the one above but you have to speak about weaknesses. For the
strengths feel free to choose similar ones as the ones for the previous question and the
answer them in a similar way. The trick on weaknesses is to make them real and significant
but not disqualifying. The weaknesses you choose should also be ones which can be
overcome with time and ones for which have an improvement plan.
You can’t cheat and say things like “I work too hard” or “I’m too much of a perfectionist”
because those sound like blatant lies. On the other hand you can’t make disqualifying
statements like “I’m not sure I totally understand how an LBO model works”, or “a lot of people
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have found me difficult to work with”, or “I get bored and unmotivated when I have to do a lot of
repetitive work”. The weaknesses you highlight need to be legitimate, but not scary.
I typically approach the weaknesses question by listing weaknesses which are real, but are
also common and expected for a professional in the position I am interviewing for. Nobody
expects you to be perfect. Some weaknesses happen to be very common for most junior IPs
and PE firms are comfortable they can be worked out over time because senior partners
remember also having them when they were younger. For example, here is a possible answer:
o “At various points in my life and career I have gotten some feedback on things I
could improve and there are a few themes which tend to recur.
My first weakness is that sometimes I struggle to focus the bulk of my
effort on the most critical tasks. As a junior professional I have sometimes
been so eager to leave no stone unturned that I’ve wasted time on issues
which don’t matter very much. I find that over time I am getting better at
identifying what matters up front, but it is proving to be a long process.
One strategy which has been helping is sitting down with my supervisor at
the start of a project and jointly discussing which tasks are the most
mission critical.
My second weakness is that I sometimes struggle to speak up when I
know my opinion is different from that of my supervisor. I know that my
supervisors usually value my opinion, but sometimes I get stuck assuming
that if we disagree they’re probably right because they have more
experience. The good news is that I know my opinions have been
generally well received when I’ve shared them. This knowledge is helping
me to gain more confidence expressing contradictory opinions.
My third weakness is that sometimes I have a hard time delegating work
or trusting the output of others. I know that trust is essential for strong
teams, but in the past I have tended to trust work only if I have either done
it or audited it extensively. There have been times when I have slowed
down my teams, wasted my own time, and possible reduced the morale of
more junior colleagues by excessively checking their output. My goal is to
trust people more once they have demonstrated their reliability and to
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learn new ways of auditing output faster at a higher level without diving
into all the details.
3 Great Sample Weaknesses and Don’t Make This Common Mistake
10. How do you feel about having to work on weekends / do you regret missing out on
other interests when work gets busy / how do you motivate yourself when a task
becomes a chore, etc.
It’s no secret that PE sometimes requires long hours of repetitive work, especially at junior
levels. Your interviewer wants to make sure that you know what you are getting into, are
comfortable making the required trade-offs, and don’t see yourself as “above” doing a bit of
grunt work. Thankfully PE isn’t banking, so you don’t have to pretend to be a borderline
workaholic, but you do need to show an awareness of what the job entails and signal a clear
willingness to make sacrifices when necessary. A simple approach to this question is to
acknowledge the necessity of certain work-life sacrifices, affirm your willingness to make
reasonable sacrifices, and cite an example which demonstrates your previous experience
doing so. For example:
o “I understand that associates here work long hours and sometimes have to be
flexible with personal plans in order to support their deal teams. This makes
sense to me because I know that the deadlines in deal processes are often tight
and the stakes are high. I am comfortable making these trade-offs because I see
them as an investment in my future and the dues that I pay for the opportunity to
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learn the art of PE. I have had to make similar trade-offs in the past, and I am
glad that I did. In my previous job I frequently had to [grunt work]. As a result of
the long hours and diligent work I put in I learned X,Y,Z (or got the opportunity to
A,B,C). At this point in my career I am more than willing to do what it takes to
support my teams and to continue to learn.”
11. What do you do for fun / what are some of your hobbies / tell me a bit about yourself
outside of work / tell me a bit about yourself as a person / etc.?
A question like this is a clear sign that the interviewer wants you to go off resume and reveal a
bit of your interests and personality. The interviewer is trying to gauge whether are a well-
balanced person who would fit in with the firm on a personal level and be fun to be around for
long stretches of time.
Put the CV away and talk about the things that make you fun and interesting. This is your
opportunity to connect with your interviewer and demonstrate your likability in addition to your
professional competence. Pick something interesting and don’t be afraid to get a little personal
(this question practically begs you to get a little personal). You probably want to avoid highly
controversial topics, but you have more leeway here than most candidates realize. Sports,
hobbies, talents, funny situations, unusual life stories, interesting achievements, outside
passions, etc. are all fair game here. The most important advice is: be interesting. Be a real life
person your interviewer will remember.
12. Do you consider yourself a risk-taker / What are some risks you have taken in the
past and what did you learn from them / How do you feel about risking other
people’s money?
Your attitude toward risk is important in a PE context. PE firms look for people who take the
responsibility of managing other people’s money very seriously, but who are willing to take
prudent risks to generate returns. Your interviewer is looking for a willingness to take risks
tempered by a careful and reasoned approach to balancing risks with rewards.
There are a couple of common ways to approach answering this type of question: You could
tell a story where you took a well calculated risk and it paid off, or you could tell a story about a
bad risk you took and how it taught you to be more careful. In either scenario you want to
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affirm your belief that some risk is required for success, but that you’re the type of person who
measures twice before cutting once. Sample answers include:
o “I believe that taking risks is important not only in investing, but also in life
because taking risks is what lets us expand our capabilities. However, I am the
type of person who feels comfortable taking risks only when I’m certain the
rewards are worth it and the downsides are well understood. This attitude toward
risk has helped me to take important leaps of faith in my life while largely
avoiding any catastrophic missteps. For example, I am currently taking a risk in
refusing sponsorship from my old company to pursue my MBA. I am sure that I
would prefer to switch careers and pursue PE full time so my upside is that I will
land my dream job. The downside is that I am foregoing a lot of sponsorship
support and risking an unpredictable interview cycle. The reason I’m taking this
risk is that it’s extremely important for me to pursue the career which I feel suits
me best, while going back to consulting is likely to always remain open for me.”
13. Do you prefer to work independently or as a team / Do you consider yourself a leader
or a follower / Tell me about a time you worked as part of a team which exceeded
expectations / etc.
Teamwork is essential to the deal process because deadlines are tight and mistakes are
expensive. Your interviewer wants to make sure that you have teamwork experience, enjoy
teamwork, are effective as both a leader and a follower, and know when the time is right to
take initiative vs. follow instructions. The impression you want to give is that you are
comfortable as an individual contributor but that you really enjoy teamwork and think that good
teams are greater than the sum of their parts. You should also highlight your understanding
that the role of a junior professional is first and foremost to diligently execute on the direction of
senior staff, while looking for opportunities to take initiative when the time is right. A sample
answer:
o “Although I am quite comfortable doing individual work, many of my most
satisfying work experiences have come as part of a team. The best part about
teams, aside from the friendships they help form, is that great teams achieve
more than what the same group of individuals can achieve independently. As a
junior team member I have always realized that first and foremost I need to
diligently follow instructions from the team leaders because they have more
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responsibility and experience. My typical approach is to first do what is asked of
me and then to look for ways to add value based on personal initiative. One
illustrative example of my approach is that at my old job analysts spent a lot of
time building custom models for each new deal. After building several such
models I noticed that many of our customizations were repetitive and could be
automated with a more flexible base model shell. I took some personal time to
build a new model shell which incorporated my observations. This improvement
saved a lot of time not only for myself but also for all of the other analysts in my
class.”
14. What do you consider to be your greatest accomplishment / What is the biggest
challenge you have ever overcome / What are you most proud of?
This question is a polite way for the interviewer to tell you “ok kid, impress me.” Most people
who work in PE have accomplished some pretty impressive things before they broke into the
industry. The ranks of PE professionals are loaded with valedictorians, entrepreneurs,
successful athletes, philanthropists, innovators, etc. This question is an opportunity for you to
show you belong in this group. Some people advise answering this question in a humble way
by pointing to a small but highly meaningful accomplishment or focusing on personal
accomplishments related to family and relationships. I take the stance that such answers might
make you seem likable, but that they duck the central challenge of the question. On this
question I say go big. Brag a little because that’s what you’re being invited to do.
Imagine you had your own Wikipedia page (some of you probably do). What would be listed
there as the thing that makes you most noteworthy? Assuming you are not a Kardashian, pick
that thing and talk about it.
15. What is the biggest mistake you have ever made / What is you biggest regret / What
is an example of a decision you wish you had made differently?
Honest self-reflection is a hallmark of good PE investors. Everybody makes mistakes. What
matters is your ability to admit them and learn from them. Your interviewer wants to see that
you’re not afraid to own your mistakes and that you’re able to prevent them from recurring.
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Much like the weaknesses question, you need to pick a real mistake, but not one so big that it
will disqualify you. If you’ve ever missed a deadline, messed up some analysis, damaged a
relationship, been suspended from school, or let a big opportunity pass you by, you’re probably
on safe ground to answer this question. Don’t be afraid to own it. On the other hand if you’ve
been arrested or fired or exhibited serious character flaws you’re playing with fire. Ditto if
you’ve ever actually been accused of lighting a squirrel on fire (you know who you are).
Sometimes discretion is the better part of valor. Choose which mistake to disclose wisely.
Whatever mistake you choose to discuss, do so without equivocation and in a way which
makes clear you take total responsibility. Then, spend the second half of your answer
discussing what you learned from your mistake and how you made sure it wouldn’t happen
again. Sample answer:
o “During my first few months at my current job I was asked to update a financial
model while simultaneously staffed on another deal. This update was difficult
because of the model’s size and complexity, but I did not ask for help out of fear
of seeming incompetent. Whenever my manager checked in I told him that it was
a challenge but that I was on track. In reality I was struggling late into the night
with little progress. When my other deal became the priority I was asked to
transfer my work to another analyst and had to come clean. My manager was
understandably upset that I had kept him in the dark. I also felt guilty for leaving
another analyst with a lot of work and little time to finish it. Had I flagged the
issue earlier, my manager would have understood the difficulties, and there
would have been time to get help. My failure to communicate honestly caused an
unpleasant surprise and a scramble to finish the job. I now proactively seek help
and clarifications on new assignments. This approach helps me meet deadlines
and avoid wasting time wondering what to do or how to do it.”
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TOP 10 BRAINTEASER QUESTIONS & ANSWERS
Brainteasers test your ability to think on your feet, apply simple logic, and do mental math. A
brainteaser can make even the smartest and best prepared candidate break down if he or she
hasn’t faced a similar question. Fortunately, some brainteasers and their variants appear
frequently. The most common are below:
1. What is the angle between the big hand and little hand on a clock face when it is 3:15
This is a common question but the time changes. Just remember that a clock face is 360
degrees, split into 12 hours of 360 / 12 = 30 degrees each. When it is 3:15, the long minutes
hand is pointing directly at the 3-hour mark, while the short hours hand is below it because the
time is 15 minutes past the 3-o’clock hour. The angle between the hands is equal to how far
the short hours hand moves in 15 minutes, which is a quarter of an hour. Since an hour equals
30 degrees, the angle between the hands is 30 / 4 = 7.5 degrees.
Clock Face at 3:15
2. There are three boxes. Two boxes are empty and the third contains a prize. You
select one of the boxes at random. The box you selected is set aside, leaving two
remaining. One of the two remaining boxes is opened and revealed to be empty.
There are now only two closed boxes remaining, the one you originally selected at
random and another one which was not subsequently opened. You may now choose
one of the two remaining boxes, and if you choose correctly you win the prize.
Should you choose the original box you selected, switch your choice to the other
box, or does it not matter? Why?
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You should always switch to the other box (i.e. don’t pick the box you originally selected).
There is a 1/3 chance that the prize is in the original box and a 2/3 chance that the prize is in
the other box. It’s simple to see how this is so if you imagine that there are 1,000 boxes
instead of three. Imagine you picked one box at random out of 1,000 and it was set aside. Of
the remaining 999 boxes, 998 were then opened to reveal no prize. The odds that you initially
picked the right box at random are 1/ 1,000, but the box which remains unopened after 998
other boxes were revealed to be empty almost certainly contains the prize.
3. What is the sum of the integers between 0 and 100 (inclusive of 0 and 100)?
The trick to solving questions like this is making pairs which add up to something that is easy
to count. In this case, 0+100, 1+99=100, 2+98=100, 3+97=100, etc. There are 50 such pairs
because there 50 numbers between 0 and 49 (including the zero). 50 times 100 is 5,000. Don’t
forget the final 50 which didn’t get paired up and you get 5,000 + 50 = 5,050.
4. Imagine I offer to play a coin flipping game with you with a fair coin. If the first flip is
heads I will give you one dollar. For each subsequent heads flip I will double the
payout. The game ends once a single tails is flipped. What is the highest price you
would pay to play this game if you are 100% sure I will pay what is owed to you and if
your only motivation is to make an expected profit?
This mathematical problem is referred to as the St. Petersburg Paradox. The strange solution
is that you would pay up to an infinite amount of money to play this game because the
expected value of playing it is also infinite. The trick to solving is realizing that the expected
value of this game equals the sum of all possible payoffs multiplied by the odds of that payoff
occurring. You will win a dollar with a ½ probability, win 2 dollars with a ¼ probability, win 4
dollars with a 1/8 probability, etc. Therefore, your expected value is:
Look up the St. Petersburg Paradox for more details. Note that some interviewers won’t
stipulate that expected value is the only thing you care about. In such cases you should caveat
your answer by saying that although the expected value is infinite, you wouldn’t pay an infinite
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amount of money to play the game because the range of outcomes is highly risky and you are
averse to risk. The odds of making you money back are below 50% if you pay anything above
a dollar. This insight is important because PE firms are risk averse, and would rather avoid
losing money than making an equal amount of profit.
5. Imagine a town with 100 married couples. The wives of this town are instantly
informed if the husband of another wife cheats, but they are not informed if their own
husband cheats. Any wife who has irrefutable proof that her husband cheated must
divorce him immediately. All divorces are made public each morning. What would
happen if “n” husbands cheat, and a reliable gossip column reveals that at least 1
husband has cheated (n is between 1 and 100).
The way to approach this (and similar) problems is to apply recursive logic. If n = 1 then the
cheater’s wife can prove her husband cheated because she knows n is at least 1, and she
knows none of the other husbands cheated. Therefore, if n = 1, the cheating husband will be
divorced on day one. If n = 2 then no woman is sure her husband cheated on day one. This is
because each cheater’s wife knows two facts: n is greater than or equal to 1, and at least one
other woman’s husband cheated. As far as each scorned wife knows, only one husband
cheated. However, after the first day passes with no divorces each wife knows that n is equal
to or greater than 2 (since wives know an n of 1 would produce a divorce on the first day).
Therefore, if n = 2, then both cheating husbands will be divorced on the 2nd day. You can apply
this logic over and over to extrapolate that all cheating husbands will be divorced within “n”
days after the publication of the gossip column. Also, don’t feel too badly for the poor wives of
this town … after all … who are these husbands cheating with?
6. There are 100 closed lockers in a row. First, you open every locker. You then close
every 2nd locker starting with locker #2. You then open every 3rd locker if it’s closed
or close it if it’s open, starting with locker #3. You then close every 4th locker if it’s
open or open it if it’s closed, starting with locker #4. You continue on in this fashion
until you complete 100 full iterations by opening (or closing) every 100th locker
beginning with locker #100. Of the 100 lockers, how many are now open?
The lockers begin in the closed position. Each locker which is touched (opened or closed) an
odd number of times by the end of the procedure will end up being open. The key insight is
that a locker will be touched (opened or closed) equal to the number of its factors. For
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example, locker number 20 has 6 factors (1, 2, 4, 5, 10, and 20), so it will be touched 6 times.
Only numbers which are perfect squares have an odd number of factors. Therefore only
lockers whose numbers are perfect squares remain open. There are 10 perfect squares
between 1 and 100: 1, 4, 9, 16, 25, 36, 49, 64, 81, 100. Therefore, 10 lockers are open.
7. You drop a 10x10 Rubik’s cube into a bucket of paint. How many individual cubes
have paint on them?
The trick is to realize that cubes on the edge of any one of the 6 faces have a side on two
faces (3 faces for corner cubes), so you can’t simply calculate the number of cubes on a single
face and multiply by the number of faces. The most intuitive way to solve this problem is to
calculate the total number of individual cubes in a 10x10x10 Rubik’s cube, and then subtract
the number of cubes which are all internal with no facings on the outside. There are 10 * 10 *
10 total individual cubes. On the inside of a 10x10x10 cube, there is an 8x8x8 cube with no
outside facings. The 8x8x8 cube contains 512 individual cubes. Therefore, there are 1,000 –
512 = 488 cubes on the outside of the Rubik’s cube with paint on them.
8. How would you isolate exactly three gallons of water if you are standing in a river
with a 5 gallon jug and a 2 gallon jug?
Fill the 5 gallon jug to the top and pour water out of it into the 2 gallon jug until the 2 gallon jug
is full. You will have exactly 3 gallons of water in the 5 gallon jug.
9. You have ten black marbles, ten white marbles, and two buckets. I am going to select
one bucket at random and pull out one marble from it at random. How would you fill
each bucket with marbles to maximize the odds that I select a white marble?
Put one white marble in one bucket and put the other 19 marbles in the other bucket. The
bucket with the lone white marble will be chosen 50% of the time. When the other bucket is
selected, the odds that a white marble is pulled are still nearly 50%. By allocating marbles this
way you make the overall odds of a white marble being selected nearly 75%.
10. A car drives from point A to point B at 60mph. It then returns from point B to point A
at 30mph. What is the average speed of the total round trip?
A lot of people say 45mph, which is wrong. Average speed equals total distance over total
time. In this case let’s assume the distance between A and B is 60 miles. The first leg of the
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journey takes one hour and the return trip takes 2 hours. The total distance traveled is 120
miles and the total time the trip takes is 3 hours. Therefore, the average speed of the round trip
is 120 miles / 3 hours = 40mph.
Follow These 5 Steps if You Get Stuck on a Brainteaser
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Chapter 5: LBO Modeling
In this chapter… This chapter focuses on teaching

x Introduction to LBO
you how to build the three types of
Modeling Tests
x Paper LBO LBO models you may come across
x Basic (1-Hour) LBO in your interview process. We walk
x Full (3-Hour) LBO
through each type step-by-step and
provide additional examples with
answer keys to help you master
these skills.
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INTRODUCTION TO LBO MODELING TESTS
The final step in preparing for your PE interviews is to master the art of LBO modeling. There
are three main types of LBO modeling you should be able to do before you walk through the
door of your interview: the Paper LBO, the Basic (1-hour) LBO, and the Full (3-hour) LBO.
- The Paper LBO: This is an exercise in mental math and paper calculation. This will often
come up in the middle of an interview, with an interviewer giving you assumptions and
simply asking “how does the deal look?” This is an opportunity for you to show off your
understanding of how PE firms make money, your ability to think on your feet, and your
investment judgment.
- The Basic (1-hour) LBO: This is where your Excel abilities come into play. Often the
interviewer will give you a computer, some assumptions, an empty office and a time limit.
Your job is to model out the deal and give a recommendation. The Basic LBO will usually
require limited Balance Sheet modeling (e.g., just a debt schedule), and assumptions that
require less nuanced modeling than the Full LBO.
- The Full (3-hour) LBO: Here is the final test of your modeling capabilities. You will be given
more time, but be expected to churn out a full three-statement LBO model. You may also
be asked to model in some more complicated deal structures.
This chapter will walk you through how to do each type of model along with illustrative
examples. You should be following along and trying to build the models yourself, and then
checking your work against ours. At the end, we will also provide additional practice questions
and modeling tests with example answers so you can build your capabilities. The good news is
that if you have made it to the Excel modeling stage of the interview process, you are likely
being considered seriously; nail the test and you are in excellent position to land the job.
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THE PAPER LBO
The following example corresponds to the accompanying Excel file titled “WSO – PE Guide –
Paper LBO Example 1.xlsx”.
The Paper LBO is a simplified version of the LBO that is designed to test your understanding
of the logic and basic mechanics of buyouts. These questions can come in the middle of both
first round and later stage interviews. Your interviewer will give you some basic assumptions
and deal details, and ask whether this deal is attractive. You then can walk your interviewer
through the rough calculations of the Paper LBO, and after generating a deal IRR you can
comment on the attractiveness of the deal.
A few quick points before we jump into the mechanics. First, the interviewer may not give you
all of the assumptions you need up front. This is fine; they are looking to see whether you
know what the missing terms are to ask for or whether you can make reasonable assumptions
about them (e.g., “Do you know what the tax rate is here? Or should I just assume 40%?”).
Second, this is always a simplified version of the LBO and is designed to get you in the
ballpark of the deal IRR; do not be afraid to round numbers as necessary, because giving an
IRR to the third decimal point is an exercise in false precision. Third, if you are comfortable
doing the math in your head that is great, but do not feel like you absolutely have to. Finally,
this is an exercise where you are trying to show your thought process and understanding of the
mechanics; as you are making your calculations, explain what you are doing to the interviewer
so they can follow along.
Paper LBO Example

Your interviewer opens with the following: “Let’s say we’re looking at a company that did
$200M in revenue last year and has a 25% EBITDA margin. We could buy it for 6x EBITDA
with 75% debt, and sell it for 5x EBITDA in 5 years. We expect EBITDA to grow at 10% during
our hold period. Does this look like a good deal?”
You have gotten most of the information you will need to do the Paper LBO, but not all of it.
However, you have enough to do the first step of the Paper LBO: the Deal Entry Calculation.
- Deal Entry Calculation
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o Multiplying revenues ($200M) by the EBITDA margin (25%) will give you LTM
EBITDA at the time of the deal ($50M).
o Multiplying LTM EBITDA ($50M) by the EBITDA multiple (6x) gives you the initial
TEV ($300M).
o Multiplying the TEV ($300M) by the debt percentage (75%) gives you the implied
debt ($225M). The remainder ($75M) is the size of the equity check at entry.
o An Excel version of how your paper may look when you have finished this step
may look like this:
EntryCalculation
LTMRevenue $200.0
xEBITDAMargin 25.0%
LTMEBITDA $50.0
xEntryMultiple 6.0x
EntryTEV $300.0
Less:Debt ($225.0)
EntryEquity $75.0
The next step is to project the financials and cash flow of the business during the hold period,
or the Forecasted Financials. This is important to understand both how much cash the
business will generate while you own it, as well as to understand the price you will get for the
business at exit (which here will be based on a multiple of EBITDA at exit). However, you do
not have enough information to complete this step yet. At this point you should ask your
interviewer about the cost of debt, the debt paydown policy, the tax rate, capex, D&A, and net
working capital.
Your interviewer responds with: “Let’s keep it simple. The cost of debt will be 10%, and we’ll
assume that we don’t pay down any debt during the hold period and instead take cash out at
the end. The tax rate is 40%, and capex and D&A are both $15M per year. Net working capital
increases by $5M each year.”
You now have the information to project the Forecasted Financials during the hold period.
- Forecasted Financials
o Income Statement
We calculated above that LTM EBITDA was $50M. Given the 10% growth
rate, we can calculate EBITDA for years 1-5 by multiplying each prior year
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by 1.1. Doing this we calculate EBITDAs of $55M, $60.5M, $66.6M,
$73.2M, and $80.5M for years 1-5 respectively.
D&A is steady at $15M per year, so we can populate that for each year.
Subtracting D&A from EBITDA, we get EBITs of $40M, $45.5M, $51.6M,
$58.2M, and $65.5M for years 1-5.
Calculating interest in this situation is as simple as multiplying the amount
of debt (calculated as $225M in the Deal Entry Calculation above) times
the cost of debt (10%) to yield $22.5M. Because we are not paying down
debt during the hold period, it is the same each year.
Subtracting interest from EBIT gives us EBTs of $17.5M, $23M, $29.1M,
$35.7M, and $43M for years 1-5.
Taxes are then calculated as 40% of EBT for each year. These will equal
$7M, $9.2M, $11.6M, $14.3M and $17.2M respectively.
Subtracting taxes from EBT will give us our Net Income each year:
$10.5M, $13.8M, $17.4M, $21.4M and $25.8M.
This gives us our Income Statement. An Excel version of your paper may
look like this:
Year 0 1 2 3 4 5
IncomeStatement
EBITDA $50.0 $55.0 $60.5 $66.6 $73.2 $80.5
%Growth 10.0% 10.0% 10.0% 10.0% 10.0%
Less:D&A ($15.0) ($15.0) ($15.0) ($15.0) ($15.0)

EBIT $40.0 $45.5 $51.6 $58.2 $65.5
Less:Interest ($22.50) ($22.50) ($22.50) ($22.50) ($22.50)
EBT $17.5 $23.0 $29.1 $35.7 $43.0
Less:Taxes ($7.0) ($9.2) ($11.6) ($14.3) ($17.2)
NetIncome $10.5 $13.8 $17.4 $21.4 $25.8
o Cash Flow
From here we can calculate cash flow. We will start with Net Income
calculated above.
To this we add back D&A of $15M each year.
We then subtract capex of $15M each year.
Finally, we subtract an increase in NWC of $5M each year.
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This will give us a Cash Flow line of $5.5M, $8.8M, $12.4M, $16.4M, and
$20.8M in years 1-5 respectively.
We can sum across the Cash Flow line to see that cumulatively the
business will generate $64M in cash during the hold period, which we will
receive at exit.
An Excel version of your paper may look like this:
Year 0 1 2 3 4 5
CashFlow
NetIncome $10.5 $13.8 $17.4 $21.4 $25.8
Plus:D&A $15.0 $15.0 $15.0 $15.0 $15.0
Less:Capex ($15.0) ($15.0) ($15.0) ($15.0) ($15.0)
Less:ChangeinNWC ($5.0) ($5.0) ($5.0) ($5.0) ($5.0)
LeveredCashFlow $5.5 $8.8 $12.4 $16.4 $20.8
CumulativeCashFlow $5.5 $14.3 $26.7 $43.2 $64.0
We’re almost done. All we have left is the Deal Exit Calculation and your recommendation.
- Deal Exit Calculation
o At Exit, we know LTM EBITDA will be $80.5M (Year 5 EBITDA from above).
o Multiplying LTM EBITDA at exit ($80.5M) by our Exit Multiple (5x) will give us our
exit TEV ($402.5M).
o To this figure, we add our cumulative cash generated ($64M) and subtract our
debt (still $225M) to get an Exit Equity value of $241.5M.
o Next we must calculate our Multiple on Invested Capital (MOIC) / Multiple of
Money (MoM). To do this we divide the Exit Equity value by our Entry Equity
($241.5M / $75M) to yield 3.2x.
o Finally, to convert the 3.2x MOIC into IRR we can do one of two things:
We can calculate it by using the typical CAGR formula. We take our MOIC
^ (1/Hold Period) – 1. In this case: 3.2 ^ (1/5) – 1, giving us an IRR of
26.4%.
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Alternatively, we can rely on the rough heuristic table below:
MOICtoIRRConversionGrid
LengthofInvestment(Years)
1 2 3 4 5 6 7
1.0x 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
MOICGenerated
1.5x 50.0% 22.5% 14.5% 10.7% 8.4% 7.0% 6.0%
2.0x 100.0% 41.4% 26.0% 18.9% 14.9% 12.2% 10.4%
2.5x 150.0% 58.1% 35.7% 25.7% 20.1% 16.5% 14.0%
3.0x 200.0% 73.2% 44.2% 31.6% 24.6% 20.1% 17.0%
3.5x 250.0% 87.1% 51.8% 36.8% 28.5% 23.2% 19.6%
4.0x 300.0% 100.0% 58.7% 41.4% 32.0% 26.0% 21.9%
We see that a 3x deal over five years yields around a 25% IRR, while a
3.5x deal is almost 29%. Thus, for a 3.2x deal we can assume an IRR
around 26%. This level of precision should be fine for a Paper LBO. (In
fact, you should memorize the year 5 column of this grid for your own
reference, regardless of how you choose to calculate IRR during a Paper
LBO. Knowing that a 2x deal is a 15% IRR, a 2.5x deal is a 20% IRR, and
a 3x deal is a 25% IRR is quite useful.)
o An Excel version of your paper may look like this:
ExitCalculation
LTMEBITDA $80.5
xExitMultiple 5.0x
TEV $402.6
Plus:CashGenerated $64.0
Less:Debt ($225.0)
ExitEquity $241.6
MOIC 3.2x
IRR 26.4%
The final step is to provide a recommendation. This specific deal looks good, with a 3.2x MOIC
and a 26% IRR. However, you may want to comment on whether this return adequately
compensates you for the risk you are carrying (e.g., if faced with a deal that has a 19% IRR,
you may comment “This deal looks to be decent, but it depends on how risky the business is. If
this is a very safe business, I’d be more comfortable pulling the trigger here and accepting a
high-teens return.”) You may also want to comment on what is important to make the deal a
success and how that would affect the way you diligence the business (e.g., here you might
say “This deal looks great with a 26% IRR, but we would have to dig in during diligence to get
conviction around the 10% EBITDA growth. Cash flow generation provides some of the return
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here, but this is primarily an EBITDA growth story.”). This kind of analysis is pretty basic, but it
lets you to show some of your investment judgment rather than just your math skills.
One final comment on the Paper LBO is to be aware that there are a number of twists that can
be thrown into these questions. For example, rather than asking you what the IRR of a given
deal is, the interviewer may ask you what the exit multiple must be given a set of assumptions
to get a 20% return on a deal, or what price you could pay at entry to receive a target return.
They also may ask you to include things that have been simplified away in this case, like
including management options or deal fees. Ultimately, the mechanics of the exercise will be
the same, but you’ll be solving for a different variable or adding a few additional line items.
Don’t get caught off guard by these tweaks; just calmly walk through the mechanics and show
you can deal with anything they throw your way.
Watch The Paper LBO Get Built with Play by Play
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THE BASIC (1-HOUR) LBO
Basic LBO Example 1.xlsx”.
Many Private Equity firms ask their candidates to do more than just an LBO on paper; they
also want to see your modeling capabilities. They will give you some information about a
potential deal, a computer, and a set amount of time and ask you to build an LBO model for
them. The Basic (1-Hour) LBO test is the simplest version of this test.
The model you will need to build in the Basic LBO test is akin to what many PE shops refer to
internally as a “mini-model” (rather than a “full model”). The mini-model has all of the major
items necessary to judge the attractiveness of a deal in the early-to-medium stages; as a deal
heads toward completion, however, firms will build a full model that includes all of the
intricacies of the transaction.
Fundamentally, the steps to doing a Basic LBO model are the same as for the Paper LBO:
Deal Entry, Forecasted Financials, and Deal Exit. Each step along the way is just a bit more
detailed.
Basic LBO Example

You receive the following prompt:
“Company ABC is a public company that is trading at $20 / share. They have 25 million fully
diluted shares outstanding, and $200M of net debt. Last year, the business realized the
following operating numbers:
Revenue $500
EBITDA $100
D&A $25
Capex $20
NWC $75
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“The MD believes it can be taken private at a 20% premium. The MD believes the business
has a strong management team, and to retain and incentivize them he believes a 5%
management option pool would be necessary.
“ABC’s management has presented an operating plan that we believe they can hit. It calls for
4% top line growth, and EBITDA margin expansion of 50 bps per year. They anticipate D&A,
Capex, and NWC to remain the same as a percentage of sales, and for the tax rate to remain
at 35%. While the business has $75M of cash on the balance sheet now, it only needs $20M to
run its day-to-day operations.
“The investment bankers advising you suggest that the deal could be funded with 3.0x Bank
Debt priced at L+300 bps and 2.0x Senior Notes with a 12% coupon. The five year LIBOR
swap rate at the moment is 3.0%. The equity analyst at the bank believes the long-run
valuation of this business should be 8.5x EBITDA. Between financing, legal, and accounting,
fees and expenses should be around $50M.
“What are the returns of this deal at the 20% take-out premium the MD anticipates being
necessary assuming management hits its operating plans? Would you recommend we do the
deal?”
That seems like a lot to digest, but you can organize everything by creating an assumptions
section at the top of your model. Write down every number, and code it in blue to represent
that it is hard-coded. This will allow you to keep track of and organize everything in the prompt,
as well as centralize the assumptions that you will link to for the rest of your model. Here is an
example assumptions section:
Assumptions
Entry CapitalStructure Exit

CurrentStockPrice $20.00 Amount Cost Multiple 8.5x
TakeoutPremium 20.0% BankDebt 3.0x L+300 bps MgmtOptions 5.0%
FDShares 25 Sr.Notes 2.0x 12.0%
CashtoEquityHolders 600 LIBOR 3.0% LTMFinancials
ExistingNetDebt 200 Revenue $500
TEV(incl.premium) 800 OperatingAssumptions EBITDA $100
RevenueGrowth 4.0% D&A $25
Fees&Expenses 50 YoYmarginexpansion 0.5% Capex $20
MinCash 20 TaxRate 35.0% NWC $75
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Next, it is time to move onto calculating the details around Entry as well as create the Sources
and Uses table.
- Deal Entry
o Sources and Uses
The Sources and Uses (S&U) table explains where the cash is coming
from to do the LBO, and where it is going to. The Sources must equal the
Uses.
S&U tables are often structured with a list of sources on one side, and a
list of uses on the other side (or one on top of the other). Each line item
will have a dollar amount next to it, and many times will have stats around
the xEBITDA or the percentage of the total deal it represents (see
example below).
Starting with the Uses side is usually easier. Here there are four uses of
cash:
x Cash to buy the shares of existing equity holders.
o We’ve already calculated this figure above in our
assumptions example. This is done by taking the current
stock price, multiplying it by (1 + Takeout Premium) to get
the price per share paid to shareholders, and multiplying that
by the number of shares outstanding. In this case, the math
is $20 / share * (1+20%) * 25M shares = $600M.
x Cash to retire / refinance the existing net debt.
o This figure was given to us in the prompt as $200M. Note
that we are using net debt here, which means we are netting
the cash currently on the balance sheet against the gross
debt. It is possible to use gross debt on the Uses side, and
then use existing cash on the balance sheet as a source of
cash on the Sources side, but you must be consistent to
make sure you do not double-count. Either use net debt on
the Uses and do not use existing cash as a Source, or use
gross debt on the Uses and do use existing cash as a
Source.
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x Cash to go to the balance sheet to run the business.
o This was given in the prompt. Use the minimum cash
required in the business ($20M) for this number. Note that
because we are netting all of the existing cash against net
debt (and reducing that Use of cash), we need to include this
line item to make sure we “put” enough cash into the
business for it to run.
x Cash for fees and expenses.
o This was given in the prompt as $50M.
Next is the Sources side. Here there are only three sources of cash for the
deal:
x Bank Debt
o The prompt said we anticipated being able to get 3.0x Bank
Debt on this deal; the question is: 3.0x what? In PE, when
people give multiples for leverage purposes, it is safe to
assume they mean multiples of EBITDA unless they state
otherwise. Here, 3.0x EBITDA implies total bank debt of
$300M.
x Senior Notes
o The prompt indicated we could get 2.0x Senior Notes, which
implies $200M.
x Sponsor Equity
o Sponsor Equity is actually the ‘plug’ here. We know that the
Sources and Uses must sum to the same total, and we see
the total uses are $870M ($600M to existing equity holders +
$200M to existing net debt + $20M to put on the balance
sheet to run the business + $50M of fees). We also know
that we can finance $500M of the deal with debt ($300M of
Bank Debt and $200M of Senior Notes). Thus, to do the deal
the sponsor will need to invest $370M ($870M – $500M).
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An example Sources and Uses table may look like this:
SourcesandUses
Sources Uses
Amount xEBITDA %Capital Amount xEBITDA %Capital
Debt MinimumCash 20 0.2x 2.3%
BankDebt 300 3.0x 34.5%
Sr.Notes 200 2.0x 23.0% Exist.DebtRetirement 200 2.0x 23.0%
TotalDebt 500 5.0x 57.5% Exist.EquityPayment 600 6.0x 69.0%
SponsorEquity 370 3.7x 42.5% FeesandExpenses 50 0.5x 5.7%
TotalSources 870 8.7x 100.0% TotalUses 870 8.7x 100.0%
Now that we have all of the details around the Sources and Uses and the Deal Entry, we are
ready to start modeling out the finances of the business for the hold period. There are three
main components necessary in the Basic LBO model, and they are all interconnected: the
Operating Model, the Levered Cash Flow, and the Debt Schedule.
o Operating Model
The operating model is where you will model out all of the details about
how the business performs. It will feed into Levered Cash Flow and the
Debt Schedule, as well as pull from the Debt Schedule.
We know from the prompt that revenue in Year 0 is $500M, and that
revenue is expected to grow at 4% per year for the next five years. Thus,
we can project revenues of $520M, $541M, $562M, $585M, and $608M in
years 1-5 respectively.
We also know that EBITDA in Year 0 is $100M. This implies an EBITDA
margin in Year 0 of 20%. Management’s plan anticipates 50 bps of
EBITDA margin expansion each year during the hold period, so we can
project margins going forward of 20.5% in Year 1 trending up to 22.5% in
Year 5. By multiplying our projected revenues and our projected EBITDA
margins, we can get expected EBITDAs of $107M, $114M, $121M,
$129M, and $137M.
We know D&A in Year 0 is $25M from the prompt, which is 5% of sales.
Holding this percentage constant per management’s expectations yields
us D&A projections of $26M, $27M, $28M, $29M, and $30M.
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Subtracting D&A from EBITDA gives us EBIT. The next step is to take out
Interest to get to EBT. However, Interest will come from the Debt
Schedule, so let’s put in a placeholder line item for now, and generate
EBT by taking EBIT minus that placeholder.
Management expects taxes to be 35% going forward, so we can multiply
EBT by this figure to get annual taxes.
Finally we can then take EBT minus taxes to get Net Income.
Though everything else so far in the Operating Model has been part of an
Income Statement, we now need to add two other assumptions relevant
for generating cash flow projections to the operating model.
x Net Working Capital was $75M in Year 0, representing 15% of
sales. Assuming this percentage remains the same, we can project
NWC going forward of $78M, $81M, $84M, $88M, and $91M.
x Capex was $20M in Year 0, representing 4% of sales. Assuming
this percentage remains the same, we project Capex of $21M,
$22M, $22M, $23M, and $24M.
Note that we still have the Interest issue to sort out, but we are done with
the Operating Model for now. Because the Interest figure is incorrect,
everything below that line is also incorrect and will change later on.
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Here is what the current version of your model may look like right now:
OperatingModel Year0 Year1 Year2 Year3 Year4 Year5 CAGR
Revenue 500 520 541 562 585 608 4.0%
%YoYgrowth 4.0% 4.0% 4.0% 4.0% 4.0%
EBITDA 100 107 114 121 129 137 6.5%
%sales 20.0% 20.5% 21.0% 21.5% 22.0% 22.5%
D&A (25) (26) (27) (28) (29) (30) 4.0%
%sales (5.0%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)
EBIT 75 81 87 93 99 106 7.3%
%sales 15.0% 15.5% 16.0% 16.5% 17.0% 17.5%
Interest Ͳ Ͳ Ͳ Ͳ Ͳ
EBT 81 87 93 99 106
Taxes (28) (30) (32) (35) (37)
%taxrate 35.0% 35.0% 35.0% 35.0% 35.0%
NetIncome 52 56 60 65 69
%sales 10.1% 10.4% 10.7% 11.1% 11.4%
NetWorkingCapital 75 78 81 84 88 91
%sales 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%
ChangeinNWC 3 3 3 3 4
Capex 20 21 22 22 23 24
%sales 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%
o Levered Cash Flow

Next is the Levered Cash Flow section, which pulls directly from the
Operating Model and feeds into the Debt Schedule. In this section we
calculate how much cash flow we will generate each year.
Levered Cash Flow can be calculated a number of ways, but the two main
ways are a) starting from EBITDA, and b) starting from Net Income.
x The “starting from EBITDA” methodology begins by pulling the
EBITDA line from the Operating Model, and subtracting from that
the following line items: Capex, Interest, Taxes, and any increases
in NWC.
x The “starting from Net Income” methodology begins by pulling the
Net Income line from the Operating Model, then adding back D&A,
then subtracting Capex and any increases in NWC.
The sum of these calculations will provide you with the Levered Cash Flow
for each year, which we will use in the Debt Schedule next. Note that
because Interest (and consequently Taxes and Net Income) are incorrect
in the Operating Model still, LCF will be incorrect as well until this is fixed.
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An Excel version of your Levered Cash Flow section may look like this:
LeveredCashFlow Year1 Year2 Year3 Year4 Year5
EBITDA 107 114 121 129 137
Less:Capex (21) (22) (22) (23) (24)
Less:Interest Ͳ Ͳ Ͳ Ͳ Ͳ
Less:Taxes (28) (30) (32) (35) (37)
Less:ChangeinNWC (3) (3) (3) (3) (4)
LeveredCashFlow 55 59 63 67 72
o Debt Schedule
The Debt Schedule is where we forecast the debt structure (and
consequently the Interest expenses) of ABC over time. We know that we
are going to buy the business with $500M of debt, but we also know that
we are going to generate cash during the hold period with which we can
pay down debt. We are going to pull information from the S&U,
Assumptions, and LCF sections, and will end up feeding information into
the Operating Model (which will flow back into the LCF section and the
Debt Schedule).
It is important to understand what your debt payback policy will be during
the hold period. Are you going to keep cash generated on the balance
sheet, or repay debt? If you are going to repay debt, which tranche will
you repay?
x The most common answer to this is to use all cash above the
minimum cash on your balance sheet to repay debt, and to start to
repay any revolvers or bank debt first. This is because revolvers
and bank debt usually do not have prepayment penalties, while
most notes and other forms of junior debt have a no-call period or a
call schedule that makes it expensive to prepay these debts early
on.
x Here we will assume excess cash flow will go to repaying Bank
Debt.
Within the Debt Schedule, you should start by building a four-line
infrastructure for each tranche of debt separately that includes Beginning
of Period (BOP) Balance, Interest, Paydown, and End of Period (EOP)
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Balance. You should also create a similar structure for Cash, Total Gross
Debt, and Total Net Debt.
Our Bank Debt uses a floating interest rate of L+300 bps, so we should
also insert a LIBOR line in our Debt Schedule that we can reference while
calculating our Interest payments.
x When populating the LIBOR line, you can use:
o The expected LIBOR forward curve (meaning LIBOR
changes over time based on current expectations), or
o The 5-year LIBOR forward swap rate for every year
(meaning LIBOR stays constant over time; implies you
hedge your floating rate position at the close of the deal).
o Here we do not have information about the LIBOR forward
curve, so we are simply going to use the swap rate.
First, let’s fill in the BOP numbers for Year 1 for each tranche. Pulling from
the S&U section above, we get $300M for Bank Debt, $200M for Senior
Notes, and $20M for Cash. The mechanics of our Total Gross Debt and
Total Net Debt should yield figures of $500M and $480M respectively.
Second, we need to calculate the Interest for each tranche.
x There are two ways of calculating Interest for each tranche. One is
to multiply the interest rate by the BOP figure, and the other is to
multiply the interest rate by the average of the BOP and EOP
figures. This second methodology will typically be more accurate,
but will create a circular reference. Circular references will slow
down your model, and to use them you must turn them on in Excel.
Here we will use the first methodology.
o To turn on circular references in Excel: press Alt, then t, then
o to open the Excel options menu, then go down to the
“Formula” submenu on the left, then check “Enable iterative
calculation” in the top right.
x To calculate the Interest for each tranche using the first
methodology, we multiply the BOP amount outstanding by the
interest rate.
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o For the Bank Debt, the rate will be the LIBOR in Year 1
(which we have swapped to the 5-year rate of 3%) plus the
spread (300 bps or 3%).
o For the Senior Notes, the interest rate will simply be the 12%
we have in the Assumptions section.
o For interest earned on cash, there are several things we can
do here. We do not have information in the prompt, so we
should make a “reasonable” assumption and be prepared to
justify it. We could assume this cash is required to run the
business so it is in use and will not earn an interest rate
(e.g., cash sitting in the register at retail locations). One
could also assume that this cash is in a bank account which
earns some “reasonable” rate. In this case, we are assuming
that this cash will be invested and earn LIBOR.
x These calculations give us the Interest for each tranche in Year 1.
For Bank Debt, this is $18M, for the Senior Notes it is $24M, for
Cash it is $1M, and the Total Gross Interest and Total Net Interest
equal $42M and $41M respectively.
Third, we need to calculate the amount of debt Paydown in each tranche.
x The cash flow available to pay down debt is the output of the
Levered Cash Flow section. Note that this information is not 100%
accurate yet because we have not linked the Operating Model to
our Debt Schedule, but we can still set up the mechanics now.
x Our debt policy is to maintain a minimum cash level of $20M, and
then with excess cash flow repay Bank Debt first, then Sr. Notes.
Thus, the mechanics of how to allocate the Levered Cash Flow
must follow this ‘waterfall’ structure.
x Crafting this ‘waterfall’ structure is a bit tricky if you have never
done it before, and it requires a lot of Excel logic.
o Cash logic: Our change in cash balance will simply be the
sum of the Levered Cash Flow and the Paydown of the Bank
Debt and the Senior Notes. The complexity of the waterfall
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will come through in our Bank Debt and Sr. Note Paydown
calculations.
The Excel manifestation of this: = LCF + Bank Debt
Paydown + Sr. Notes Paydown
o Bank Debt logic: If cash flow is negative, pay down zero
Bank Debt. If it is positive, use all LCF above what is needed
to make sure the Cash balance is in line with Min Cash to
pay down the Bank Debt until the balance is zero.
The Excel manifestation of this logic: =MIN(MAX(
-BOP Bank Debt, -LCF – (BOP Cash – Min Cash)),0)
The Excel logic here is such that if the Cash Balance
is less than Min Cash, the Bank Debt Paydown will
“claim” less than the full amount of the LCF, thereby
leaving some left to increase the cash balance.
o Senior Notes logic: Pay down Sr. Notes after the Bank Debt
is fully repaid with any LCF left over (after maintaining Cash
at Min Cash) until the balance is zero.
The Excel manifestation of this logic: =MIN(MAX(
-BOP Sr. Notes, -LCF – Bank Debt Paydown – (BOP
Cash – Min Cash)),0)
o Be sure to double-check your signs here, as they can be
tricky.
Next, we need to calculate the End of Period balance for each tranche.
This is simply the BOP balance minus any paydowns (or plus any
additions for Cash).
We now have the mechanics for Year 1 of the Debt Schedule. To roll this
forward, we then link the Year 2 BOP balances for each tranche to the
Year 1 EOP balance, and then copy the remainder of the formulas to the
right. Make sure references to static assumptions (e.g., Min. Cash,
Interest Rates, etc.) are locked when you copy your formulas over. Repeat
until we have the Debt Schedule mechanics built for Years 1-5.
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Note that we now have the mechanics built correctly, but we do not have
the right figures because we have not linked the Interest to the Operating
Model and LCF. Your Excel model may look like this:
DebtSchedule Year1 Year2 Year3 Year4 Year5
LIBOR 3.0% 3.0% 3.0% 3.0% 3.0%
Cash
BOP 20 20 20 20 20
Interest 1 1 1 1 1
Changeincash Ͳ Ͳ Ͳ Ͳ Ͳ
EOP 20 20 20 20 20
BankDebt
BOP 300 245 187 124 57
Interest (18) (15) (11) (7) (3)
Paydown (55) (59) (63) (67) (57)
EOP 245 187 124 57 Ͳ
Sr.Notes
BOP 200 200 200 200 200
Interest (24) (24) (24) (24) (24)
Paydown Ͳ Ͳ Ͳ Ͳ (15)
EOP 200 200 200 200 185
TotalGrossDebt
BOP 500 445 387 324 257
Interest (42) (39) (35) (31) (27)
Paydown (55) (59) (63) (67) (72)
EOP 445 387 324 257 185
TotalNetDebt
BOP 480 425 367 304 237
Interest (41) (38) (35) (31) (27)
Paydown (55) (59) (63) (67) (72)
EOP 425 367 304 237 165
Memo:NetLeverage 4.0x 3.2x 2.5x 1.8x 1.2x

Memo:InterestCoverage 2.6x 3.0x 3.5x 4.2x 5.1x
o The last step remaining is to build the final link between the three sections of our
projections. So far we have been excluding the Interest expense from our
Operating Model (and thus our LCF) because we did not have the correct
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numbers. Now, we can link the Interest expense line from the Operating Model to
the Total Net Debt Interest numbers. This will lower your EBT, Taxes, Net
Income, and Levered Cash Flow, which will also reduce your debt paydown.
An Excel output of your final Operating Model, Levered Cash Flow, and
Debt Schedule may look like the following:
OperatingModel Year0 Year1 Year2 Year3 Year4 Year5 CAGR
Revenue 500 520 541 562 585 608 4.0%
%YoYgrowth 4.0% 4.0% 4.0% 4.0% 4.0%
EBITDA 100 107 114 121 129 137 6.5%
%sales 20.0% 20.5% 21.0% 21.5% 22.0% 22.5%
D&A (25) (26) (27) (28) (29) (30) 4.0%
%sales (5.0%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)
EBIT 75 81 87 93 99 106 7.3%
%sales 15.0% 15.5% 16.0% 16.5% 17.0% 17.5%
Interest (41) (40) (38) (35) (33)
EBT 39 47 55 64 74
Taxes (14) (16) (19) (22) (26)
%taxrate 35.0% 35.0% 35.0% 35.0% 35.0%
NetIncome 25 30 36 42 48
%sales 4.9% 5.6% 6.4% 7.1% 7.9%
NetWorkingCapital 75 78 81 84 88 91
%sales 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%
ChangeinNWC 3 3 3 3 4
Capex 20 21 22 22 23 24
%sales 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%
LeveredCashFlow Year1 Year2 Year3 Year4 Year5

EBITDA 107 114 121 129 137
Less:Capex (21) (22) (22) (23) (24)
Less:Interest (41) (40) (38) (35) (33)
Less:Taxes (14) (16) (19) (22) (26)
Less:ChangeinNWC (3) (3) (3) (3) (4)
LeveredCashFlow 28 33 38 44 50
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DebtSchedule Year1 Year2 Year3 Year4 Year5
LIBOR 3.0% 3.0% 3.0% 3.0% 3.0%
Cash
BOP 20 20 20 20 20
Interest 1 1 1 1 1
Changeincash Ͳ Ͳ Ͳ Ͳ Ͳ
EOP 20 20 20 20 20
BankDebt
BOP 300 272 240 201 157
Interest (18) (16) (14) (12) (9)
Paydown (28) (33) (38) (44) (50)
EOP 272 240 201 157 107
Sr.Notes
BOP 200 200 200 200 200
Interest (24) (24) (24) (24) (24)
Paydown Ͳ Ͳ Ͳ Ͳ Ͳ
EOP 200 200 200 200 200
TotalGrossDebt
BOP 500 472 440 401 357
Interest (42) (40) (38) (36) (33)
Paydown (28) (33) (38) (44) (50)
EOP 472 440 401 357 307
TotalNetDebt
BOP 480 452 420 381 337
Interest (41) (40) (38) (35) (33)
Paydown (28) (33) (38) (44) (50)
EOP 452 420 381 337 287
Memo:NetLeverage 4.2x 3.7x 3.2x 2.6x 2.1x

Memo:InterestCoverage 2.6x 2.9x 3.2x 3.6x 4.2x
We now have the Sources and Uses to understand the Deal Entry, as well as the important
Forecasted Financials during the hold period. The last step is to model the Deal Exit.
- Deal Exit
o Modeling the Exit is similar to what was done in the Paper LBO, though this time
there is an additional wrinkle of management options to take into account.
o First, we know LTM EBITDA at exit will be $137M as we calculated in the
Operating Model above. We also know from our assumptions that we expect to
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exit at 8.5x LTM EBITDA. Multiplying these together gives us a TEV of $1,163M
at exit.
o At exit we have $287M of net debt (as per the EOP Net Debt balance in our Debt
Schedule). We can subtract this from the TEV for a total Equity value of $876M.
o At this point, we need to take into account management options, which are to be
5% of the company. There will be two steps to this calculation: the cash
management puts in to exercise its options, and the equity value it receives for
these options.
Note that there are two ways to interpret the 5% figure. One is that
management will own 5% of the company after they exercise the options.
The second is that they are given options that are equivalent to 5% of the
pre-exercise shares outstanding (e.g., they have 5M in options while the
sponsor has 100M shares, so after they exercise management will own
5/105 of the company). Here we are using the second treatment, but
simply be conscious of which you are using.
When management exercises its options, it will pay cash into the company
of the strike price times the number of options struck.
x This will only occur if the equity value is above the strike price,
otherwise management will not exercise its options.
x Though option packages can vary, typically the strike price for
management is equal to the price of equity at entry.
x To calculate this figure, we use the following logic: =IF(Exit Equity
Value>Sponsor Entry Equity in S&U, Management Options
%*Sponsor Entry Equity in S&U, 0). This value should be $19M in
this case.
Next we need to calculate the value management will get from the options
it just exercised.
x The value of the equity after the options are exercised is the Equity
from above ($876M) plus the cash management just put in ($19M).
x Because we are using the second methodology mentioned above,
management’s share of this value is just below 5% (equal to 5/105).
x To calculate this figure, we use the following logic: =IF(Cash from
Management Options>0,-(Management Options %
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/(1+Management Options %))*SUM(Exit Equity Value Pre-Options,
Cash from Management Options), 0). This value should be $43M
here.
o To calculate Sponsor Equity Value at Exit, we take total pre-options Equity value
($876M), add Cash from Management Options ($19M), and subtract Equity
Value to Management Options ($43M). This gives us an Exit Equity Value of
$852M.
o The Exit Calculation of your Excel model may look like this:
ExitCalculation
LTMEBITDAatExit 137
ExitMultiple 8.5x
TEV 1,163
Less:NetDebt (287)
EquityValue 876
Plus:Cashfrommgmtoptions 19
Less:Equitytomgmtoptions (43)
SponsorEquityValue 852
Now that we have modeled the deal exit, we can calculate the MOIC and IRR of the deal, as
well as generate any necessary sensitivity tables that will be useful in helping us craft our
recommendation.
- Calculating MOIC and IRR are the same as they were in the Paper LBO. Calculate MOIC
by dividing the Sponsor Equity at Exit by Sponsor Equity at Entry, yielding a 2.3x MOIC
here. Then, given the five-year time horizon, calculate IRR as MOIC ^ (1/5) – 1. In this
case, IRR is 18.2%.
- Before we make our recommendation, we may want to do a few sensitivity tables.
o Most sensitivity tables in LBO models use IRR as the dependent variable.
o There are many combinations of tables you can do, but the most common
include:
Entry Price / Multiple / Premium vs. Exit Multiple
Entry Price / Multiple / Premium vs. Leverage
Entry Price / Multiple / Premium vs. Key Operating Driver (e.g., Revenue
Growth, EBITDA margin, Synergies)
Key Operating Driver 1 vs. Key Operating Driver 2 (e.g., Revenue Growth
vs. EBITDA margin)
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o Here we’ve included Entry Price vs. Exit Multiple and Entry Price vs. Revenue
Growth:
PricePaidvs.ExitMultiple
7.5x 7.8x 8.0x 8.3x 8.5x 8.8x 9.0x 9.3x 9.5x ImpliedEntryMultiple(xEBITDA)
$22.00 $23.00 $24.00 $25.00 $26.00 $27.00 $28.00 $29.00 $30.00 StockPrice
18.2% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% Premium
7.0x 15.4% 13.7% 12.2% 10.7% 9.4% 8.2% 7.1% 6.0% 5.0%
7.5x 17.6% 15.9% 14.3% 12.9% 11.5% 10.3% 9.1% 8.0% 7.0%
8.0x 19.7% 17.9% 16.3% 14.8% 13.5% 12.2% 11.0% 9.9% 8.8%
8.5x 21.6% 19.8% 18.2% 16.7% 15.3% 14.0% 12.8% 11.6% 10.6%
9.0x 23.4% 21.6% 19.9% 18.4% 17.0% 15.7% 14.4% 13.3% 12.2%
9.5x 25.1% 23.3% 21.6% 20.0% 18.6% 17.3% 16.0% 14.8% 13.7%
10.0x 26.7% 24.9% 23.1% 21.6% 20.1% 18.8% 17.5% 16.3% 15.2%
ExitMultiple(xEBITDA)
PricePaidvs.RevenueGrowth
7.5x 7.8x 8.0x 8.3x 8.5x 8.8x 9.0x 9.3x 9.5x ImpliedEntryMultiple(xEBITDA)
$22.00 $23.00 $24.00 $25.00 $26.00 $27.00 $28.00 $29.00 $30.00 StockPrice
18.2% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% Premium
2.0% 18.1% 16.4% 14.8% 13.4% 12.0% 10.8% 9.6% 8.5% 7.5%
2.5% 19.0% 17.3% 15.7% 14.2% 12.9% 11.6% 10.4% 9.3% 8.3%
3.0% 19.9% 18.1% 16.5% 15.0% 13.7% 12.4% 11.2% 10.1% 9.0%
3.5% 20.7% 19.0% 17.3% 15.9% 14.5% 13.2% 12.0% 10.9% 9.8%
4.0% 21.6% 19.8% 18.2% 16.7% 15.3% 14.0% 12.8% 11.6% 10.6%
4.5% 22.4% 20.6% 19.0% 17.5% 16.1% 14.8% 13.5% 12.4% 11.3%
5.0% 23.2% 21.4% 19.8% 18.3% 16.8% 15.5% 14.3% 13.2% 12.1%
5.5% 24.1% 22.2% 20.6% 19.0% 17.6% 16.3% 15.1% 13.9% 12.8%
6.0% 24.9% 23.0% 21.4% 19.8% 18.4% 17.0% 15.8% 14.6% 13.5%
RevenueGrowth
Finally, we have built our Basic LBO model and can make our recommendation. A response
might be: “The proposed buyout of ABC does not look particularly compelling at the moment,
but it may be worth spending more time understanding the opportunity. The preliminary figures
suggest the deal at a 20% premium to the current stock price would yield a 2.3x MOIC and an
18% IRR, which is not terribly enticing. This includes giving management full credit for their
plan, which could prove to be optimistic. That said, if the stock drops another 10%, or we
believe we could sell it for 9.5x EBITDA, or that we could grow revenues at 5.5%, the IRR on
this deal would reach the low-20% range which would be interesting. We should also think
about how risky this asset is, and what the potential is for upsides and downsides to this base
case. If ABC is particularly stable, a high-teens IRR would be more palatable. Likewise, if we
think there are big upsides with limited downsides, this may prove to be an attractive
opportunity yet. However, if further work does not improve the profile of this deal, I would
recommend that we pass on the opportunity.”
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Watch The Basic LBO Get Built with Play by Play
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THE FULL (3-HOUR) LBO
Full LBO Example 1.xlsx”.
The Full (3-Hour) LBO test is one some firms give in their final round interviews. Like the Basic
LBO, this is designed to test both your knowledge of the mechanics of the LBO as well as your
modeling capabilities. It also serves as a good screening mechanism to separate those who
have really done their homework (presumably those who are truly interested in PE) from those
who have not.
The good news is that the Full LBO test is actually not that different from the Basic LBO; you
still need to model Deal Entry, the Operating Model, and Deal Exit. However, the Full LBO
demands that you produce a forecast of the three financial statements, and it will often have
more nuances to model.
With regards to these nuances, we will cover a number of them in our examples, but there are
infinite variations that can be thrown at you in an actual test. It is possible to build a model that
is so flexible that it can handle almost all of the permutations that you could possibly expect,
but given the limited amount of time you will have we recommend including only the relevant
bells and whistles and refrain from building flexibility into your model that is not necessary
given the prompt.
The prompt here will necessarily be more complicated and give more information than in the
Paper or Basic LBO test. It may include specific directions as to the nuances to include in the
model and the kinds of outputs necessary, or it may be silent on those issues and force you to
infer what is needed. As always, rely on your business intuition when there is less information
than you would like, as the interviewers care just as much about that as they do about your
modeling capabilities.
Full LBO Example

You receive the following prompt:
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“Company XYZ has hired Bank DEF to contact several potential financial buyers about the
prospect of doing an LBO on the company. While the rest of the market was up 15% on the
year, XYZ’s stock price had stagnated at $25/share despite management’s announcement of a
new $100M plant that would enable it to grow over for the next decade.
“DEF sent all potential investors a CIM which included a detailed description of XYZ’s business
and operations, as well as its historical financials and management projections. The following
Exhibits are copied from the CIM:
OperatingModel LTM BalanceSheet
Assets Liabilities
Volume 200
Cash 100 AccountsPayable 150
Price $5.00 Inventory 100 OtherCurrentLiabilities 100
Revenue 1,000 AccountsReceivable 150 CurrentPortionofLTDebt Ͳ
OtherCurrentAssets 50 TotalCurrentLiabilities 250
TotalCurrentAssets 400
COGS/Unit $3.00 LongͲTermDebt 450
COGS (600) Property,Plant&Equipment OtherLiabilities Ͳ
GrossProfit 400 GrossPP&E 700 TotalLiabilities 700
AccumulatedDepreciation (250)
NetPP&E 450 Equity
SG&A (200) PaidͲinCapital 50
EBITDA 200 CapitalinExcessofParValue 50
Goodwill Ͳ RetainedEarnings/(Losses) 50
OtherAssets Ͳ TotalEquity 150
D&A (25)
EBIT 175 TotalAssets 850 TotalLiabilities&Equity 850
ManagementCase
Year1 Year2 Year3 Year4 Year5 Year6 Year7
VolumeGrowth 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
PriceGrowth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
COGS/UnitGrowth 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5%
SG&AGrowth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
MaintenanceCapex (25) (25) (25) (25) (25) (25) (25)
PlantCapex (75) (25) Ͳ Ͳ Ͳ Ͳ Ͳ
LIBOR 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
MaintenanceDepreciation (25) (25) (25) (25) (25) (25) (25)
InventoryDays 60 60 60 60 60 60 60
A/RDays 55 55 55 55 55 55 55
OtherCurrentAssets%Sales 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
A/PDays 90 90 90 90 90 90 90
OtherCurrentLiabilities%Sales 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%
“In addition to the historical financials and management projections, DEF also sent along a
proposed staple financing package (with an unfunded Revolver at close), as well as details
about the employee stock options outstanding at XYZ.
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StapleCapitalStructure
Origination
Amount Cost Price Other Term Fees
Revolver $100 L+250 100 50 bps 7 2.0%
TermLoan $600 L+300 99 N/A 7 2.0%
PIKNotes $450 12.0% 100 14.0% 7 2.0%
EmployeeStockOptions
#(millions) Strike
CommonStockOutstanding 25.0 NM
OptionTraunche1 2.0 $10.00
“Having talked to the bankers at DEF, the MD believes that the above capital structure is likely
the best we can do in the market, but the capital structure must have a minimum of 30% equity
at entry. The bankers have also signaled that there would be heavy call protections on the PIK
notes in the current market and thus won’t be repaid early. The MD believes this deal could
potentially get done at a 25% premium to today’s $25 share price, and that to do the
transaction would require $25M in advisory fees.
“The MD also believes that given the size and brand name of XYZ the most likely exit path is
via IPO. The plan would likely be to IPO 15% of the company in Year 4 of the deal and use the
cash proceeds to pay down debt, and then to sell a third of our stake each year for the next
three years. IPO underwriting costs would be 7%, and the IPO discount on shares would likely
be 15%; in secondary sales of our shares to the market in Years 5, 6, and 7 there would likely
be a 5% discount to ‘fair value’. The MD believes a ‘fair value’ exit multiple for this business
would be 7x EBITDA.
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“We have been impressed by management, and would want to give them an options pool of
5% to keep them around. They would be precluded from selling shares in the initial IPO, but
after a 1-year lockup they could exercise their options in Year 5.
“In talking to management, a number of relevant facts about XYZ came to light. The minimum
cash in the business is $25M, and the company earns 1% on its cash balance. The effective
tax rate for XYZ is 40%, and there are no NOLs in the business. The new plant that is being
built will be ¾ completed in Year 1, with the remainder finishing in Year 2; the depreciable life
of the plant is 10 years.
“After reviewing the CIM and discussing the business with management, you have generated
the following Upside and Downside cases to go along with case provided by Management:
UpsideCase
VolumeGrowth 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5%
PriceGrowth 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
COGS/UnitGrowth 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
SG&AGrowth 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
LIBOR 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
InventoryDays 50 50 50 50 50 50 50
A/RDays 50 50 50 50 50 50 50
A/PDays 100 100 100 100 100 100 100
DownsideCase
VolumeGrowth 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
PriceGrowth 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
COGS/UnitGrowth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
SG&AGrowth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
LIBOR 0.5% 0.5% 0.5% 1.0% 1.5% 2.0% 2.5%
InventoryDays 60 60 60 60 60 60 60
A/RDays 60 60 60 60 60 60 60
A/PDays 80 80 80 80 80 80 80
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“Build a Full LBO model, complete with Income Statement, Balance Sheet, and Cash Flow
statement. Would you recommend we pursue this deal at the price the MD expects is
necessary? What is the highest price you would be willing to pay to buy XYZ? Justify your
answers with your reasoning.”
That may seem like a lot of information to take in and process in just three hours, but it is quite
manageable. As always, it’s useful to start by building an Assumptions section which can
capture all of the data from the prompt. Here’s an example assumptions section (note the FD
Shares must be calculated, which we will cover shortly):
Assumptions
Entry CapitalStructure Origination

StockPrice $25.00 Amount Cost Price Other Term Fees
Premium 25.0% Revolver $100 L+250 100 50 bps 7 2.0%
BidPrice $31.25 TermLoan $600 L+300 99 N/A 7 2.0%
FDShares 30.6 PIKNotes $450 12.0% 100 14.0% 7 2.0%
CashtoEquityHolders $955.0
ExistingNetDebt $350.0 MinEquity 30.0%
TEV(incl.premium) $1,305.0
Other
Minimumcash 25 TaxRate 40.0%
AdvisoryFees 25 CashInterest 1.0%
PlantDepr.Life 10
Exit
IPOunderwritingcosts 7.0% Year StakeSold Discount
ExitMultiple 7.0x IPO 4 15.0%
%IPOed 15.0% Secondary1 5 33.3% 5.0%
MgmtOptions 5.0% Secondary2 6 33.3% 5.0%
MgmtExerciseYear 5 Secondary3 7 33.3% 5.0%
From here, the steps are largely the same as they were in the Basic LBO, with a few added
wrinkles and the additional output of the three financial statements. Let’s start like we always
do: after we complete the Assumptions section, we then move onto the entry calculation.
- Deal Entry
o Entry is a bit more complicated here than in previous examples. In addition to the
mechanics outlined in the Basic LBO structure, we must also calculate the Fully
Diluted Shares Outstanding, model our Sources and Uses with Min Equity and
OID (Original Issue Discount), and generate a Post-Transaction Balance Sheet.
o Fully Diluted Shares Outstanding Calculation
In this situation, there are significant employee stock options that are
outstanding which will be accelerated in the event of an LBO. In order to
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calculate the true cash that will go buy the shares of XYZ, we will need to
take these options into account.
To do this, we can take the schedule given in the prompt and add a few
columns to do our calculation. First, we must determine how many options
will be struck at a given price. To do this, we add a “Shares Issued”
column which contains the following logic: IF(Deal Share Price > Strike
Price, # of Options, 0).
Next we need to calculate the cash proceeds we will receive from the
options being exercised. To do this we simply add a “Cash Proceeds”
column and multiply the Strike Price by the Shares Issued.
We then can make an assumption that we use the Cash Proceeds to
repurchase shares that were issued at the Deal Share Price (thus
reducing the number of Fully Diluted Shares Outstanding). We do this by
adding a “Shares Repurchased” column which amounts to the Cash
Proceeds divided by the Deal Share Price.
x Note this is equivalent to simply adding this cash as a source of
funds for the deal to repurchase the higher number of shares, but
this assumption simplifies our Sources and Uses, etc.
Finally, we calculate the Net FD Shares by taking the Shares Issued
minus the Shares Repurchased. Adding this total to the Common Stock
Outstanding will give you the Fully Diluted Shares needed to model our
Entry.
Your Excel model may look like this:
FDShareCalculation
Shares
Shares Cash Repurchas NetFD
#(millions) Strike Issued Proceeds ed Shares
CommonStockOutstanding 25.0 NM NM NM NM 25.0
OptionTraunche1 2.0 $10.00 2.0 $20.0 0.6 1.4
OptionTraunche2 3.0 $15.00 3.0 $45.0 1.4 1.6
OptionTraunche3 4.0 $20.00 4.0 $80.0 2.6 1.4
OptionTraunche4 5.0 $25.00 5.0 $125.0 4.0 1.0
OptionTraunche5 5.0 $30.00 5.0 $150.0 4.8 0.2
OptionTraunche6 6.0 $35.00 Ͳ $0.0 Ͳ Ͳ
TotalFullyDilutedShares@BidPrice 30.6
o Next we can fill in our Sources and Uses. This is similar to the Basic LBO.
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Uses
x Cash to Equity Holders is $955 (Current Share Price * (1 +
Premium) * FD Shares).
x Existing Debt is $450M (from Pre-Deal Balance Sheet).
o Note here we’re using Gross Debt. As you recall, this means
we will use the Cash currently on the Balance Sheet as a
Source. An alternative route is to just use Net Debt here and
not have Cash as a Source.
x Minimum Cash is $25M.
x Advisory Fees are $25M.
x Financing Fees are $21M (total of Origination Fees * Face Value of
each tranche of debt).
o Given that these fees depend on the amount of debt raised
and the amount of debt raised depends on the Uses of cash
and Min. Equity, this can create a circular reference.
x OID is $6M (total of (100 – Price at Issue) / 100 * Face Value of
each tranche of debt).
Sources
x Cash currently on the Balance Sheet is $100M.
x Revolver is $0M as it is unfunded at close.
x Term Loan is $600M.
x Here things get a bit tricky. We know we could get up to $450M of
PIK Notes, but we also know we need at least 30% Equity in the
deal. Thus, we need to build the following logic:
o Equity = Max(Total Uses of Capital – sum(Cash on B/S,
Term Loan Face Value, PIK Notes Face Value From Staple),
Min Equity * Total Uses).
o PIK Notes will be the plug for the Sources (Total Uses –
Cash on B/S – Term Loan – Equity).
o The result is that when the price is low enough that raising
the maximum amount of PIK would put Equity below the
30% threshold, the Equity Value will be set at 30% and the
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PIK will be reduced. In the situation where the price is high
enough to keep the Equity Value above the threshold with
the full amount of PIK raised, we will raise the entire $450M
of PIK.
The S&U section of your model may look like this:
SourcesandUses
Sources Uses
Amount xEBITDA %Capital Amount xEBITDA %Capital
ExistingCashonB/S 100 0.5x 6.7% MinimumCash 25 0.1x 1.7%
Debt Exist.DebtRetirement 450 2.3x 30.4%

Revolver Ͳ 0.0x 0.0% Exist.EquityPayment 955 4.8x 64.5%
TermLoan $600 3.0x 40.5%
PIKNotes 337 1.7x 22.8% AdvisoryFees 25 0.1x 1.7%
FinancingFees 21 0.1x 1.4%
SponsorEquity 445 2.2x 30.0% OID 6 0.0x 0.4%
TotalSources 1,482 7.4x 100.0% TotalUses 1,482 7.4x 100.0%
o The last thing we must do to model our Entry is to adjust the Balance Sheet for
the deal. This will give us the starting point for projecting the Balance Sheet
going forward.
To build this section, we will need to add two more columns to the existing
Balance Sheet – one for transaction adjustments and one for the Post-
Transaction totals.
Adjustments
x Cash will be adjusted down by $75M (the net of $100M of B/S cash
in Sources and the $25M min cash in Uses) to the $25M minimum
cash.
x Capitalized Financing Fees are equal to $21M (calculated in the
S&U).
x Goodwill will be generated in the transaction as we would be paying
more than the book value for the firm. It will essentially serve as a
plug to make the Balance Sheet balance.
x Pre-LBO Debt will be paid off, so it’ll be adjusted down $450M to
$0M.
x The Term Loan and PIK notes will be adjusted upward in the
transaction. It is important to note that the value on the Balance
Sheet is the Face Value minus the OID (which will be amortized
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over time). Here, the Term Loan is adjusted up to $594M and the
PIK Notes are up to $337M.
x Paid In Capital is adjusted up to the value of Sponsor Equity
($445M), while Capital in Excess of Par Value is adjusted to $0M.
o This assumes we reset the Par Value of Shares such that all
of our equity goes to Paid In Capital. This does not have to
happen; we can allocate value between PIC and CEPV
however we want, but the total should equal the Sponsor
Equity value.
x Retained Earnings is adjusted to zero out the balance (down
$50M), and then adjusted down again by the amount of the tax-
affected advisory fees ($25M * (1 – 40% tax rate)).
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Your Excel model may look like this:
TransactionBalanceSheetAccounting
BalanceSheet Year0(PreͲTransaction) TransactionAdjustments Year0(PostͲTransaction)

Assets
Cash 100 (75) 25
Inventory 100 Ͳ 100
AccountsReceivable 150 Ͳ 150
OtherCurrentAssets 50 Ͳ 50
TotalCurrentAssets 400 (75) 325
GrossPP&E 700 Ͳ 700

AccumulatedDepreciation (250) Ͳ (250)
NetPP&E 450 Ͳ 450
Goodwill Ͳ 815 815

CapitalizedFinancingFees Ͳ 21 21
OtherAssets Ͳ Ͳ Ͳ
TotalAssets 850 761 1,611
Liabilities
AccountsPayable 150 Ͳ 150
OtherCurrentLiabilities 100 Ͳ 100
CurrentPortionofLTDebt Ͳ Ͳ Ͳ
TotalCurrentLiabilities 250 Ͳ 250
PreͲLBODebt 450 (450) Ͳ

Revolver Ͳ Ͳ Ͳ
TermLoan Ͳ 594 594
PIKNotes Ͳ 337 337
OtherLiabilities Ͳ Ͳ Ͳ
TotalLiabilities 700 481 1,181
Equity
PaidͲinCapital 50 395 445
CapitalinExcessofParValue 50 (50) Ͳ
RetainedEarnings/(Losses) 50 (65) (15)
TotalEquity 150 280 430
TotalLiabilities&Equity 850 761 1,611
We have now completed the Entry section of our Full LBO Model. Next we need to project the
operations during the hold period. This will be similar to the Basic model again, with the extra
wrinkles of using cases to project operations, modeling a more nuanced Debt Schedule, and
more detailed D&A / NWC calculations.
o Operating Model (with cases)
We can start by building the Operating Model from Revenue down to Net
Income, just like we did in the Basic LBO.
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x Again, the interest number will not be correct until we finish the
Debt Schedule. Similarly, the D&A figure will not be correct until we
finish the Depreciation and Amortization Schedule.
The easiest way to add cases is to create a section that summarizes all of
the operating drivers (e.g., volume growth, SG&A growth, etc.) for each of
the cases in one place. Then, build the operating model to use these
drivers as inputs. Next, at the very top of your model create a cell where
you can input which case you want to use numerically (1, 2, or 3 in this
case). Finally, use the “CHOOSE” function in Excel which references the
case input cell as well as the corresponding drivers from each of the
cases.
x For example, we know that in Year 0, Volume was 200. To get
Volume in Year 1, we would use the following logic: =Volume Year
0 * (1 + CHOOSE(Case Input Cell, Vol. Y1 Growth Mgmt Case, Vol.
Y1 Growth Upside Case, Vol. Y1 Growth Downside Case)).
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Your Operating Model may look like this:
OperatingModel
Year0 Year1 Year2 Year3 Year4 Year5 Year6 Year7
Volume 200 206 212 219 225 232 239 246

Price $5.00 $5.10 $5.20 $5.31 $5.41 $5.52 $5.63 $5.74
Revenue 1,000 1,051 1,104 1,160 1,218 1,280 1,345 1,413
YoYGrowth 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1%
COGS/Unit $3.00 $3.08 $3.15 $3.23 $3.31 $3.39 $3.48 $3.57

COGS (600) (633) (669) (706) (745) (787) (831) (877)
%Margin (60.0%) (60.3%) (60.6%) (60.9%) (61.2%) (61.5%) (61.8%) (62.1%)
GrossProfit 400 417 435 454 473 493 514 536

%Margin 40.0% 39.7% 39.4% 39.1% 38.8% 38.5% 38.2% 37.9%
SG&A (200) (204) (208) (212) (216) (221) (225) (230)

%Growth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
%Margin (20.0%) (19.4%) (18.9%) (18.3%) (17.8%) (17.3%) (16.7%) (16.3%)
EBITDA 200 213 227 241 256 272 289 306

%Growth 6.6% 6.5% 6.3% 6.2% 6.1% 6.1% 6.0%
%Margin 20.0% 20.3% 20.6% 20.8% 21.0% 21.3% 21.5% 21.6%
D&A Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
%Margin 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
EBIT 200 213 227 241 256 272 289 306

%Margin 20.0% 20.3% 20.6% 20.8% 21.0% 21.3% 21.5% 21.6%
Interest Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
EBT 213 227 241 256 272 289 306
Taxes (85) (91) (97) (103) (109) (115) (122)
NetIncome 128 136 145 154 163 173 184
%Margin 12.2% 12.3% 12.5% 12.6% 12.8% 12.9% 13.0%
o Depreciation and Amortization Schedule

In this example we will have to calculate D&A in a schedule rather than
simply relying on a single driver like percentage of sales. In Basic and Full
LBO tests, they may ask you to build somewhat complex D&A schedules;
here we will do a simple one that is generalizable to other situations as
well.
Based on our prompt, we see that it appears that there are two types of
capex and corresponding depreciation: maintenance of the ongoing
business and that for the new plant being built. Maintenance depreciation
here is easy: we see that it is $25M each year (which aligns with
Maintenance Capex).
Plant Depreciation can be calculated as follows:
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x Start with three lines: Plant Gross PP&E (BOP), Plant Capex, and
Plant Gross PP&E (EOP).
o Year 1 Plant Gross PP&E (BOP) + Year 1 Plant Capex =
Year 1 Plant Gross PP&E (EOP); Year 2 Plant Gross PP&E
(BOP) = Year 1 Plant Gross PP&E (EOP).
o We know that Year 1 Plant Gross PP&E (BOP) is zero (plant
construction hasn’t started yet), and Year 1 & 2 Plant Capex
is in our cases. From this we can populate these rows.
x Next, we add rows for Plant Depr (Year 1 Capex) and Plant Depr
(Year 2 Capex), which will create our depreciation waterfall. These
lines represent the amount of depreciation that comes from the
capex spent in Year 1 and Year 2 respectively.
o We know from our prompt that the depreciable life of the
plant is 10 years, and we can assume straight-line
depreciation. Thus, for the $75M spent in Year 1 in the
management case there will be $7.5M of depreciation each
year (until fully depreciated), and for the $25M in Year 2 the
number will be $2.5M.
o If we assume that the capex is spent evenly throughout the
year and begins depreciating as soon as it is spent, in Year
1 the depreciation on the $75M in spent that year will be
$3.75M ($75M / 10 / 2), and for Year 2 the depreciation on
the $25M spent in that year will be $1.25M.
x Total Plant Depreciation is the sum of the two rows of the waterfall.
Finally, we can calculate the amortization of the Capitalized Financing
Fees.
x In the prompt, we see that we spend $21M in financing fees. These
will be amortized over the life of the corresponding loans.
o To make our lives easy in this example, all of the loans have
the same length so we can lump them all together rather
than breaking each loan out individually.
Normally more senior debt will have shorter maturities
than more junior debt, so you would need to break out
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the fees of each individually and amortize each at
different rates.
x Here it is rather simple – the $21M of fees is amortized on a
straight-line basis over 7 years, yielding $3M in amortization each
year.
Now that we’ve finished modeling the components of D&A, we can
calculate the total D&A (Maintenance Depreciation + Plant Depreciation +
Capitalized Financing Fees Amortization), which we can link back to our
Operating Model.
Your D&A schedule may look like this:
DepreciationandAmortizationSchedule Year1 Year2 Year3 Year4 Year5 Year6 Year7
PlantDepreciation
PlantGrossPP&E(BOP) Ͳ 75 100 100 100 100 100
PlantCapex 75 25 Ͳ Ͳ Ͳ Ͳ Ͳ
PlantGrossPP&E(EOP) 75 100 100 100 100 100 100
PlantDepr(Year1Capex) (4) (8) (8) (8) (8) (8) (8)
PlantDepr(Year2Capex) (1) (3) (3) (3) (3) (3)
TotalPlantDepr (4) (9) (10) (10) (10) (10) (10)
PlantAccum.Depr (4) (13) (23) (33) (43) (53) (63)
PlantNetPP&E(EOP) 71 88 78 68 58 48 38
CapitalizedFinancingFees
BOPBalance 21 18 15 12 9 6 3
Amortization (3) (3) (3) (3) (3) (3) (3)
EOPBalance 18 15 12 9 6 3 0
TotalD&A (32) (37) (38) (38) (38) (38) (38)
o NWC Calculation
In this prompt, we were given Net Working Capital assumptions based on
days of A/R, A/P, and Inventory, as well as % sales for other current
assets and liabilities rather than based on a single driver of NWC. Thus,
we have to do a little extra work to get to the annual change in NWC.
Accounts Receivable = Days Receivable / 365 * Revenue.
Accounts Payable = Days Payable / 365 * COGS.
Inventory = Days Inventory / 365 * COGS.
Other Current Assets and Liabilities = % sales * Revenue.
Just as before, NWC = A/R + Inv + OCA – A/P – OCL.
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Your NWC calculation may look like this:
NWCCalculation Year0 Year1 Year2 Year3 Year4 Year5 Year6 Year7
Inventory 100 104 110 116 123 129 137 144

InventoryDays 61 60 60 60 60 60 60 60
AccountsReceivable 150 158 166 175 184 193 203 213
A/RDays 55 55 55 55 55 55 55 55
OtherCurrentAssets 50 53 55 58 61 64 67 71
%Sales 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
AccountsPayable 150 156 165 174 184 194 205 216
A/PDays 91 90 90 90 90 90 90 90
OtherCurrentLiabilities 100 105 110 116 122 128 134 141
%Sales 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%
NetWorkingCapital 50 54 56 59 61 64 67 70
%Sales 5.0% 5.4% 5.6% 5.9% 6.1% 6.4% 6.7% 7.0%
ChangeinNWC 4 2 3 3 3 3 3
o Levered Cash Flow

This will be set up very similar to the way it was done in the Basic LBO.
LCF = EBITDA – Capex – Cash Interest – Taxes – Increase in NWC.
x Again, the interest figures will be incorrect for the time being until
we complete the Debt Schedule (and, this time, the IPO and
management options calculations).
This time we will also add a line which will be “Plus: CF from Stock
Issuance”.
x This will capture the cash generated from the IPO and the
exercising of management stock options. We will use this cash to
repay debt.
The sum of LCF plus CF from Stock Issuance will be the FCF Available for
Debt Paydown, which we will pull into our Debt Schedule.
Your LCF Schedule may look like this:
LeveredFreeCashFlow Year1 Year2 Year3 Year4 Year5 Year6 Year7
EBITDA 213 227 241 256 272 289 306

LessCapex (100) (50) (25) (25) (25) (25) (25)
LessCashInterest Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
LessTaxes (48) (52) (58) (67) (76) (85) (92)
LessIncreaseinNWC (4) (2) (3) (3) (3) (3) (3)
LeveredFCF 62 123 155 162 168 176 186
Plus:CFFromStockIssuance Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
FCFAvailableforDebtPaydown 62 123 155 162 168 176 186
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o Debt Schedule
The fundamentals of this debt schedule are similar to what was done in
the Basic LBO, but there are a few additional wrinkles here.
x One thing we are going to do in this case is use the average of the
beginning of period balance and the end of period balance for each
of the debt tranches to calculate interest income / expense. This is
slightly more realistic than the methodology we used in the Basic
LBO, but it creates circs in our model.
Cash
x Cash is treated exactly the same as it is in the Basic LBO model.
Revolver
x The revolver facility we have in this capital structure acts like a
credit card for XYZ. It will be undrawn at close, but will be available
to borrow from if necessary. There will be a 50 bps fee for this
borrowing capacity.
x In addition to the normal structure of BOP Balance, Interest,
(Payment) / Drawdown, and EOP Balance, the Revolver needs an
additional structure keeping track of the BOP Undrawn Capacity,
the Commitment Fee, and the EOP Undrawn Capacity.
x Like before, BOP Balance + (Payment) / Drawdown = EOP
Balance. Also, BOP Undrawn Capacity = Total Capacity ($100M) –
BOP Balance; EOP Undrawn Capacity = Total Capacity ($100M) –
EOP Balance.
x Interest and Commitment fees are calculated at their respective
costs times the average of the BOP and EOP balances.
x The logic for the (Payment) / Drawdown line is a bit more complex.
If CF is negative and we have capacity in the Revolver, we want to
draw it down as necessary. If we have a balance on the Revolver
and positive CF, we want to repay the Revolver as much as we can
(after Cash has reached Min cash).
o Example Excel logic for this: =IF(AND(BOP Undrawn>0,FCF
for Debt Paydown<0), MIN(BOP Undrawn,-FCF for Debt
Paydown),IF(AND(BOP Balance>0, FCF for Debt
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Paydown>0),MAX(-BOP Balance,-FCF for Debt Paydown –
(BOP Cash – Min Cash)),0))
Term Loan (with OID)
x The Term Loan here is similar to that from the Basic LBO, with the
additional wrinkle that there is an Original Issue Discount (or OID).
In this case, it means that to buy $100 of Face Value of the Term
Loan, lenders would only have to give us $99 in cash. This $1
difference is amortized over time or when the loan is repaid.
x Here we will have normal BOP Balance, Interest, (Payment), and
EOP Balance all represented in terms of face value of the debt, and
in addition to this we will add a structure that captures BOP
Balance (Book), OID Balance BOP, OID Amortization, OID
Recognized In Repayment, OID Balance EOP, and EOP Balance
(Book).
x The face value schedule is exactly the same as the Basic LBO,
including the repayment logic.
x The Book / OID section is calculated as follows:
o BOP Book = BOP Face value – BOP OID. EOP Book = EOP
Face value – EOP OID.
o Year 1 BOP OID is calculated from the capital structure as
Face Value * (100 – Price) / 100.
x OID is recognized in two situations: amortization and recognition
due to paydown. If the loan was outstanding for the duration, the
OID would be amortized on a straight-line basis over that period.
However, when part of the loan is paid down we must recognize
that part during that period. Example Excel logic for OID
Amortization and OID Recognized in Repayment are as follows:
o OID Amortization = -MIN(BOP OID Balance/(Years
Remaining On Loan), BOP OID Balance).
o OID Recognized in Repayment = IFERROR((BOP OID
Balance + OID Amortization)*Payment/BOP Face,0).
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x The interest calculated in the Face value section is cash interest,
while the OID Amortization and Recognition are a non-cash interest
expenses.
PIK Notes
x Modeling PIK notes is similar to what we did in the Basic LBO,
except you have a choice between choosing to pay cash interest at
one rate or PIK interest at a higher rate.
x To model this, simply make three changes to the typical structure
we did before:
o Add a PIK toggle row, where you can manually insert a 1 if
you wish to PIK in this period or a 0 if you wish to pay cash
interest.
If the prompt gives you a rule for when to PIK, you
may insert logic into the PIK toggle row that reflects
this rule. Here, we are simply using a manual toggle.
o Add a PIK Interest row and change the normal interest row
to Cash Interest. If the PIK toggle is set to 1 for a year, Cash
Interest will equal zero and PIK Interest will equal average
BOP and EOP balance times the PIK interest rate. If the PIK
toggle is set to 0, the PIK Interest will equal zero and the
Cash Interest will equal the average BOP and EOP balance
times the cash pay interest rate.
o EOP Balance is now equal to BOP Balance + (Payment) /
Drawdown + PIK Interest.
Total Gross Debt and Net Debt
x These schedules are largely the same, with three additional self-
explanatory lines added to them: BOP Balance (Book), Non-cash
Interest Expense, and EOP Balance (Book)
That is it for our Debt Schedule. We can now link the Cash Interest + Non-
cash Interest to the Operating Model, and the Cash Interest to the Levered
Cash Flow section. Note that because we have not yet included the CF
from Share Issuance in the Levered Cash Flow section (which will flow
through the Debt Schedule) these figures will change yet again.
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Your debt schedule may look something like this:
DebtSchedule Year1 Year2 Year3 Year4 Year5 Year6 Year7
LIBOR 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
Cash
BOPBalance 25 25 25 25 25 25 25
Interest 0.3 0.3 0.3 0.2 0.3 0.2 0.5
Increase/(Decrease) Ͳ Ͳ Ͳ 0 (0) 0 55
EOPBalance 25 25 25 25 25 25 80
Revolver
BOPBalance Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
Interest Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
(Payment)/Drawdown Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
EOPBalance Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
BOPUndrawn 100 100 100 100 100 100 100

CommitmentFee (0.5) (0.5) (0.5) (0.5) (0.5) (0.5) (0.5)
EOPUndrawn 100 100 100 100 100 100 100
TermLoan
BOP(Face) $600 $600 $539 $444 $338 $221 $90
CashInterest (21) (23) (22) (20) (15) (9) (3)
(Payment)/Drawdown (0) (61) (95) (106) (117) (131) (90)
EOP(Face) $600 $539 $444 $338 $221 $90 $0
BOP(Book) 594 595 535 441 337 220 90

OIDBalance(BOP) 6 5 4 3 1 0.6 0.1
OIDAmortization (1) (1) (1) (1) (0) (0) (0)
OIDRecognizedinRepayment (0) (0) (1) (0) (0) (0) Ͳ
OIDBalance(EOP) 5 4 3 1 0.6 0.1 Ͳ
EOP(Book) 595 535 441 337 220 90 Ͳ
PIKNotes
PIKing? 0 0 0 0 0 0 0
BOP 337 337 337 337 337 337 337
CashInterest (40) (40) (40) (40) (40) (40) (40)
PIKInterest Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
(Payment)/Drawdown Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
EOP 337 337 337 337 337 337 337
TotalDebt
BOPBalance(Face) 937 937 876 781 675 558 427
BOPBalance(Book) 931 932 872 778 674 557 427
CashInterest/Fees (62) (64) (63) (61) (56) (50) (44)
NonͲcashInterest (1) (1) (1) (1) (1) (1) (0)
EOPBalance(Face) 937 876 781 675 558 427 337
EOPBalance(Book) 932 872 778 674 557 427 337
NetDebt
BOPBalance(Face) 912 912 851 756 650 533 402
BOPBalance(Book) 906 907 847 753 649 532 402
CashInterest/Fees (62) (63) (63) (60) (56) (50) (43)
NonͲcashInterest (1) (1) (1) (1) (1) (1) (0)
EOPBalance(Face) 912 851 756 650 533 402 258
EOPBalance(Book) 907 847 753 649 532 402 258
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Now that we’ve modeled what the business will look like over the hold period, we can model
the Deal Exit of the business and our returns.
- Deal Exit
o Here we are actually planning to do an IPO for our Exit. As mentioned in the
prompt, we are planning to IPO in Year 4 by selling 15% of the equity and diluting
our share. After this we will sell-down our position by 1/3 each year until we’ve
completely exited. Along the way, management will also exercise their stock
options after their lockup expires in Year 5. We’ll use the cash from both share
issuances to repay debt.
IPOs have considerable underwriting costs, and shares sold in an IPO are
usually done at a discount. Thus, we will have to make a judgment about
what the ‘fair value’ of the equity will be at the IPO, and then take out
costs and discounts from that to understand how much cash will actually
be raised in the IPO. Similarly, there will be a discount on our secondary
sales when we actually sell-down our position.
o TEV and Shares Outstanding
The first step is to calculate the ‘fair’ equity value. This is done by taking
the EBITDA in each year and multiplying it by the assumed Exit Multiple
(here 7x) to give us TEV. We then subtract out Net Debt (EOP) to get the
Equity Value (EOP).
Next we need to calculate Shares Outstanding to get a price per share.
We should generate a four-line schedule: Shares Outstanding (BOP),
Shares Issued / (Repurchased), Shares Outstanding (EOP), Value / Share
(EOP).
x The obvious relationships hold here: Shares Outstanding (EOP) =
Shares Outstanding (BOP) + Shares Issued / (Repurchased); Value
/ Share (EOP) = Equity Value (EOP) (calculated above) / Shares
Outstanding (EOP).
x We can input whatever we want for the Shares Outstanding at the
beginning of Year 1; after all, we are buying the company so can
reset the share count to whatever we want. Here, we will use 100M.
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219
x The Shares Issued / (Repurchased) line will be populated with the
details from the IPO and management options sections, which we
will build next.
o IPO
To model the IPO from here will consist of 5 lines: Shares Issued, IPO
Price (incl. Discount), Gross IPO Proceeds, Underwriting Costs, and Net
IPO Proceeds.
The IPO will only happen in Year 4, so we can either manually make these
calculations just in Year 4, or we can build mechanics around a driver in
our Assumptions section to make sure it only occurs in Year 4.
Shares Issued is based on the share of the company we are planning to
sell. We know from the prompt that we are going to IPO 15% of the
company, so the calculation will be 15% * Shares Outstanding Before IPO
/ (1 – 15%).
IPO Price (incl. Discount) is an easy one: take the ‘fair’ Value / Share
(EOP) we calculated above and multiply it by (1 – IPO Discount).
Gross IPO Proceeds = Shares Issued * IPO Price (incl. Discount).
Underwriting costs = Gross IPO Proceeds * IPO Underwriting Costs
assumption from the prompt (here 7%).
Net IPO Proceeds = Gross IPO Proceeds – Underwriting Costs.
The IPO Shares Issued should feed into the overall Shares Issued /
(Repurchased) line in the section above. The Net IPO Proceeds will feed
into the CF from Stock Issuance line in the Levered Cash Flow section.
o Management Options
Sometimes management options can have complicated structures to
create different incentives for management. Here we do not have any
information about the options structure, so we can assume that all
management options are struck at the entry price of the sponsor, which is
$4.45 / share ($445M entry sponsor equity / 100M shares outstanding).
We know from the prompt that this will occur in Year 5 after the lockup
expires.
We need three lines here: Shares Issues, Strike Price, and Cash from
Options.
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Shares Issued will be the Options Pool times the Shares Outstanding at
the beginning of the deal (here 100M). Like before, however, these shares
will only be issued if the options are in the money, so we will need some if
logic that states if the current Value / Share is greater than the original
Value / Share they are struck, but otherwise they are not.
The Strike Price is simply the $4.45 mentioned above.
Cash from Options = Shares Issued * Strike Price.
Management Options Shares Issued should feed into the overall Shares
Issued / (Repurchased) line in the section above. The Cash from Options
will feed into the CF from Stock Issuance line in the Levered Cash Flow
section.
o Now that we have modeled both the IPO and the Management Options and
linked them back to the Levered Cash Flow section, the rest of our model (LCF,
Debt Schedule, Operating Model, etc.) is accurate.
o Sponsor Secondary Sales
Now we can finally calculate our exit. We know that we have 100M in
shares, and we will sell 1/3 at the end of Years 5, 6, and 7. To model this
we need five lines: Sponsor Shares Owned (BOP), Sponsor Shares Sold,
Sponsor Shares Owned (EOP), Secondary Sale Price, and Sponsor
Proceeds.
Sponsor Shares Owned (BOP) in Year 1 is whatever we set it to be (here
100M).
Sponsor Shares Owned (EOP) = Sponsor Shares Owned (BOP) –
Sponsor Shares Sold.
Sponsor Shares Sold will be zero in years 1-4, and 33.3M in years 5, 6
and 7.
Secondary Sale Price will be the ‘fair’ Value / Share from the calculation
above times 1 – Secondary Sale Discount (here 5%).
Sponsor Proceeds = Sponsor Shares Sold * Secondary Sale Price. Here
we see in the Management Case we get proceeds of $402M, $467M, and
$536M in Years 5, 6, and 7.
Sponsor Shares Sold will not affect the Shares Outstanding account;
these are not new shares issued, but shares we held that are now owned
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by the public. The Sponsor Proceeds do not affect the CF from Stock
Issuance, as the money does not go to the company but rather to the
sponsor.
o Your Deal Exit / IPO section may look like this:
DealExit/IPO
EBITDA 213 227 241 256 272 289 306

EBITDAMultiple 7.0x 7.0x 7.0x 7.0x 7.0x 7.0x 7.0x
TEV 1,492 1,588 1,689 1,795 1,905 2,020 2,141
NetDebt(EOP) 912 851 756 493 348 213 65
EquityValue 580 737 933 1,301 1,557 1,808 2,076
SharesOutstanding(Millions)BOP 100 100 100 100 118 123 123

SharesIssued/(Repurchased) Ͳ Ͳ Ͳ 18 5 Ͳ Ͳ
SharesOutstanding(Millions)EOP 100 100 100 118 123 123 123
Value/Share(EOP) $5.80 $7.37 $9.33 $11.06 $12.69 $14.74 $16.92
IPO
SharesIssued Ͳ Ͳ Ͳ 17.6 Ͳ Ͳ Ͳ
IPOPrice(incl.discount) Ͳ Ͳ Ͳ $9.40 Ͳ Ͳ Ͳ
GrossIPOProceeds Ͳ Ͳ Ͳ 165.9 Ͳ Ͳ Ͳ
UnderwritingCosts Ͳ Ͳ Ͳ (11.6) Ͳ Ͳ Ͳ
NetProceeds Ͳ Ͳ Ͳ 154.3 Ͳ Ͳ Ͳ
ManagementOptions
SharesIssued Ͳ Ͳ Ͳ Ͳ 5.0 Ͳ Ͳ
StrikePrice Ͳ Ͳ Ͳ Ͳ $4.45 Ͳ Ͳ
CashfromOptions Ͳ Ͳ Ͳ Ͳ 22.2 Ͳ Ͳ
SponsorSecondarySales
SponsorSharesOwned(BOP) 100 100 100 100 100 67 33
SponsorSharesSold Ͳ Ͳ Ͳ Ͳ (33.3) (33.3) (33.3)
SponsorSharesOwned(EOP) 100 100 100 100 67 33 Ͳ
SecondarySalePrice Ͳ Ͳ Ͳ Ͳ $12.06 $14.00 $16.08
SponsorProceeds Ͳ Ͳ Ͳ Ͳ 402 467 536
o Now we have enough information to calculate our returns.

Because we are exiting over time, we will need to use the XIRR function in
Excel. Thus, we will need to add two new lines: Cash Flow Dates, and
Sponsor Cash Flows.
Cash Flow Dates will simply detail the actual dates the cash flow occurred.
We can assume that the original equity payment happens on December
31 of Year 0 (which here we will say is 2014), and all of the remaining
cash flows also occur on December 31 of their respective years.
Cash outflows are represented by negative numbers; cash inflows are
positive.
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The Sponsor Cash Flows are the cash outflow to purchase Equity at entry
(here $445M) on 12/31/2014, and then cash inflows from Sponsor
Proceeds on 12/31/2019, 2020, and 2021 of $402M, $467M, and $536M.
From here, calculating MOIC is simply the sum of Sponsor Proceeds
($402M + $467M + $536M) / Sponsor Equity at entry ($445M). Here we
see in the Management Case at a 25% premium a MOIC of 3.2x.
To calculate IRR, we will use the XIRR function in Excel. The syntax of
this formula is =XIRR(Sponsor Cash Flows, Cash Flow Dates). Here we
see in the management case at a 25% premium an IRR of 21%.
From here we can build whatever sensitivity tables we want to help us
think about how the returns of the deal vary as we change assumptions.
This is essentially the same as in the Basic LBO.
x The one difference is that if you tie something to an operating
variable (e.g., Annual Price Increases) in one case, it will only work
when that case is turned on. Be conscious of this when building
your model.
Your Returns Calculations section may look like this:
ReturnsCalculationsandSensitivities
CashFlowDates 12/31/2014 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020 12/31/2021

SponsorCashFlows (445) Ͳ Ͳ Ͳ Ͳ 402 467 536
MOIC 3.2x
IRR 21.0%
PricePaidvs.ExitMultiple
$27.50 $28.75 $30.00 $31.25 $32.50 $33.75 $35.00 $36.25 $37.50 StockPrice
21.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% Premium
5.0x 17.1% 15.5% 14.0% 12.3% 10.5% 8.8% 7.1% 5.1% 3.3%
5.5x 19.4% 17.9% 16.4% 14.8% 13.1% 11.5% 9.8% 7.8% 6.0%
6.0x 21.5% 20.0% 18.6% 17.0% 15.5% 13.9% 12.3% 10.2% 8.3%
6.5x 23.4% 22.0% 20.6% 19.1% 17.6% 16.1% 14.5% 12.4% 10.4%
7.0x 25.2% 23.8% 22.5% 21.0% 19.5% 18.1% 16.6% 14.3% 12.4%
7.5x 26.9% 25.5% 24.2% 22.8% 21.3% 19.9% 18.5% 16.2% 14.2%
8.0x 28.5% 27.2% 25.9% 24.4% 23.0% 21.7% 20.2% 17.9% 15.9%
8.5x 30.0% 28.7% 27.4% 26.0% 24.6% 23.3% 21.8% 19.5% 17.4%
9.0x 31.4% 30.1% 28.9% 27.5% 26.1% 24.8% 23.4% 21.0% 18.9%
ExitMultiple(xEBITDA)
If we were doing a Basic LBO, now that we’ve calculated our Deal Exit and Returns we would
be done modeling and ready to make our recommendation. With a Full LBO test, however, we
need to produce the three main Accounting Financial Statements.
- Accounting Financial Statements
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o In the Full LBO model, you will often be expected to generate the three main
financial statements: Income Statement, Balance Sheet, and Cash Flow
Statement.
o Income Statement
This is the easiest one, and will flow almost completely from the operating
model we already built.
It is useful to build a check to make sure your numbers here match what
you get in the Operating Model.
Your Income Statement may look like this:
IncomeStatement Year1 Year2 Year3 Year4 Year5 Year6 Year7
Revenue 1,051 1,104 1,160 1,218 1,280 1,345 1,413

COGS (633) (669) (706) (745) (787) (831) (877)
GrossProfit 417 435 454 473 493 514 536
GrossMargin 39.7% 39.4% 39.1% 38.8% 38.5% 38.2% 37.9%
SG&A (204) (208) (212) (216) (221) (225) (230)

EBITDA 213 227 241 256 272 289 306
EBITDAMargin 20.3% 20.6% 20.8% 21.0% 21.3% 21.5% 21.6%
D&A (32) (37) (38) (38) (38) (38) (38)

EBIT 181 190 203 218 234 251 268
EBITMargin 17.3% 17.2% 17.5% 17.9% 18.3% 18.6% 19.0%
Interest (63) (65) (64) (58) (47) (41) (39)

EBT 119 125 139 160 187 209 229
Taxes (48) (50) (56) (64) (75) (84) (92)

NetIncome 71 75 84 96 112 126 137
NetIncomeMargin 6.8% 6.8% 7.2% 7.9% 8.8% 9.3% 9.7%
Check Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
o Balance Sheet
To build the balance sheet, we start from the Post-Transaction Balance
Sheet we created during Entry. This will serve as the Year 0 Balance
Sheet.
A few of the line items we have already calculated in our schedules.
x NWC Schedule already has Accounts Receivable, Inventories,
Other Current Assets, Accounts Payable, and Other Current
Liabilities.
x Debt Schedule already has Cash, Long-Term Debt and Current
Portion of LT Debt.
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o All of our debt is effectively LT Debt until we get to Year 7, at
which points the debt is maturing and becomes Current. In
reality we would likely refinance this debt before this
occurred, but we are ignoring that for simplicity here.
x Depreciation & Amortization Schedule already has the EOP
balance for Capitalized Financing Fees.
There are a few line items that we can assume will stay the same over
time.
x Goodwill is generated from the transaction, but is not amortized or
written down in the hold period. Thus, we pull in Goodwill from the
Post-Transaction Balance Sheet and hold it constant.
x Other Assets and Other Liabilities are assumed to be zero, and we
maintain that assumption throughout the hold period.
There are a few line items left that we will have to calculate, but we have
the information to do so.
x Gross PP&E Year 1 = Gross PP&E Year 0 + Capex Year 1.
x Accumulated Depreciation Year 1 = Accumulated Depreciation
Year 0 + Plant Depreciation Year 1 + Maintenance Depreciation
Year 1.
x Net PP&E = Gross PP&E – Accumulated Depreciation.
x Retained Earnings Year 1 = Retained Earnings Year 0 + Net
Income Year 1 (there are no dividends here).
x Paid In Capital Year 1 = Paid In Capital Year 0 + Shares Issued *
Par Value of Shares.
o Shares Issued will come both from the IPO and from
management’s options.
o Par Value of Shares will be equal to Sponsor Equity Value /
Shares Outstanding at the time of the initial deal (here
$4.45).
x Capital In Excess of Par Value Year 1 = Capital In Excess of Par
Value Year 0 + CF from Stock Issuance Year 1 – (Paid In Capital
Year 1 – Paid In Capital Year 0).
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o Here we are just capturing the difference between the actual
cash raised from the IPO or management options and the
Par Value of the Shares Issued (calculated in the last bullet
point).
It is important once you have built your Balance Sheet to build a check
and make sure it actually balances (i.e., Assets = Liabilities + Equity).
Your Balance Sheet may look like this:
BalanceSheet Year0 Year1 Year2 Year3 Year4 Year5 Year6 Year7
Assets
Cash 25 25 25 25 25 25 125 272
Inventory 100 104 110 116 123 129 137 144
AccountsReceivable 150 158 166 175 184 193 203 213
OtherCurrentAssets 50 53 55 58 61 64 67 71
TotalCurrentAssets 325 340 356 374 392 411 531 700
GrossPP&E 700 800 850 875 900 925 950 975

AccumulatedDepreciation (250) (279) (313) (348) (383) (418) (453) (488)
NetPP&E 450 521 538 528 518 508 498 488
Goodwill 815 815 815 815 815 815 815 815

CapitalizedFinancingFees 21 18 15 12 9 6 3 Ͳ
OtherAssets Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
TotalAssets 1,611 1,694 1,724 1,728 1,733 1,740 1,847 2,002
Liabilities
AccountsPayable 150 156 165 174 184 194 205 216
OtherCurrentLiabilities 100 105 110 116 122 128 134 141
CurrentPortionofLTDebt Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ 337
TotalCurrentLiabilities 250 261 275 290 306 322 339 695
LongͲtermDebt 931 932 872 778 518 373 337 Ͳ

OtherLiabilities Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
TotalLiabilities 1,181 1,193 1,148 1,069 823 695 677 695
Equity
PaidͲinCapital(Parvalue$4 445 445 445 445 523 545 545 545
CapitalinExcessofParValue Ͳ Ͳ Ͳ Ͳ 76 76 76 76
RetainedEarnings/(Losses) (15) 56 132 215 311 423 549 686
TotalEquity 430 501 576 660 910 1,044 1,170 1,307
TotalLiabilities&Equity 1,611 1,694 1,724 1,728 1,733 1,740 1,847 2,002
Check Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
o Cash Flow Statement

The Cash Flow Statement will also draw from the schedules and financial
statements we’ve already created.
Cash Flow From Operations
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x Start from Net Income and add back D&A (both from the Income
Statement).
x Also add back Non-cash Interest Expense from the Debt Schedule.
x Make working capital adjustments either from the NWC calculation
or the Balance Sheet.
Cash Flow from Investing
x Since there are no acquisitions or divestitures, here all we have to
include are the Plant Capex and the Maintenance Capex (either
from the Operating Model or the Depreciation and Amortization
Schedule).
Cash Flow from Financing
x Drawdown / (Repayment) of each tranche of debt will be pulled in
here from the Debt Schedule.
x Proceeds from the IPO and Proceeds from the Management
Options will be pulled in from the Deal Exit / IPO section.
Finally, sum the Cash Flow from Operations, Investing, and Financing,
and check to get the total change in cash during the year. Use this end of
year cash balance to check against the cash balance on your Balance
Sheet or Debt Schedule to make sure things are flowing correctly.
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227
Your Cash Flow Statement may look like this:
CashFlowStatement Year1 Year2 Year3 Year4 Year5 Year6 Year7
CashFlowFromOperations
NetIncome 71 75 84 96 112 126 137
Depreciation&Amortization 32 37 38 38 38 38 38
NonͲcashInterestExpense 1 1 1 2 1 0 Ͳ
(Increase)/DecreaseinA/R (8) (8) (8) (9) (9) (10) (10)
(Increase)/DecreaseinInventories (4) (6) (6) (6) (7) (7) (8)
(Increase)/DecreaseinOtherCurrentA (3) (3) (3) (3) (3) (3) (3)
Increase/(Decrease)inA/P 6 9 9 10 10 11 11
Increase/(Decrease)inOtherCurrentLi 5 5 6 6 6 6 7
TotalCashFlowFromOperations 100 111 120 133 148 161 172
CashFlowFromInvesting
GrowthCapex(NewPlant) (75) (25) Ͳ Ͳ Ͳ Ͳ Ͳ
TotalCashFlowFromInvesting (100) (50) (25) (25) (25) (25) (25)
CashFlowFromFinancing
Drawdown/(Repayment)ofRevolver Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
Increase/(Repayment)ofTermLoan (0) (61) (95) (263) (145) (36) Ͳ
Increase/(Repayment)ofPIKNotes Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
ProceedsfromIPO Ͳ Ͳ Ͳ 154 Ͳ Ͳ Ͳ
ProceedsfromManagementOptions Ͳ Ͳ Ͳ Ͳ 22 Ͳ Ͳ
TotalCashFlowFromFinancing (0) (61) (95) (108) (123) (36) Ͳ
CashatBeginningofYear 25 25 25 25 25 25 125
Increase/(Decrease)incash (0) Ͳ 0 (0) (0) 100 147
CashatEndofYear 25 25 25 25 25 125 272
Check Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ
We’ve just completed our Full LBO model, including with the three financial statements. Now
that it is built, it is time to actually answer the question from the prompt. Again, here you want
to not only show that you’ve gotten to the right answer, but that you have decent business
judgment and intuition around the deal. A potential answer could read:
“The deal looks fairly attractive at the 25% premium that the MD anticipates is required to get it
done. The management case implies a 3.2x MOIC and a 21% IRR at this price. While this is
attractive, the main concern I have is that the upside of the deal seems to be more limited than
the downside. The Upside case gives us a return of 28.1% (which is a very good return but not
necessarily a major home run), while the Downside case gives us a 2.7% return. Despite this, I
would still pursue the deal at that price, but in addition to the normal diligence work I would
also focus on whether there are additional sources of value we can find to boost the upside or
ways we can structure the deal to limit our downside.
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“If management truly insisted that a 25% premium was not adequate for the business, I would
be willing to continue to pursue the deal up to 30% premium (Management case return of
19.5%). At a 30% premium, however, the burden of proof around the Management case would
be higher and we would have to find more upside / risk mitigation opportunities than at the
25% premium. If they demanded a 35% premium (which would imply an 18% Management
case return, a 25.5% Upside return and a -2% Downside return), I would walk away from the
deal.”
Watch The Full LBO Get Built with Play by Play
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Final Thoughts on LBO Modeling Tests
Now that you’ve made it through these examples and understand how to do the Paper LBO,
the Basic LBO, and the Full LBO, you are almost ready for your PE interviews. We say almost
because practice truly makes perfect here and going through these just once is not enough.
Ultimately interviews are high-pressure situations, and you will want to be well-versed enough
to have this be second nature to you when you walk through that door. It is also important to
have the basics down cold so that when the interviewers throw in a new wrinkle (again, there
are infinite variations of these) you will be able to think on your feet and incorporate it
accordingly.
To help you get to the point where the LBO models are second nature, we’ve also included
Excel files with several additional example prompts for each type of test, as well as sample
answers. These will include a few additional wrinkles that we have not covered here to give
you more exposure to things you could see in an interview. Here is a thorough (but by no
means inclusive of everything that could come your way) list of complexities you could see:
x Roll-over equity of prior shareholders / management (covered in Basic LBO Example 3)
x Roll-over debt
x Call premiums (covered in Basic LBO Example 2, Full LBO Example 2)
x Debt covenants and cushions (covered in Full Example 2)
x Seller notes (especially when interviewing with shops that do smaller deals)
x Net Operating Losses (covered in Basic LBO Example 3)
x Interest rate or commodity price hedges
x Modeling partial years
x Calculating exits using forward P/E multiples based on post-IPO capital structures
x Dividend recapitalizations (covered in Basic LBO Example 2)
x Business unit divestitures
x Add-on acquisitions
x Opco / Propco structures
x Preferred equity investments or PIPEs
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We recommend going through the additional examples we have provided, as well as any other
practice tests you can find. Also, don’t hesitate to go to the WSO community with your
questions and to discuss the technical aspects of the LBO models and the different wrinkles
people have seen in interviews. The more you prepare, think, and discuss these things, the
more natural and intuitive they will become, and the better you will do in your interviews.
GOOD LUCK!!
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Appendix
In this appendix…
x Sample CVs of
Successful PE
Candidates
x Common PE Terms
Glossary
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SAMPLE CVs OF SUCCESSFUL PE CANDIDATES
Remember to download the WSO PE resume template for formatting and layout guidance. If
you would like guidance from actual PE professionals, please consider the WSO Resume
Review service.
From Consulting to Large PE Fund
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From Banking to Mid-Market PE Fund
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From Banking to Sector-Focused PE Fund
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MBA Student with International PE Experience
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COMMON TERMS GLOSSARY11
“A” round: a financing event whereby venture capitalists become involved in a fast growth company that was previously financed by founders and/or
angels.
Accredited investor: a person or legal entity, such as a company or trust fund, that meets certain net worth and income qualifications and is considered to be
sufficiently sophisticated to make investment decisions in complex situations. Regulation D of the Securities Act of 1933 exempts accredited investors from
protection under the Securities Act. Typical qualifications for a person are: $1 million net worth and annual income exceeding $200,000 individually or
$300,000 with a spouse. Directors and executive officers are considered to be accredited investors.
Alternative asset class: a class of investments that includes private equity, real estate, and oil and gas, but excludes publicly traded securities. Pension plans,
college endowments and other relatively large institutional investors typically allocate a certain percentage of their investments to alternative assets with an
objective to diversify their portfolios.
Angel: a wealthy individual that invests in companies in relatively early stages of development. Usually angels invest less than $1 million per startup. The
typical angel financed startup is in concept or product development phase.
Anti-dilution: a contract clause that protects an investor from a substantial reduction in percentage ownership in a company due to the issuance by the
company of additional shares to other entities. The mechanism for making adjustments is called a Ratchet.
“B” round: a financing event whereby professional investors such as venture capitalists are sufficiently interested in a company to provide additional funds
after the “A” round of financing. Subsequent rounds are called “C”, “D” and so on.
Best efforts offering: a commitment by a syndicate of investment banks to use best efforts to ensure the sale to investors of a company’s offering of
securities. In a best efforts offering, the syndicate avoids any firm commitment for a specific number of shares or bonds.
Beta Product: a product that is being tested by potential customers prior to being formally launched into the marketplace.
Blow-out round: see Cram-down round.
Board of directors: a group of individuals, typically composed of managers, investors and experts, which have a fiduciary responsibility for the wellbeing
and proper guidance of a corporation. The board is elected by the shareholders.
Boat anchor: a person, project or activity that hinders the growth of a company.
Book: see Private placement memorandum.
Bootstrapping: the actions of a startup to minimize expenses and build cash flow, thereby reducing or eliminating the need for outside investors.
Bridge financing: temporary funding that will eventually be replaced by permanent capital from equity investors or debt lenders. In venture capital, a bridge
is usually a short term note (6 to 12 months) that converts to preferred stock. Typically, the bridge lender has the right to convert the note to preferred stock
at a price that is a 20% discount from the price of the preferred stock in the next financing round. See Wipeout bridge and Hamburger Helper bridge.
Broad-based weighted average ratchet - a type of anti-dilution mechanism. A weighted average ratchet adjusts downward the price per share of the
preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received.
Investor A’s preferred stock is repriced to a weighted average of investor A’s price and investor B’s price. A broad-based ratchet uses all common stock
outstanding on a fully diluted basis (including all convertible securities, warrants and options) in the denominator of the formula for determining the new
weighed average price. See Narrow-based weighted average ratchet.
Burn rate: the rate at which a startup with little or no revenue uses available cash to cover expenses. Usually expressed on a monthly or weekly basis.
Business plan: a document that describes a new concept for a business opportunity. A business plan typically includes the following sections: executive
summary, market need, solution, technology, competition, marketing, management, operations and financials.
Buyout: a sector of the private equity industry. Also, the purchase of a controlling interest of a company by an outside investor (in a leveraged buyout) or a
management team (in a management buyout).
Buy-sell agreement: a contract that sets forth the conditions under which a shareholder must first offer his or her shares for sale to the other shareholders
before being allowed to sell to entities outside the company.
C corporation: an ownership structure that allows any number of individuals or companies to own shares. A C corporation is a stand-alone legal entity so it
offers some protection to its owners, managers and investors from liability resulting from its actions.
Capital call: when a private equity fund manager (usually a “general partner” in a partnership) requests that an investor in the fund (a “limited partner”)
provide additional capital. Usually a limited partner will agree to a maximum investment amount and the general partner will make a series of capital calls
over time to the limited partner as opportunities arise to finance startups and buyouts.
Capitalization table: a table showing the owners of a company’s shares and their ownership percentages. It also lists the forms of ownership, such as
common stock, preferred stock, warrants and options.
Capital gains: a tax classification of investment earnings resulting from the purchase and sale of assets. Typically, an investor prefers that investment
earnings be classified as long term capital gains (held for a year or longer), which are taxed at a lower rate than ordinary income.
Capital stock: a description of stock that applies when there is only one class of shares.
This class is known as “common stock”.
Capped participating preferred stock: preferred stock whose participating feature is limited so that an investor cannot receive more than a specified
amount. See Participating preferred stock.
Carried interest: a share in the profits of a private equity fund. Typically, a fund must return the capital given to it by limited partners plus any preferential
rate of return before the general partner can share in the profits of the fund. The general partner will then receive a 20% carried interest, although some
successful firms receive 25%-30%. Also known as “carry” or “promote.”
Catch-up: a clause in the agreement between the general partner and the limited partners of a private equity fund. Once the limited partners have received a
certain portion of their expected return, the general partner can then receive a majority of profits until the previously agreed upon profit split is reached.
Change of control bonus: a bonus of cash or stock given by private equity investors to members of a management group if they successfully negotiate a
sale of the company for a price greater than a specified amount.
Clawback: a clause in the agreement between the general partner and the limited partners of a private equity fund. The clawback gives limited partners the
right to reclaim a portion of disbursements to a general partner for profitable investments based on significant losses from later investments in a portfolio.
Closing: the conclusion of a financing round whereby all necessary legal documents are signed and capital has been transferred.
Collateral: hard assets of the borrower, such as real estate or equipment, for which a lender has a legal interest until a loan obligation is fully paid off.
Commitment: an obligation, typically the maximum amount that a limited partner agrees to invest in a fund.
Common stock: a type of security representing ownership rights in a company. Usually, company founders, management and employees own common
stock while investors own preferred stock. In the event of a liquidation of the company, the claims of secured and unsecured creditors, bondholders and
preferred stockholders take precedence over common stockholders. See Preferred stock.
11
Foster Center for Private Equity: Private Equity Glossary, 2002
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Comparable: a publicly traded company with similar characteristics to a private company that is being valued. For example, a telecommunications
equipment manufacturer whose market value is 2 times revenues can be used to estimate the value of a similar and relatively new company with a new
product in the same industry. See Liquidity discount.
Control: the authority of an individual or entity that owns more than 50% of equity in a company or owns the largest block of shares compared to other
shareholders.
Consolidation: see Rollup.
Conversion: the right of an investor or lender to force a company to replace the investor’s preferred shares or the lender’s debt with common shares at a
preset conversion ratio. A conversion feature was first used in railroad bonds in the 1800’s.
Convertible debt: a loan which allows the lender to exchange the debt for common shares in a company at a preset conversion ratio
Convertible preferred stock: a type of stock that gives an owner the right to convert to common shares of stock. Usually, preferred stock has certain rights
that common stock doesn’t have, such as decision-making management control, a promised return on investment (dividend), or senior priority in receiving
proceeds from a sale or liquidation of the company. Typically, convertible preferred stock automatically converts to common stock if the company makes an
initial public offering (IPO). Convertible preferred is the most common tool for private equity funds to invest in companies.
Convertible security: a security that gives its owner the right to exchange the security for common shares in a company at a preset conversion ratio. The
security is typically preferred stock, warrants or debt.
Co-sale right- the right that gives the investor a contractual right to sell some of the investor’s stock along with the founder’s stock if the founder elects to
sell stock to a third-party.
Cost of revenue: the expenses generated by the core operations of a company.
Covenant: a legal promise to do or not do a certain thing. For example, in a financing arrangement, company management may agree to a negative
covenant, whereby it promises not to incur additional debt. The penalties for violation of a covenant may vary from repairing the mistake to losing control of
the company.
Cram down round: a financing event upon which new investors with substantial capital are able to demand and receive contractual terms that effectively
cause the issuance of sufficient new shares by the startup company to significantly reduce
(“dilute”) the ownership percentage of previous investors..
Cumulative dividends: the owner of preferred stock with cumulative dividends has the right to receive accrued (previously unpaid) dividends in full before
dividends are paid to any other classes of stock.
Current ratio: the ratio of current assets to current liabilities.
Deal flow: a measure of the number of potential investments that a fund reviews in any given period.
Debt service: the ratio of a loan payment amount to available cash flow earned during a specific period. Typically lenders insist that a company maintain a
certain debt service ratio or else risk penalties such as having to pay off the loan immediately.
Default: a company’s failure to comply with the terms and conditions of a financing arrangement.
Defined benefit plan: a company retirement plan in which both the employee and the employer contribute to the plan. Typically the plan is based on the
employee’s salary and number of years worked. Fixed benefits are outlined when the employee retires. The employer bears the investment risk and is
committed to providing the benefits to the employee. Defined benefit plan managers can invest in private equity funds.
Defined contribution plan: a company retirement plan in which the employee elects to contribute some portion of his or her salary into a retirement plan,
such as a 401(k) or 403(b). With this type of plan, the employee bears the investment risk. The benefits depend solely on the amount of money made from
investing the employee’s contributions. Defined contribution plan capital cannot be invested in private equity funds.
Demand rights: a type of registration right. Demand rights give an investor the right to force a startup to register its shares with the SEC and prepare for a
public sale of stock (IPO).
Dilution: the reduction in the ownership percentage of current investors, founders and employees caused by the issuance of new shares to new investors.
Dilution protection: see Anti-dilution and Ratchet.
Direct costs: see Cost of revenue.
Disbursement: an investment by a fund in a company.
Discount rate: the interest rate used to determine the present value of a series of future cash flows.
Discounted cash flow (DCF): a valuation methodology whereby the present value of all future cash flows expected from a company is calculated.
Distribution: the transfer of cash or securities to a limited partner resulting from the sale, liquidation or IPO of one or more portfolio companies in which a
general partner chose to invest.
Dividends: regular payments made by a company to the owners of certain securities.
Typically, dividends are paid quarterly, by approval of the board of directors, to owners of preferred stock.
Down round: a round of financing whereby the valuation of the company is lower than the value determined by investors in an earlier round.
Drag-along rights: the contractual right of an investor in a company to force all other investors to agree to a specific action, such as the sale of the company.
Drive-by VC: a venture capitalist that only appears during board meetings of a portfolio company and rarely offers advice to management.
Due diligence: the investigatory process performed by investors to assess the viability of a potential investment and the accuracy of the information
provided by the target company.
Early stage: the state of a company after the seed (formation) stage but before middle stage (generating revenues). Typically, a company in early stage will
have a core management team and a proven concept or product, but no positive cash flow.
Earnings before interest and taxes (EBIT): a measurement of the operating profit of a company. One possible valuation methodology is based on a
comparison of private and public companies’ value as a multiple of EBIT.
Earnings before interest, taxes, depreciation and amortization (EBITDA): a measurement of the cash flow of a company. One possible valuation
methodology is based on a comparison of private and public companies’ value as a multiple of EBITDA.
Earn out- an arrangement in which sellers of a business receive additional future payments, usually based on financial performance metrics such as revenue
or net income.
Elevator pitch: a concise presentation, lasting only a few minutes (an elevator ride), by an entrepreneur to a potential investor about an investment
opportunity.
Employee Stock Ownership Program (ESOP): a plan established by a company to reserve shares for long-term incentive compensation for employees.
Equity: the ownership structure of a company represented by common shares, preferred shares or unit interests. Equity = Assets - Liabilities.
ESOP: see Employee Stock Ownership Program.
Evergreen fund: a fund that reinvests its profits in order to ensure the availability of capital for future investments.
Exit strategy: the plan for generating profits for owners and investors of a company.
Typically, the options are to merge, be acquired or make an initial public offering (IPO).
Expansion stage: the stage of a company characterized by a complete management team and a substantial increase in revenues.
Fairness opinion: a letter issued by an investment bank that charges a fee to assess the fairness of a negotiated price for a merger or acquisition.
Firm commitment - a commitment by a syndicate of investment banks to purchase all the shares available for sale in a public offering of a company. The
shares will then be resold to investors by the syndicate.
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Flipping: the act of selling shares immediately after an initial public offering. Investment banks that underwrite new stock issues attempt to allocate shares
to new investors that indicate they will retain the shares for several months. Often management and venture investors are prohibited from selling IPO shares
until a “lock-up period” (usually 6 to 12 months) has expired.
Founder: a person who participates in the creation of a company. Typically, founders manage the company until it has enough capital to hire professional
managers.
Founders stock: nominally priced common stock issued to founders, officers, employees, directors, and consultants.
Friends and family financing: capital provided by the friends and family of founders of an early stage company. Founders should be careful not to create
an ownership structure that may hinder the participation of professional investors once the company begins to achieve success.
Full ratchet: an anti-dilution protection mechanism whereby the price per share of the preferred stock of investor A is adjusted downward due to the
issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A’s preferred stock is repriced to
match the price of investor B’s preferred stock.
Usually as a result of the implementation of a ratchet, company management and employees who own a fixed amount of common shares suffer significant
dilution. See Narrow-based weighted average ratchet and Broad-based weighted average ratchet.
Fully diluted basis: a methodology for calculating any per share ratios whereby the denominator is the total number of shares issued by the company on the
assumption that all warrants and options are exercised and preferred stock.
Fund-of-funds: a fund created to invest in private equity funds. Typically, individual investors and relatively small institutional investors participate in a
fund-of-funds to minimize their portfolio management efforts.
Gatekeepers- intermediaries which endowments, pension funds and other institutional investors use as advisors regarding private equity investments.
General partner (GP): a class of partner in a partnership. The general partner retains liability for the actions of the partnership. In the private equity world,
the GP is the fund manager while the limited partners (LPs) are the institutional and high net worth investors in the partnership. The GP earns a management
fee and a percentage of profits (see Carried interest).
GP: see General partner.
Grossing up: an adjustment of an option pool for management and employees of a company which increases the number of shares available over time. This
usually occurs after a financing round whereby one or more investors receive a relatively large percentage of the company. Without a grossing up, managers
and employees would suffer the financial and emotional consequences of dilution, thereby potentially affecting the overall performance of the company.
Growth stage: the state of a company when it has received one or more rounds of financing and is generating revenue from its product or service. Also
known as “middle stage.”
Hamburger helper: a colorful label for a traditional bridge loan that includes the right of the bridge lender to convert the note to preferred stock at a price
that is a 20% discount from the price of the preferred stock in the next financing round.
Hart-Scott-Rodino Act: a law requiring entities that acquire certain amounts of stock or assets of a company to inform the Federal Trade Commission and
the Department of Justice and to observe a waiting period before completing the transaction.
Harvest: to generate cash or stock from the sale or IPO of companies in a private equity portfolio of investments.
Hockey stick: the general shape and form of a chart showing revenue, customers, cash or some other financial or operational measure that increases
dramatically at some point in the future. Entrepreneurs often develop business plans with hockey stick charts to impress potential investors.
Hot issue: stock in an initial public offering that is in high demand.
Hurdle rate: a minimum rate of return required before an investor will make an investment.
Incorporation: the process by which a business receives a state charter, allowing it to become a corporation. Many corporations choose Delaware because
its laws are business friendly and up to date.
Incubator: a company or facility designed to host startup companies. Incubators help startups grow while controlling costs by offering networks of contacts
and shared backoffice resources.
Initial public offering (IPO): the first offering of stock by a company to the public. New public offerings must be registered with the Securities and
Exchange Commission. An IPO is one of the methods that a startup that has achieved significant success can use to raise additional capital for further
growth. See Qualified IPO.
Inside round: a round of financing in which the investors are the same investors as the previous round. An inside round raises liability issues since the
valuation of the company has no third party verification in the form of an outside investor. In addition, the terms of the inside round may be considered self-
dealing if they are onerous to any set of shareholders or if the investors give themselves additional preferential rights.
Institutional investor: professional entities that invest capital on behalf of companies or individuals. Examples are: pension plans, insurance companies and
university endowments.
Internal rate of return (IRR): the interest rate at which a certain amount of capital today would have to be invested in order to grow to a specific value at a
specific time in the future.
Investment thesis / Investment philosophy: the fundamental ideas which determine the types of investments that an investment fund will choose in order
to achieve its financial goals.
IPO: see Initial public offering.
IRR: see Internal rate of return.
Issuer: the company that chooses to distribute a portion of its stock to the public.
Junior debt: a loan that has a lower priority than a senior loan in case of a liquidation of the asset or borrowing company. Also known as “subordinated
debt”.
Later stage: the state of a company that has proven its concept, achieved significant revenues compared to its competition, and is approaching cash flow
break even or positive net income. Typically, a later stage company is about 6 to 12 months away from a liquidity event such as an IPO or buyout. The rate
of return for venture capitalists that invest in later stage, less risky ventures is lower than in earlier stage ventures.
LBO: see Leveraged buyout.
Lead investor: the venture capital investor that makes the largest investment in a financing round and manages the documentation and closing of that round.
The lead investor sets the price per share of the financing round, thereby determining the valuation of the company.
Letter of intent: a document confirming the intent of an investor to participate in a round of financing for a company. By signing this document, the subject
company agrees to begin the legal and due diligence process prior to the closing of the transaction. Also known as a “Term Sheet”.
Leverage: the use of debt to acquire assets, build operations and increase revenues. By using debt, a company is attempting to achieve results faster than if it
only used its cash available from pre-leverage operations. The risk is that the increase in assets and revenues does not generate sufficient net income and
cash flow to pay the interest costs of the debt.
Leveraged buyout (LBO): the purchase of a company or a business unit of a company by an outside investor using mostly borrowed capital.
Limited liability company (LLC): an ownership structure designed to limit the founders’ losses to the amount of their investment. An LLC does not pay
taxes, rather its owners pay taxes on their proportion of the LLC profits at their individual tax rates.
Limited partnership: a legal entity composed of a general partner and various limited partners. The general partner manages the investments and is liable
for the actions of the partnership while the limited partners are generally protected from legal actions and any losses beyond their original investment. The
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general partner receives a management fee and a percentage of profits (see Carried interest), while the limited partners receive income, capital gains and
tax benefits.
Limited partner (LP): an investor in a limited partnership. The general partner is liable for the actions of the partnership while the limited partners are
generally protected from legal actions and any losses beyond their original investment. The limited partner receives income, capital gains and tax benefits.
Liquidation: the selling off of all assets of a company prior to the complete cessation of operations. Corporations that choose to liquidate declare Chapter 7
bankruptcy. In a liquidation, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common
stockholders.
Liquidation preference: the contractual right of an investor to priority in receiving the proceeds from the liquidation of a company. For example, a venture
capital investor with a “2x liquidation preference” has the right to receive two times its original investment upon liquidation.
Liquidity discount: a decrease in the value of a private company compared to the value of a similar but publicly traded company. Since an investor in a
private company cannot readily sell his or her investment, the shares in the private company must be valued less than a comparable public company.
Liquidity event: a transaction whereby owners of a significant portion of the shares of a private company sell their shares in exchange for cash or shares in
another, usually larger company. For example, an IPO is a liquidity event.
Lock-up agreement: investors, management and employees often agree not to sell their shares for a specific time period after an IPO, usually 6 to 12
months. By avoiding large sales of its stock, the company has time to build interest among potential buyers of its shares.
LP: see Limited partner.
Management buyout (MBO): a leveraged buyout controlled by the members of the management team of a company or a division.
Management fee: a fee charged to the limited partners in a fund by the general partner. Management fees in a private equity fund typically range from
0.75% to 3% of capital under management, depending on the type and size of fund.
Management rights: the rights often required by a venture capitalist as part of the agreement to invest in a company. The venture capitalist has the right to
consult with management on key operational issues, attend board meetings and review information about the company’s financial situation.
Market capitalization: the value of a publicly traded company as determined by multiplying the number of shares outstanding by the current price per
share.
MBO: see Management buyout.
Mezzanine: a layer of financing that has intermediate priority (seniority) in the capital structure of a company. For example, mezzanine debt has lower
priority than senior debt but usually has a higher interest rate and often includes warrants. In venture capital, a mezzanine round is generally the round of
financing that is designed to help a company have enough resources to reach an IPO.
Middle stage: the state of a company when it has received one or more rounds of financing and is generating revenue from its product or service. Also
known as “growth stage.”
Multiples: a valuation methodology that compares public and private companies in terms of a ratio of value to an operations figure such as revenue or net
income. For example, if several publicly traded computer hardware companies are valued at approximately 2 times revenues, then it is reasonable to assume
that a startup computer hardware company that is growing fast has the potential to achieve a valuation of 2 times its revenues. Before the startup issues its
IPO, it will likely be valued at less than 2 times revenue because of the lack of liquidity of its shares. See Liquidity discount.
Narrow-based weighted average ratchet: a type of anti-dilution mechanism. A weighted average ratchet adjusts downward the price per share of the
preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received.
Investor A’s preferred stock is repriced to a weighted average of investor A’s price and investor B’s price. A narrow-based ratchet uses only common stock
outstanding in the denominator of the formula for determining the new weighed average price.
NDA: see Non-disclosure agreement.
Non-compete: an agreement often signed by employees and management whereby they agree not to work for competitor companies or form a new
competitor company within a certain time period after termination of employment.
Non-cumulative dividends: dividends that are payable to owners of preferred stock at a specific point in time only if there is sufficient cash flow available
after all company expenses have been paid. If cash flow is insufficient, the owners of the preferred stock will not receive the dividends owed for that time
period and will have to wait until the board of directors declares another set of dividends.
Non-interference: an agreement often signed by employees and management whereby they agree not to interfere with the company’s relationships with
employees, clients, suppliers and sub-contractors within a certain time period after termination of employment.
Non-solicitation: an agreement often signed by employees and management whereby they agree not to solicit other employees of the company regarding job
opportunities.
Non-disclosure agreement (NDA): an agreement issued by entrepreneurs to protect the privacy of their ideas when disclosing those ideas to third parties.
Offering memorandum: a legal document that provides details of an investment to potential investors. See Private placement memorandum.
OID: see Original issue discount.
Optics: the way a concept is presented. Sometimes entrepreneurs’ presentations are strong on optics but weak in content.
Options: see Stock options.
Option pool: a group of options set aside for long term, phased compensation to management and employees.
Original issue discount (OID): a discount from par value of a bond or debt-like instrument. In structuring a private equity transaction, the use of a preferred
stock with liquidation preference or other clauses that guarantee a fixed payment in the future can potentially create adverse tax consequences. The IRS
views this cash flow stream as, in essence, a zero coupon bond upon which tax payments are due yearly based on “phantom income” imputed from the
difference between the original investment and “guaranteed” eventual payout. Although complex, the solution is to include enough clauses in the investment
agreements to create the possibility of a material change in the cash flows of owners of the preferred stock under different scenarios of events such as a
buyout, dissolution or IPO.
Orphan: a startup company that does not have a venture capitalist as an investor.
Outstanding shares: the total amount of common shares of a company, not including treasury stock, convertible preferred stock, warrants and options.
Oversubscription: when demand exceeds supply for shares of an IPO or a private placement.
Pay or play: a clause in a financing agreement whereby any investor that does not participate in a future round agrees to suffer significant dilution compared
to other investors. The most onerous version of “pay to play” is automatic conversion to common shares, which in essence ends any preferential rights of an
investor, such as the right to influence key management decisions.
Pari passu: a legal term referring to the equal treatment of two or more parties in an agreement. For example, a venture capitalists may agree to have
registration rights that are pari passu with the other investors in a financing round.
Participating dividends: the right of holders of certain preferred stock to receive dividends and participate in additional distributions of cash, stock or other
assets.
Participating preferred stock: a unit of ownership composed of preferred stock and common stock. The preferred stock entitles the owner to receive a
predetermined sum of cash (usually the original investment plus accrued dividends) if the company is sold or has an IPO. The common stock represents
additional continued ownership in the company. Participating preferred stock has been characterized as “having your cake and eating it too.”
PE ratio: see Price earnings ratio.
Piggyback rights: rights of an investor to have his or her shares included in a registration of a startup’s shares in preparation for an IPO.
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PIPEs: see Private investment in public equities.
Placement agent: a company that specializes in finding institutional investors that are willing and able to invest in a private equity fund. Sometimes a
private equity fund will hire a placement agent so the fund partners can focus on making and managing investments in companies rather than on raising
capital.
Portfolio company: a company that has received an investment from a private equity fund.
Post-money valuation: the valuation of a company including the capital provided by the current round of financing. For example, a venture capitalist may
invest $5 million in a company valued at $2 million “pre-money” (before the investment was made). As a result, the startup will have a post-money
valuation of $7 million.
PPM: see Private placement memorandum.
Preference: seniority, usually with respect to dividends and proceeds from a sale or
dissolution of a company.
Preferred stock: a type of stock that has certain rights that common stock does not have. These special rights may include dividends, participation, liquidity
preference, antidilution protection and veto provisions, among others. Private equity investors usually purchase preferred stock when they make investments
in companies.
Pre-money valuation: the valuation of a company prior to the current round of financing. For example, a venture capitalist may invest $5 million in a
company valued at $2 million pre-money. As a result, the startup will have a “post-money” valuation of $7 million.
Price earnings ratio (PE ratio): the ratio of a public company’s price per share and its net income after taxes on a per share basis.
Primary shares: shares sold by a corporation (not by individual shareholders).
Private equity: equity investments in non-public companies.
Private investment in public equities (PIPES): investments by a private equity fund in a publicly traded company, usually at a discount.
Private placement: the sale of a security directly to a limited number of institutional and qualified individual investors. If structured correctly, a private
placement avoids registration with the Securities and Exchange Commission.
Private placement memorandum (PPM): a document explaining the details of an investment to potential investors. For example, a private equity fund will
issue a PPM when it is raising capital from institutional investors. Also, a startup may issue a PPM when it needs growth capital. Also known as “Offering
Memorandum.”
Private securities: securities that are not registered with the Securities and Exchange Commission and do not trade on any exchanges. The price per share is
negotiated between the buyer and the seller (the “issuer”).
Promote: see Carried interest.
Prospectus: a formal document that gives sufficient detail about a business opportunity for a prospective investor to make a decision. A prospectus must
disclose any material risks and be filed with the Securities and Exchange Commission.
Prudent man rule: a fundamental principle for professional money management which serves as a basis for the Prudent Investor Act. The principle is based
on a statement by Judge Samuel Putnum in 1830: “Those with the responsibility to invest money for others should act with prudence, discretion, intelligence
and regard for the safety of capital as well as income.”
Qualified IPO: a public offering of securities valued at or above a total amount specified in a financing agreement. This amount is usually specified to be
sufficiently large to guarantee that the IPO shares will trade in a major exchange (NASDAQ or New York Stock Exchange).
Quartile: one fourth of the data points in a data set. Often, private equity investors are measured by the results of their investments during a particular period
of time. Institutional investors often prefer to invest in private equity funds that demonstrate consistent results over time, placing in the upper quartile of the
investment results for all funds.
Ratchet: a mechanism to prevent dilution. An anti-dilution clause is a contract clause that protects an investor from a reduction in percentage ownership in a
company due tothe future issuance by the company of additional shares to other entities.
Realization ratio: the ratio of cumulative distributions to paid-in capital. The realization ratio is used as a measure of the distributions from investment
results of aprivate equity partnership compared to the capital under management.
Recapitalization: the reorganization of a company’s capital structure.
Red herring: a preliminary prospectus filed with the Securities and Exchange Commission and containing the details of an IPO offering. The name refers to
the disclosure warning printed in red letters on the cover of each preliminary prospectus advising potential investors of the risks involved.
Redeemable preferred: preferred stock that can be redeemed by the owner (usually a venture capital investor) in exchange for a specific sum of money.
Redemption rights: the right of an investor to force the startup company to buy back the shares issued as a result of the investment. In effect, the investor
has the right to take back his/her investment and may even negotiate a right to receive an additional sum in excess of the original investment.
Registration: the process whereby shares of a company are registered with the Securities and Exchange Commission under the Securities Act of 1933 in
preparation for a sale of the shares to the public.
Registration rights: the rights of an investor in a startup regarding the registration of a portion of the startup’s shares for sale to the public. Piggyback rights
give the shareholders the right to have their shares included in a registration. Demand rights give the shareholders the option to force management to register
the company’s shares for a public offering. Often times registration rights are hotly negotiated among venture capitalists in multiple rounds of financing.
Regulation D: an SEC regulation that governs private placements. Private placements are investment offerings for institutional and accredited individual
investors but not for the general public. There is an exception that 35 non-accredited investors can participate.
Restricted shares: shares that cannot be traded in the public markets.
Return on investment (ROI): the proceeds from an investment, during a specific time period, calculated as a percentage of the original investment. Also,
net profit after taxes divided by average total assets.
Rights offering: an offering of stock to current shareholders that entitles them to purchase the new issue, usually at a discount.
Rights of co-sale with founders: a clause in venture capital investment agreements that allows the VC fund to sell shares at the same time that the founders
of a startup chose to sell.
Right of first refusal: a contractual right to participate in a transaction. For example, a venture capitalist may participate in a first round of investment in a
startup and request a right of first refusal in any following rounds of investment.
Road show: presentations made in several cities to potential investors and other interested parties. For example, a company will often make a road show to
generate interest among institutional investors prior to its IPO.
ROI: see Return on investment.
Rollup: the purchase of relatively smaller companies in a sector by a rapidly growing company in the same sector. The strategy is to create economies of
scale. For example, the movie theater industry underwent significant consolidation in the 1960’s and 1970’s.
Round: a financing event usually involving several private equity investors.
Rule 144: a rule of the Securities and Exchange Commission that specifies the conditions under which the holder of shares acquired in a private transaction
may sell those shares in the public markets.
S corporation: an ownership structure that limits its number of owners to 100. An S corporation does not pay taxes, rather its owners pay taxes on their
proportion of the corporation’s profits at their individual tax rates.
Small Business Investment Company (SBIC): a company licensed by the Small
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Business Administration to receive government loans in order to raise capital to use in venture investing.
Scalability: a characteristic of a new business concept that entails the growth of sales and revenues with a much slower growth of organizational complexity
and expenses. Venture capitalists look for scalability in the startups they select to finance.
Scale-down: a schedule for phased decreases in management fees for general partners in a limited partnership as the fund reduces its investment activities
toward the end of its term.
Scale-up: the process of a company growing quickly while maintaining operational and financial controls in place. Also, a schedule for phased increases in
management fees for general partners in a limited partnership as the fund increases its investment activities over time.
SEC: see Securities and Exchange Commission.
Secondary market: a market for the sale of partnership interests in private equity funds. Sometimes limited partners chose to sell their interest in a
partnership, typically to raise cash or because they cannot meet their obligation to invest more capital according to the takedown schedule. Certain
investment companies specialize in buying these partnership interests at a discount.
Secondary shares: shares sold by a shareholder (not by the corporation).
Security: a document that represents an interest in a company. Shares of stock, notes and bonds are examples of securities.
Securities and Exchange Commission (SEC): the regulatory body that enforces federal securities laws such as the Securities Act of 1933 and the Securities
Exchange Act of 1934.
Seed capital: investment provided by angels, friends and family to the founders of a startup in seed stage.
Seed stage: the state of a company when it has just been incorporated and its founders are developing their product or service.
Senior debt: a loan that has a higher priority in case of a liquidation of the asset or company.
Seniority: higher priority.
Series A preferred stock: preferred stock issued by a fast growth company in exchange for capital from investors in the “A” round of financing. This
preferred stock is usually convertible to common shares upon the IPO or sale of the company.
Spin out: a division of an established company that becomes an independent entity.
Stock: a share of ownership in a corporation.
Stock option: a right to purchase or sell a share of stock at a specific price within a specific period of time. Stock purchase options are commonly used as
long term incentive compensation for employees and management of fast growth companies.
Strategic investor: a relatively large corporation that agrees to invest in a young company in order to have access to a proprietary technology, product or
service. By having this access, the corporation can potentially achieve its strategic goals.
Subordinated debt: a loan that has a lower priority than a senior loan in case of a liquidation of the asset or company. Also known as “junior debt”.
Sweat equity: ownership of shares in a company resulting from work rather than investment of capital.
Syndicate: a group of investors that agree to participate in a round of funding for a company. Alternatively, a syndicate can refer to a group of investment
banks that agree to participate in the sale of stock to the public as part of an IPO.
Syndication: the process of arranging a syndicate.
Tag-along rights: the right of an investor to receive the same
Takedown: a schedule of the transfer of capital in phases in order to complete a commitment of funds. Typically, a takedown is used by a general partner of
a private equity fund to plan the transfer of capital from the limited partners.
Takeover: the transfer of control of a company.
Ten bagger: an investment that returns 10 times the initial capital.
Term sheet: a document confirming the intent of an investor to participate in a round of financing for a company. By signing this document, the subject
company agrees to begin the legal and due diligence process prior to the closing of the transaction. Also known as “Letter of Intent”.
Trade secret: something that is not generally known, is kept in secrecy and gives its owners a competitive business advantage.
Turnaround: a process resulting in a substantial increase in a company’s revenues, profits and reputation.
Two x: an expression referring to 2 times the original amount. For example, a preferred stock may have a “two x” liquidation preference, so in case of
liquidation of the company, the preferred stock investor would receive twice his or her original investment.
Under water option: an option is said to be under water if the current fair market value of a stock is less than the option exercise price.
Underwriter: an investment bank that chooses to be responsible for the process of selling new securities to the public. An underwriter usually chooses to
work with a syndicate of investment banks in order to maximize the distribution of the securities.
Venture capital: a segment of the private equity industry which focuses on investing in new companies with high growth rates.
Venture capital method: a valuation method whereby an estimate of the future value of a company is discounted by a certain interest rate and adjusted for
future anticipated dilution in order to determine the current value. Usually, discount rates for the venture capital method are considerably higher than public
stock return rates, representing the fact that venture capitalists must achieve significant returns on investment in order to compensate for the risks they take
in funding unproven companies.
Vintage: the year that a private equity fund stops accepting new investors and begins to make investments on behalf of those investors.
Voting rights: the rights of holders of preferred and common stock in a company to vote on certain acts affecting the company. These matters may include
payment of dividends, issuance of a new class of stock, merger or liquidation.
Warrant: a security which gives the holder the right to purchase shares in a company at a pre-determined price. A warrant is a long term option, usually
valid for several years or indefinitely. Typically, warrants are issued concurrently with preferred stocks or bonds in order to increase the appeal of the stocks
or bonds to potential investors.
Washout round: a financing round whereby previous investors, the founders and management suffer significant dilution. Usually as a result of a washout
round, the new investor gains majority ownership and control of the company.
Weighted average ratchet: an anti-dilution protection mechanism whereby the conversion rate of preferred stock is adjusted in order to reduce an investor’s
loss due to an increase in the number of shares in a company. Without a ratchet, an investor would suffer from a dilution of his or her percentage ownership.
Usually as a result of the implementation of a weighted average ratchet, company management and employees who own a fixed amount of common shares
suffer significant dilution, but not as badly as in the case of a full ratchet.
Wipeout round: see Washout round.
Wipeout bridge: a short term financing that has onerous features whereby if the company does not secure additional long term financing within a certain
time frame, the bridge investor gains ownership control of the company. See Bridge financing.
Write-down: a decrease in the reported value of an asset or a company.
Write-off: a decrease in the reported value of an asset or a company to zero.
Write-up: an increase in the reported value of an asset or a company.
Zombie: a company that has received capital from investors but has only generated sufficient revenues and cash flow to maintain its operations without
significant growth. Typically, a venture capitalist has to make a difficult decision as to whether to kill off a zombie or continue to invest funds in the hopes
that the zombie will become a winner.
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Private Equity

Industry & Interview Guide

Copyright 2014 by WallStreetOasis.com. All rights reserved.

Daniel Sheyner has worked as a Private Equity

Daniel’s industry expertise stems from his years as a

Welcome to the PE Prep Package

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What This Guide Will Teach You

Common Traits of Successful PE Candidates

In this chapter… This chapter is a high level overview

Industry Structure Diagram

Fund Fund Fund

PE firm uses funds to do deals

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BRIEF INDUSTRY HISTORY

Origin (1946 – 1950s)

Early Growth Stage (1950s – 1981)

The first boom and bust (1982 – 1992)

The second boom and bust (1993 – 2002)

The third boom and bust (2003 – 2009)

This unprecedented boom was driven by several factors:

Thoughts for the future

Know This 1 Fact About PE History

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Global PE Capital Raised by Fund Type

US Buyout Deal Value

PE Deal Types Table

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Dimension 1: Fund size

Dimension 3: Vertical Focus

Dimension 4: Geographic Focus

Dimension 5: Diligence Philosophy

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Other Revenue Sources

Illustrative Fund Economics5

Senior Associate / Vice President (VP)

Vice President (VP) / Principal

Partner / Managing Director (MD)

“Show Me the Money!”

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In this chapter… This chapter describes how the PE

 A deal can come from several sources:

(Timing x One of a PE firm’s existing portfolio companies finds a potential add-on

(4-12+ x Regulatory approval must be obtained

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3 Actual Examples of a Teaser, NDA, and CIM

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Here is What an IOI Looks Like

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Staple Financing 101: What is it and Why do Banks Offer it?

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3 Material Adverse Changes (MACs) to Watch Out For

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Cash Out: • Equity • Equity for add-on acquisitions (if

- Next Financial Buyer (NFB) analysis

- Sum of the-Parts Analysis

- Acquisition / divestiture accounting: Are any reported pro-forma statements accurate

A deal can come from several sources: