Private Equity Interview Guide

PRIVATE EQUITY INTERVIEW GUIDE
Table of Contents
Introduction ..............................................................................................................................................................2
Private Equity Overview ........................................................................................................................................2
Types of Private Equity ..........................................................................................................................................3
On The Job ...............................................................................................................................................................5
Roles ......................................................................................................................................................................5
Career Path .............................................................................................................................................................6
Responsibilities.......................................................................................................................................................7
Preparing For the Interview ....................................................................................................................................9
General Questions ..................................................................................................................................................9
Technical Questions .............................................................................................................................................10
Case Studies..........................................................................................................................................................11
LBO Modeling......................................................................................................................................................14
LBO On Paper.............................................................................................................................................14
LBO On Computer ......................................................................................................................................19
Additional Information ..........................................................................................................................................35
Recommended Readings ......................................................................................................................................35
1
Introduction
This guide is designed for students seeking to find an investment position in the private equity industry.
There are two major roles in most private equity firms: investment and portfolio roles. Associates joining the
investment team will be responsible for deal origination/execution and monitoring of portfolio companies at the
board level. On the other hand, associates joining the portfolio team can either join one of the companies’ operations
team or work as an in-house strategy consultant for the portfolio companies. In some companies these roles have
significant overlap, and the division of roles and responsibilities between these two teams is heavily influenced by
the investment strategy of the private equity firm.
PRIVATE EQUITY OVERVIEW
Private Equity is a broad term used to describe firms that invest in non-publicly traded assets. This encompasses a
broad array of investment types, from minority (less than 50%) equity stakes to control (51% - 100%) investments.
Private Equity firms invest capital raised from outside investors including fund of funds, pension funds, sovereign
wealth funds, endowments, and wealthy individuals. The firm is generally structured as limited partnerships with
investment horizons of five to ten years, depending on the investment strategy.
Private Equity firms use this sourced capital to make investments according to their defined investment strategy,
and are compensated based on the returns they generate. A typical partnership follows the “two and twenty”
structure: firms earn 2% of total asset value (fund size) and 20% of any returns.
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TYPES OF PRIVATE EQUITY FIRMS
Growth Capital (also referred to as Growth Equity): Growth capital investments typically consist of a private
equity firm making a majority or minority ownership stake in an early-stage company. These investment
opportunities normally involve companies that are more developed than classic VC investment companies, making
them less risky than VC investments, but with less upside potential.
Growth equity firms extensively research various industries and market trends in order to identify attractive
investment opportunities. They are looking for companies where they can add significant value in order to help
companies realize their market potential and become market leaders in their respective industries. This expertise
can come in a variety of forms including strategic guidance, industry relationships, operational support, management
expertise, and efficient capital allocation. A successful growth equity investment will typically return at least a 3x
multiple of invested capital to investors. A few notable growth equity firms include General Atlantic, Golden Gate
Capital, TA Associates, and Warburg Pincus.
Mezzanine Financing: A private equity firm may offer mezzanine financing in the form of subordinated debt
(junior to senior debt) or preferred equity, where return expectations are typically around 15%-20% per year.
Mezzanine financing, in general, usually involves investor compensation in the form of interest combined with
upside participation (i.e., equity or options/warrants on equity). Companies will often search for other sources of
capital before turning to mezzanine capital, because it is expensive. However, this type of capital can help fill the
gap between senior debt and equity when a private equity firm considers a leveraged buyout—mezzanine financing
effectively lowers the required amount of equity capital invested in a leveraged buyout, and the equity capital has a
higher required rate of return. Therefore, mezzanine financing, while expensive, can help reduce the overall required
rate of return on the capital used to execute the LBO, by lowering the required equity investment, and thereby make
some LBO deals feasible that otherwise were not.
Leveraged Buyout (“LBO”): A leveraged buyout is the acquisition of a publicly or privately-held company,
typically characterized by the significant amount of debt financing used for the acquisition relative to the equity
financing used. LBOs are the bread-and-butter investment strategy for most private equity firms. In an LBO
transaction, a PE firm (also called a financial sponsor) or a group of firms (called a consortium or investor group)
acquire the target company using debt instruments for the majority of the purchase price (debt typically represents
about 60-75% of the total price). The leveraged buyout relies heavily on the future cash flows of the acquired
business to service the interest expense on the debt and, additionally, pay down the outstanding debt as quickly as
possible. (This pay-down is usually small at first, because the initial interest expense burden is substantial, but
typically the pay-down amount grows each year as the company’s cash flow grows and as the outstanding debt
balance decreases from previous pay-downs.) As the debt balance is lowered and the company’s value increases,
the equity very quickly grows as a proportion of the company’s capital structure. It is this deleveraging process that
can help lead to substantial gains for the equity holders in a successful LBO investment.
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Top LBO PE firms are characterized by their large fund size; they are able to make the largest buyouts and take on
the most debt. However, LBO transactions come in all shapes and sizes. Total transaction sizes can range from tens
of millions to tens of billions of dollars, and can occur on target companies in a wide variety of industries and
sectors.
Due to their reliance on high leverage, LBO firms must be adept at creating optimal capital structures for their target
companies (a process sometimes referred to as “financial engineering”). LBO firms rely on financial engineering as
a skill that is core to their investment strategy—much more so than growth equity firms, who focus almost
exclusively on company value creation. Well-known LBO firms include KKR, Blackstone, The Carlyle Group,
TPG Capital, Goldman Sachs Private Equity, and Bain Capital.
Source: Street of Walls
4
On The Job
ROLES
Like investment banks, Private Equity firms typically have a fairly rigid seniority structure with big differences in
experience level and responsibilities from top to bottom. In general the senior-most professionals (VPs and up) are
responsible for deal sourcing, relationship management, and investment decision making, while the junior-most
professionals carry the brunt of the analytical workload. However, unlike investment banks, private equity firms
tend to employ a fairly flat hierarchy structure with fewer layers.
ASSOCIATE/SENIOR ASSOCIATE: Pre-MBA associates are typically the most junior professionals at the
majority of PE firms. The associate handles most of the financial modelling and initial due diligence for investment
opportunities, and also assisting with the management and monitoring of portfolio companies.
A majority of Pre-MBA associates are hired for a two-year to three-year program. At the completion of the program,
associates are typically expected to attend a top-tier MBA program. Smaller firms will often promote associates to
senior associates, and those firms in general tend to provide more opportunities for internal promotions to more
senior roles. On the flip side, large LBO firms generally have a more regimented hierarchy and firm structure where
the roles are more defined for associates, and where there are limited internal promotion opportunities and limited
opportunities to get involved in deal sourcing. Most PE hierarchies start at the Pre-MBA associate level, and
associates will usually have 2-3 years of prior experience in investment banking or (sometimes) strategy consulting.
VICE PRESIDENT/SENIOR VICE PRESIDENT/PRINCIPAL: Vice Presidents, Senior Vice Presidents, and
Principals typically manage the daily responsibilities of the deal teams and work closely with the senior partners of
the firm on strategy and negotiations. Professionals in these roles are also expected to generate investment
opportunities and potential acquisition ideas. Compensation for a VP or Principal varies depending on the size of
the PE firm. PE firms will almost always offer some amount of carried interest in the fund to employees at this
level.
VPs/Principals manage internal due diligence streams by themselves and have a large role in negotiations. They
typically have an MBA degree from a top-tier business school, and one of their main responsibilities is to source
investment opportunities by cultivating and maintaining relationships with investment bankers, consultants, and
others. VPs/Principals also usually manage the pre-MBA Associates.
MANAGING DIRECTOR/PARTNER: Managing Directors and Partners are the most senior members of the
firm and are the ultimate decision makers. They interact directly with the management of portfolio companies, target
companies, and investment banks, they conduct negotiations, they source deals, and they deal routinely with or may
even sit on the PE firm’s Investment Committee. A typical managing director receives significant compensation in
terms of carried interest in the PE fund(s).
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CAREER PATH
Career trajectory into and within private equity is far less structured than investment banking or consulting. Once
at a private equity firm, despite the general mobility and performance-based atmosphere of most private equity
firms, moving to new positions within the company can be difficult. Promotion is often tied with the successful
execution or transactions – acquisitions, refinancings, and exits. The table below outlines a stereotypical career
progression within a PE firm:
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RESPONSIBILITIES
As mentioned in the introduction, responsibilities within a PE firm fall into two broad categories: investment and
operational. The typical process for evaluating and completing a new private equity investment opportunity has
many different and structured steps that can vary widely by PE firm, and can differ greatly due to specifics of the
target company or the transaction process. The initial investment evaluation can happen very quickly, but the
entire process may take several months or even a year or more.
Deal sourcing: Fund managers will assess the various opportunities brought by investment bankers, brokers, and
other contacts in their networks. Typically, no more than 25 per cent of the deals are proprietary—the rest comes
from the bankers (50 per cent) and from affiliated funds or advisors (25 per cent). Some firms have a thorough
process of monitoring thousands of public and private companies to identify underperformers or companies with
non-core assets and excess costs. Most big firms will have to analyse hundreds of targets.
Due diligence: During the due diligence, they will select and monitor their various advisors (investment bankers,
lawyers, accountants, management consultants and other specialised advisors), often leaving the investment
bankers with the responsibility of coordinating the team.
Financial structure: The fund manager will discuss the financial structure and the use of leverage with the debt
and mezzanine finance providers. They may have to get approval from the General Partners.
Investment Committee: Often working within a team, the fund manager will put together the various elements of
the investment case and will submit it to the investment committee, composed of the senior partners and some of
their advisors.
Post-acquisition: The performance of the companies in the portfolio is constantly monitored and actions are
taken if the results deviate from the tight plan that was agreed upon with the management. Some firms will just
have a fund manager sitting on the board of the company; some will delegate one of their employees to work with
the executive team; others will put entire teams of operational consultants to work.
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Exit: After a period of three to seven years, the portfolio company should have repaid a substantial part of its
debt. Hopefully, the new company has a reasonable leverage ratio and can be sold with a handsome profit to the
public through an IPO, to another PE firm, or to a strategic investor through a trade sale. In recent years,
numerous secondary and tertiary transactions have occurred, when further growth in the ownership of a bigger
private equity firm is considered the best option, i.e., the option that maximises the current value of the portfolio
company.
Source: Vault
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Preparing For the Interview

In case you have no previous experience in investment banking, we advise you to study the valuation and accounting
questions in the LBS Investment Banking Recruitment Guide.
GENERAL QUESTIONS
General
 Why do you want to work in private equity?
 Why our firm?
 Are you interested in [add private equity firm’s industry expertise]?
 Why did you choose investment banking/consulting?
 What characteristics do you think are needed to be a successful private equity professional?
 5 years from now, where do you see yourself? 10 years?
 What do you like to do in your spare time?
 What is the most recent book you have read?
Behavioural
 What would your previous boss say if I asked him/her where you needed to improve?
 What would your study group say about you?
 What would a first year analyst in your previous job say about you?
 What happened when you worked in a team and one member wasn’t contributing appropriately? How did you
respond?
 What do you feel are your greatest strengths? Greatest weaknesses?
 Are you risk-averse or risk-seeking? Under what conditions do you seek risk the most and why?
 If I asked your senior manager, what would he or she say about you?
 What motivates you?
 Why should we hire you?
 What is the biggest risk you took in your life?
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TECHNICAL QUESTIONS
Be prepared to talk about your previous transaction experience in case you come from a career in investment
banking.
General Technical Questions
 Tell me about the deals you participated while you were working in investment banking
- Do you think it was a good deal? Did the acquirer overpay?
- Why did the deal happen?
- Where did the synergies come from?
 Tell me about one of our investments that you liked and why
 Tell me about one of our investments that you did not like and why
 If I gave you $10bn, where would you invest? Give me a top down view, covering the macro trends, sector
trends, relevant players, etc.
 Tell me about 2 industries/stocks that you like
 Tell me about 2 industries/stocks that you do not like
 What is your view on the global, European, British economy?
 How would you motivate management?
 What are the pros and cons of using mezzanine to finance a transaction? In which cases will you consider it?
What should you be aware of?
 Give an example of an industry with high Capex, with no Capex.
Private Equity or Finance-specific questions
 What makes a good LBO candidate?
 Walk me through the mechanics of an LBO model
 Walk me through the calculation of free cash flow
 How do you model in PIK notes?
 What three questions would you ask a CEO of a company you were looking to invest in?
 How would you decide what amount of leverage to use in building a company’s capital structure?
 What do you think lenders care most about when evaluating a capital structure?
 What are some of the reasons EBITDA multiples might be different across industries?
 Company A has depreciation overstated by $10mm. Walk me through the impact of this overstatement on the
financial statements
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CASE STUDIES
Case studies are very common components of private equity interviews, particularly at the Associate and Vice
President level. Unlike consulting case studies, the private equity version is set up to ask one question: Should we
invest in this company? Materials are typically provided in advance of the interview, allowing for anywhere from a
day to a week to complete an investment recommendation. In some situations, the materials may be given to the
interviewee at the interview with 2-3 hours to complete the analysis.
The information packets will usually consist of an abbreviated Confidential Information Memorandum (“CIM”)
containing a brief company and product overview, market information, historical and projected financials, and
customer/supplier information. The firm usually won’t give guidance on how to value the company or how to build
your models, because, well that’s the point of the case study.
Sample Presentation Output Structure
1. Summary slide stating investment recommendation and brief overview

a. Should we invest?
b. What are the major factors that influenced this recommendation?
c. Hedge decision by covering 1-2 key risks
2. 2-3 qualitative slides discussing market, management, etc.
a. Market: Is this an industry that’s growing? Will it grow more quickly/slowly in future years? Do
you see positive or negative trends due to technology/regulations/competitors?
b. Competition: How does this company fare against its competitors? Does it have some type of
unique advantage that others can’t replicate? What about the barriers to entry?
c. Growth Opportunities: How quickly can the company grow in the future? Do you expect it to grow
faster or slower than the market as a whole?
d. Risks: Every investment carries with it risks – are the key risks here related to the market, or the
economy as a whole? To the competition? To government regulations? Customer/supplier
concentration? Include ways to attempt to mitigate these risks, either in brief bullets or verbally
when you present the recommendation.
3. 3-4 quantitative slides covering valuation and returns
a. Valuation Overview: How much is this company worth, and what methodologies are you basing
it on? This is where the “football field” goes.
b. Valuation Detail: Here you can show the public comps and transaction comps, along with DCF
output (if relevant). Depending on the company and situation, you may be using different or
additional methodologies as well – this is most common for real estate, energy, and financial
services.
c. LBO Model Output: It isn’t necessary to print out every page of the model, just show the
assumptions and the output of the model under a range of sensitivities. These are the pages a lot of
interviewers like to pick apart, so having sensitivities around the large assumptions can help
provide leeway when explaining why you chose certain values.
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i. Common pages: Assumptions, Sources & Uses, simple Income Statement/Balance

Sheet/Cash Flow Statement/Debt Schedule, Returns & Sensitivities.
4. Conclusion slide reiterating summary slide
a. Rephrase summary slide
b. Include additional detail on the purchase price levels that are attractive
Source: Mergers & Inquisitions
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Mini-case studies:
Valuation Multiples
The interviewer may ask you to solve these cases during the interview. These are not difficult, so you should answer
them very quick.
We have two companies, A and B, with the same enterprise value of $100m. They are from the same industry and
sell basically the same products. The LTM EV/EBITDA multiple for companies A and B is 10x and the forward
EV/EBITDA multiple for company A is 8x and for company B is 10x.
 Give me 4 reasons why they trade at different multiples
 What is the EBITDA growth of company A?
 If the EBITDA of company B were to grow 5%, what would be the new forward multiple?
Business / Accounting Case
Imagine a production line where there are two steps involved in manufacturing products A and B. In the first step,
one person operates a machine, which processes raw materials into materials that will be used in step two. In the
second step there are two persons operating two different machines (one person each). One machine produces
product A and the other produces product B. After step 2, the products are ready to be sold.
 What are the costs involved in the production of products A and B?
 Where and how these costs would be allocated to a P&L?
 What if you wanted a P&L by product, how would you allocate costs?
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LBO MODELLING
LBO on Paper
The interviewer will give you pen and paper and ask you to calculate IRR and money multiple. You will have to
build the LBO from scratch and will ask questions to do so. In addition, you will be asked to break down the IRR
into the different levers, i.e. operational improvement (EBITDA growth), leverage, and multiple expansion.
Example (Source: Street of Walls)
An illustrative example of a paper LBO is provided below in 5 simple steps. In a paper LBO exercise, you will be
expected to complete the important components of a working LBO model with the use of paper and pencil and
without the use of a computer.
Given LBO Parameters and Assumptions
 XYZ Private Equity Partners purchases ABC Target Company for 5.0x Forward 12 months (FTM) EBITDA
at the end of Year 0.
 The debt-to-equity ratio for the LBO acquisition will be 60:40.
 Assume the weighted average interest rate on debt to be 10%.
 ABC expects to reach $100 million in sales revenue with an EBITDA margin of 40% in Year 1.
 Revenue is expected to increase by 10% year-over-year (y-o-y).
 EBITDA margins are expected to remain flat during the term of the investment.
 Capital expenditures are expected to equal 15% of sales each year.
 Operating working capital is expected to increase by $5 million each year.
 Depreciation is expected to equal $20 million each year.
 Assume a constant tax rate of 40%.
 XYZ exits the target investment after Year 5 at the same EBITDA multiple used at entry (5.0x FTM EBITDA).
 Assume all debt pay-down occurs at the moment of sale at the end of Year 5 (this eliminates the
iterative/circular dependency between debt pay-down/cash balances and interest expense in a computer-based
LBO model).
1. CALCULATE THE PURCHASE PRICE OF ABC.
Using a 5.0x entry multiple, calculate the price paid by multiplying by Year 1 EBITDA. $40 million in EBITDA
(which represents a 40% EBITDA margin on $100 million in revenue) multiplied by 5. The purchase price is $200
million.
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2. CALCULATE THE DEBT AND EQUITY FUNDING AMOUNTS USED FOR THE PURCHASE PRICE.
The given information assumes debt to equity ratio of 60:40 for the purchase price.
Debt portion = 60% × $200 million, or $120 million.
Equity portion = 40% × $200 million, or $80 million.
3. BUILD THE INCOME STATEMENT.
(Notice that, because the exit value at the end of Year 5 will be based on a forward EBITDA multiple, we must
calculate six years’ worth of income statement, not 5. Also note that the numbers might not agree perfectly because
of rounding. It is reasonable to round your intermediate calculations to the nearest integer in carrying over
calculations to the next step.)
1. Project revenue: Revenue is expected to grow 10% annually.

$100 million Year 1 sales × (1 + 10% growth rate) = $110 million sales in Year 2.
$110 million Year 2 sales × (1 + 10% growth rate) = $121 million sales in Year 3.
$121 million Year 3 sales × (1 + 10% growth rate) = $133.1 million sales in Year 4.
2. Use EBITDA margin to calculate EBITDA.

$100 million Year 1 sales × 40% EBITDA margin = $40 million Year 1 EBITDA.
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3. Subtract Depreciation & Amortization (D&A) to get EBIT.

$40 million Year 1 EBITDA – $20 million D&A = $20 million Year 1 EBIT. (etc. for Years 2-6)
4. Calculate interest expense using the debt amount used for purchase multiplied by the interest rate to
calculate the yearly interest expense line item.
$120 million of debt × 10% interest rate = $12 million interest expense per year.
5. Calculate Earnings Before Tax (EBT).

$20 million Year 1 EBIT – $12 million int. exp. = $8 million Year 1 EBT. (etc. for Years 2-6)
6. Subtract taxes using the tax rate to get to tax-effected EBT (a proxy for Net Income).
$8 million Year 1 EBT × 40% tax rate = $3 million taxes, so $5 million Year 1 t/e EBT.
4. CALCULATE CUMULATIVE LEVERED FREE CASH FLOW (FCF).
1. Start with EBT (Tax-effected) and then add back non-cash expenses (D&A).
$5 million Year 1 tax-effected EBT + $20 million D&A.
2. Subtract capital expenditures (Capex).

(NOTE: We do not need Year 6 capital expenditures, or Free Cash Flow for that matter, because EBITDA does
not incorporate capex and because only FCF in Years 1-5 can be used to pay down debt.)
$100 million Year 1 sales × 15% capex/sales = $15 million Year 1 capital expenditures.
3. Subtract the annual increase in operating working capital to get to Free Cash Flow (FCF).
$5mm Y1 t/a EBT + $20mm D&A – $15mm Y1 capex – $5mm NWC = $5mm Year 1 FCF.
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4. Calculate Cumulative Free Cash Flow during the life of the LBO.
Cumulative FCF until exit equals total debt pay-down, if it is assumed that 100% of FCF is used to pay down
debt. (This is a standard assumption for a basic LBO model.)
$5 mm Year 1 FCF + $5 mm Year 2 FCF + $7 mm Year 3 FCF + $8 mm Year 4 FCF +
$9 mm Year 5 FCF = $34 mm Cumulative FCF.
5. CALCULATE ENDING PURCHASE PRICE (EXIT VALUE) AND RETURNS
1. Calculate Total Enterprise Value (TEV) at Exit.

Take Forward EBITDA at exit (Year 6 EBITDA) along with a 5.0x exit multiple to calculate Exit TEV. $64 million
Year 6 EBITDA × 5.0x multiple = $320 million Enterprise Value at Exit.
2. Calculate Net Debt at Exit (also known as Ending Debt).

Beginning Debt – Debt Pay-down = Ending Debt.
$120 million in Beginning Debt – $34 million in Cumulative FCF = $86 million in Ending Debt.
3. Calculate ending Equity Value (EV) by subtracting Ending Debt from Exit TEV.
$320 Exit TEV – $86 million Ending Debt = $234 million Ending EV.
4. Calculate the Multiple-of-Money (MoM) EV return (Ending EV ÷ Beginning EV).

$234 million Ending EV ÷ $80 Beginning EV = 2.93x MoM.
5. Estimate IRR based on the MoM multiple.

The following table is useful for estimating IRR based upon 5-year MoM multiples:
2.0x MoM over 5 years ~15% IRR
Therefore, we can assume that the implied IRR for the paper LBO case study is approximately 25%, or slightly
below. (It is actually very close to 24%.)
The following is the full paper LBO case study exhibit, calculated using Excel rather than pen and paper. As a result,
some of the numbers might be slightly different, as rounding has been eliminated:
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FINAL STEPS
Make sure to take your time and calculate every formula correctly since this is not a race, and any error that you
make will flow through the model you’re building. If you catch a mistake part-way through, you will have to go
back and correct it—sometimes causing you to have to recalculate nearly everything, and possibly leading to
compounding mistakes on top of the original one.
In addition, the interviewer will ask you to walk through your thought process and calculations. Thus it is important
to be able to build the proper paper LBO in simple, accurate steps, and make sure you can walk through the reasoning
regarding the process and each calculation. This takes practice, so be sure to practice at least one more paper LBO
before your next private equity interview.
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LBO on Computer
The interviewer will give you a laptop computer with a blank Excel spreadsheet. You are expected to build a LBO
model in 45-120 minutes using either numbers provided or any numbers.
Example
When interviewing for a junior private equity position, a candidate must prepare for in-office modeling tests on
potential private equity investment opportunities—especially LBO scenarios. In this module, we will walk through
an example of an in-office LBO modeling test. In-office case studies and modeling tests can occur at various stages
of an interview process, and additional interviews with other members of the private equity team could occur on the
same day. Therefore, you should strive to be able to do these studies effectively and efficiently without draining
yourself so much that you can’t quickly rebound and move on to the next interview. Make sure to take your time
and build every formula correctly, since this process is not a race. There are many complex formulas in this test, so
make sure you understand every calculation.
This type of LBO test will not be mastered in a day or even a week. You must therefore begin practicing this
technique in advance of meeting with headhunters. Repeated practice, checking for errors and difficulties and
learning how to correct them, all the while enhancing your understanding of how an LBO works, is the key to
success.
In the following LBO Case Study module, we will cover the following key areas:
 Investment Scenario Overview
 Given Information (Parameters and Assumptions)
 Exercises:
Step 1: Income Statement Projections
Step 2: Transaction Summary
Step 3: Pro Forma Balance Sheet
Step 4: Full Income Statement Projections
Step 5: Balance Sheet Projections
Step 6: Cash Flow Statement Projections
Step 7: Depreciation Schedule
Step 8: Debt Schedule
Step 9: Returns Calculations
GIVEN INFORMATION (PARAMETERS AND ASSUMPTIONS)
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Below we provide the given information from a real-life LBO test that was given to a pre-MBA associate candidate
at a large PE firm. We will use it as an example of how to build an LBO model from scratch during the interview.
Remember that candidates will receive a laptop and a printout with key information regarding the transaction to
complete this assignment.
ABC Company, Inc.
SCENARIO OVERVIEW AND REVENUE ASSUMPTIONS:
ABC Company, Inc. is a developer of software applications for smartphone devices. The company sells two
products for the various smartphones. The first is a software application called Cloud that tracks weather data. The
second application, Time, acts as a calendar that keeps track of a user’s schedule. ABC Company prices Cloud at
$16.00 and Time at $36.00 per software license. ABC Company sold 1.5 million copies of Cloud and 3 million
copies of Time in 2010. That was the first year ABC Company generated any revenue.
Each software application requires the payment of a $5.00 renewal fee every year. ABC Company renews
approximately 25% of the licenses it sold in the prior year; this renewal fee acts as a source of recurring revenue.
To simplify, assume that renewals happen for only one additional year and that the recurring revenue stream is
based on the prior year’s new licenses. Note that ABC Company does not incur any additional costs for renewals.
COGS ASSUMPTIONS (ASSUME CONSTANT THROUGHOUT THE PROJECTION PERIOD):
 Packaging costs = $1.50 per unit
 Royalties to technology patent owners = $3.00 per unit
 Marketing expense = $3.00 per unit
 Fulfilment expense = $4.00 per unit
 Fees to smartphone companies = 15% of sale price (does not include renewal fees)
 ABC Company incurs a 15% bad debt allowance on total revenues (consider this as part of cost of sales,
wherein ABC Company is unable to collect from customers’ credit card companies).
G&A AND OTHER ASSUMPTIONS (ASSUME CONSTANT THROUGHOUT THE PROJECTION PERIOD):
 Rent of development property and warehouse facilities = $350,000 annually
 License fee to telecom internet providers = $1.5 million annually
 Salaries and benefits = $1.75 million annually
 Sales commissions = 5% of all sales including renewals
 Offices and other administrative costs = $750,000 annually
 CEO salary and bonus = $1.25 million annually + 3% of all sales including renewals
 Federal tax rate = 35% and state tax rate = 5% on EBT
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STARTING BALANCE SHEET:
INVESTMENT ASSUMPTIONS:
Due to the depressed macroeconomic and investing environment, the PE fund is able to acquire ABC Company for
the inexpensive purchase price of 5.0x 2011 EBITDA (assuming a cash-free debt-free deal), which will be paid in
cash. The transaction is expected to close at the end of 2011.
Assumptions include the following:
 Senior Revolving Credit Facility: 3.0x (2.0x funded at close) 2011 EBITDA, LIBOR + 400bps, 2017 maturity,
commitment fee of 0.50% for any available revolver capacity. RCF is available to help fund operating cash
requirements of the business (only as needed).
 Subordinated Debt: 1.5x 2011 EBITDA, 12% annual interest (8% cash, 4% PIK interest), 2017 maturity, $1
million required amortization per year. (Hint: add the PIK interest once you have a fully functioning model
that balances.)
 Assume that existing management expects to rollover 50% of its pre-tax exit proceeds from the transaction.
Existing management’s ownership pre-LBO is 10%.
 Assume a minimum cash balance (Day 1 Cash) of $5 million (this needs to be funded by the financial sponsor,
as the transaction is a cash-free / debt-free deal).
 Assume that all remaining funding comes from the financial sponsor.
 Assume that all cash beyond the minimum cash balance of $5 million and the required amortization of each
tranche is swept by creditors in order of priority (i.e. 100% cash flow sweep).
 Assume that LIBOR for 2012 is 3.00% and is expected to increase by 25bps each year.
21
 The M&A fee for the transaction is $1.5 million. Assume that the M&A fee cannot be expensed (amortized)
by ABC and will be paid out of the sponsor equity contribution upon close.
 In addition, there is a financing syndication fee of 1% on all debt instruments used. This fee will be amortized
on a five-year, straight-line schedule.
 Assume New Goodwill equals Purchase Equity Value less Book Value of Equity.
 Assume Interest Income on average cash balances is 1%.
Hint: The first forecast year for the model will be 2012. However, you will need to build out the income statement
for 2010 and 2011 to forecast the financial statements for years 2012 through 2016.
EXERCISES:
As part of the in-person LBO test, pre-MBA and post-MBA candidates are expected to complete the following
exercises in their entirety. Please note the assumptions given here apply for multiple scenarios:
 Build an integrated three-statement LBO model including all necessary schedules (see below).
 Build a Sources and Uses table.
 Make adjustments to the closing balance sheet of ABC Company post-acquisition.
 Build an annual operating forecast for ABC Company with the following scenarios (using 2010 as the first
year for the revenue forecast; note that 2010 EBITDA should be approximately $25 million). Assume that in
2011 there is 5% growth in units sold (both Cloud and Time units).
 2012-2016 assumptions include:
- Upside Case: 5% annual growth in units sold (both Cloud and Time units)
- Conservative Case: 0% annual growth in units sold (both Cloud and Time units)
- Downside Case: 5% annual decline in units sold (both Cloud and Time units)
 Build a Working Capital schedule using Accounts Receivable Days, Accounts Payable Days, Inventory Days,
and other assets and liabilities as a percentage of Revenue. Assume working capital metrics stay constant
throughout the projection period and assume 365 days per year.
 Build a Depreciation Schedule that assumes that existing PP&E depreciates by $1 million per year, and that
new capital expenditures of $1.5 million per year depreciate on a five-year, straight-line basis.
 Build a Debt schedule showing the capital structure described earlier. Use average balances for calculating
Interest Expense (except for PIK interest—assume that PIK interest is calculated based on the beginning year
Subordinated Debt balance and not the average over the year).
 Create an Exit Returns schedule (including both cash-on-cash and IRR) showing the returns to the PE firm
equity based on all possible year-end exit points from 2012 to 2016, with exit EBITDA multiples ranging from
4.0x to 7.0x.
22
 Display the results of all of these calculations using the “Upside Case.”
Note that the above description incorporates all of the information, assumptions and assignments that were given in
this LBO in-person test example.
STEP 1: INCOME STATEMENT PROJECTIONS
As part of the first step, build out the core operating Income Statement line items for years 2010 through 2016.
Based on the provided assumptions, the Upside Case estimates an annual increase of 5.0% for Revenue from 2012-
2016. Next, you should build the following exhibit in Excel in order to be able to change the case scenarios easily
(with the selected case driving the revenue growth numbers in the operating model).
 Make a distinction between 2011 assumptions and 2012-2016 assumptions
 Take the provided assumptions, make the revenue, and cost build based upon them.
Note that the highlighted “1” is the input to the operating model, and the “5.0%” in grey background represents the
formula that is built to pick up the appropriate case. We use the =OFFSET() function in Excel to drive this formula.
 OFFSET is a simple Excel formula that is used commonly to interchange scenarios, especially if the model
becomes very complex. It simply reads the value in a cell that is located an appropriate number of
rows/columns away, based on the parameters given to the function. Thus, for example, =OFFSET(A1, 3, 1)
will read the value in cell B4 (3 rows and 1 column after A1).
Next, build the costs related to Revenue based upon the information given in the case.
23
Then, build the G&A expenses from the given information.
Finally, build a simple summary schedule for the above projections.
24
STEP 2: TRANSACTION SUMMARY
As part of the second step, build out the transaction summary section which will consist of the Purchase Price
Calculation, Sources and Uses, and the Goodwill calculation.
Using this graphic, you should be able to understand and build all the formulas. Be sure to think through each
number and how it is calculated, as this is the main summary of the LBO transaction as a whole. A few points worth
noting:
 This model assumes a debt-free/cash-free balance sheet pre-transaction for simplification. Without debt or
cash, the transaction value is simply equal to the offer price for the equity (before fees and minimum cash—
discussed below).
 The funding for this model is fairly simple: the funded credit facility is 2.0x 2011E EBITDA, the subordinated
debt is 1.5x, and the remaining portion is the equity funding, which is a combination of management rollover
equity and sponsor (PE firm) equity. (Note that the 5.0x 2011E EBITDA is the offer value for the equity before
the M&A and financing fees and the minimum cash balance, not after. After fees/cash, it ends up being 5.25x.)
 The management rollover is simply half of the management team’s proceeds from selling the company. Since
management owned 10% of the company before the transaction, it constitutes 5% of the offer price for the
original equity.
 The sponsor equity is the “plug” in this calculation. In other words, it is the amount that is solved for once all
other amounts are known (offer price + minimum cash + fees – debt instruments – management rollover
equity).
 The total equity (including management rollover) represents about 30-35% of the funding for the deal, which
is about right for a typical LBO transaction.
 Goodwill is simply the excess paid for the original equity (offer price – book value of equity).
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STEP 3: PRO FORMA BALANCE SHEET
As a next step, build out the Pro Forma Balance Sheet using the given 2011 balance sheet. To do this, you need to
incorporate all the transaction and financing-related adjustments needed to produce the Pro Forma Balance Sheet.
Each adjustment is discussed in detail below.
 Since this is a cash-free and debt-free deal to start, there are no Pro Forma adjustments for the cancelling or
refinancing of debt.
 Cash increases by $5 million upon close because the sponsor is funding the minimum cash balance (minimum
cash that is assumed to be needed to run the business).
 The New Goodwill is simply the purchase value of the equity (not including fees) less the original book value
of the equity.
 The adjustment for Debt Financing Fees reflects the cost of issuing the new debt instruments to buy the
company. This fee is considered an asset, and is capitalized and amortized over 5 years.
 The Debt-related adjustments reflect the new debt instruments for the new capital structure.
 The Equity adjustment reflects the fact that the original equity is effectively wiped out in the transaction—the
“adjustment” amount shown here is simply the difference between the new equity value and the old one. The
new equity value will equal the amount of the total equity funding for the transaction (sponsor plus
management’s rollover) less the M&A fee, which is accounted for as an off balance sheet cost.
 VERY IMPORTANT: This stage of the LBO model development (once Pro Forma adjustments have been
made to reflect the impact of the transaction on the balance sheet) is a very good time to check to make sure
that everything in the model so far balances and reflects the given assumptions. This includes old and new
assets equalling old and new liabilities plus equity; new sources of capital equalling the transaction value,
which equals the offer price for the original equity (adjusting for cash, old debt, and fees), etc.
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STEP 4: FULL INCOME STATEMENT
Next, build the full Income Statement projections all the way down to Net Income. Note that a few line items
(especially Interest Expense!) will be calculated in later steps. Once the Cash Flow section and other schedules are
built, link all the final line items to complete the integrated financials.
 You can link the Revenue, COGS and SG&A calculations to the operating model (built in Step 1) to get to
EBITDA.
 To get from EBITDA to Net Income, set up the framework first (include line items to subtract D&A, and to
subtract Interest and fees, to get to EBT. Then subtract taxes to get Net Income—but keep in mind for now
that calculating D&A and Interest will come a bit later, from other schedules you have not yet created).
 D&A will be linked to the Depreciation Schedule that you will need to build (schedule of the Depreciation of
the existing PP&E and new Capital Expenditures made over the projection period).
 Interest Expense and Interest Income will be linked to the Debt Schedule that you will need to build. There
will be a natural circular reference because of the cash flow sweep feature of the LBO model, combined with
the fact that Interest Expense is dependent upon Cash balances. This is usually one of the last things you should
build in an LBO model.
 The amortization of Deferred Financing Fees is fairly straightforward: it uses a straight-line, 5-year
amortization of the fees described in the case write-up and computed in Step 2.
 The tax rates apply to EBT after all of these expenses have been subtracted out. They are given in the case
write-up.
STEP 5: BALANCE SHEET PROJECTIONS
Next, forecast the Balance Sheet from 2011 to 2016. Note that we start with the 2011 Pro Forma Balance Sheet
from Step 3, not the original Balance Sheet.
27
 Laying out the Balance Sheet is similar to laying out the Income Statement—you will have to set up the
framework for some line items and leave the formulas blank at first, as they will be calculated in the other
schedules you will create.
 Cash remains at $5 million throughout the life of the model, as we are assuming a 100% cash flow sweep and
that the minimum cash balance is $5 million. (Cash would only start to increase if we project out long enough
that all outstanding Debt is paid off.)
 You will need to build out the Operating Working Capital line items (Accounts Receivable, Inventory, Other
Current Assets, Accounts Payable, Other Current Liabilities) according to the assumptions stated in the case
write-up.
 Accounts Receivable (AR): Calculate AR days (AR ÷ Total Revenue × 365) for 2011 and keep it constant
throughout the projection period.
 Inventory: Calculate Inventory days (Inventory ÷ COGS × 365) for 2011 and keep it constant throughout the
projection period.
 Other Current Assets: Keep this line item as a constant percentage of revenue throughout the projection period.
 Accounts Payable (AP): Calculate AP days (AP ÷ COGS × 365) for 2011 and keep it constant throughout the
projection period.
 Other Current Liabilities: Keep this line item as a constant percentage of revenue throughout the projection
period.
 Total Deferred Financing Fees are computed based upon the Debt balances and percentage assumptions given
in the model. Deferred financing fees are then amortized, straight-line, over 5 years.
28
 The Credit Facility and Subordinated Debt line items will link to your Debt schedule. Their balances will
decrease over time as a function of the cash available for Debt pay down (since the case write-up specifies a
100% cash sweep function).
 Equity (specifically Retained Earnings) will increase each year by the same amount as Net Income, because
there are no dividends being declared. If dividends were to be added into the model, you would calculate ending
Retained Earnings as Beginning Retained Earnings + Net Income – Dividends Declared.
 As discussed earlier, the balance sheet has the pleasing feature that if it balances, the model is probably
operating correctly! Now is another good time to make sure everything balances before proceeding.
STEP 6: CASH FLOW STATEMENT PROJECTIONS
Next, forecast the Cash Flow Statement as requested in the Exercises section.
The primary purpose of the Cash Flow Statement in the integrated financial model is to calculate the Levered Free
Cash Flow (LFCF) being generated by the business. This is for obvious reasons: cash generation is very important
in the eyes of PE investors, as it is used to pay down debt and thereby increase equity value (and thereby decrease
future interest burdens on the business, which helps to decrease risk over time).
 Start with Net Income and add back non-cash expenses from the Income Statement, such as D&A, Non-Cash
Interest (PIK), and Deferred Financing Fees.
 Next, subtract uses of Cash that are not reflected in the Income Statement. These include the increase in
Operating Working Capital (which you calculated using your balance sheet) and Capital Expenditures (which
is calculated here or, alternatively, could be calculated in the Depreciation Schedule to be built shortly).
 Next, calculate the change in cash, which will be interconnected with the Debt schedule. In this case, the model
is assuming a 100% cash flow sweep (after mandatory debt amortization payments), so cash should not change
after the 2011PF Balance Sheet amount of $5 million.
 Even though the amount is not changing, the Cash line item should link back to the Balance Sheet. This is
because the model could later be used to relax the assumption that 100% of excess cash is swept to pay down
Debt. If it is less than 100%, Cash would accumulate, and that would need to tie in to the other financial
statements.
29
STEP 7: DEPRECIATION SCHEDULE
Next, forecast the Depreciation schedule as requested in the Exercises section.
The Depreciation schedule is broken into two parts:
 The original PP&E is depreciated $1 million annually, as stated in the assumptions.
 New Depreciation is calculated based on the annual investment in Capital Expenditures over the projection
period. This new Depreciation is created using a waterfall (see above): each year new Capital Expenditures
occur and need to be depreciated; each year, Capital Expenditures from previous projection years in the model
may have to be partially depreciated in that year. The sum of all of the component Depreciation line items (one
row for each year, plus the Depreciation on the original PP&E) gives the total Depreciation Expense for the
year.
Note that this model is less complex than it could be. Given that Capital Expenditures do not change each year, and
that each new Capital Expenditure is depreciated according to the same simple schedule, the numbers and
calculations are fairly straightforward. Here, we’re simply assuming that new Capital Expenditures are expensed
evenly over a 5 year period (using straight-line depreciation), as specified in the case write-up.
STEP 8: DEBT SCHEDULE
Next, forecast the Debt Pay down and Interest Expenses for each year via the Debt Schedule, as requested in the
Exercises section.
30
 We need to build this schedule correctly! The Debt Schedule is probably the trickiest part of the LBO model
to build—especially for anyone who has not built an LBO model before. The Debt Schedule will create the
circular (iterative) reference that is the defining characteristic of a true LBO model. Before linking the Debt,
Cash, and Interest calculations to one another in the Debt schedule, be sure to turn “Iterations” on in the
Formulas section of Microsoft Excel’s Options menu.
 WARNING: Be very careful about changing formulas once you have built the iterative calculation. If you do
so and introduce an error, it could bust your entire model if you are not careful. This is because the error will
travel all the way through the iterative calculations and end up everywhere! If you run into this problem, break
the circular reference entirely (by deleting it), reconstruct the calculations for the first forecast year (2012), and
then copy and paste them across the columns, one year at a time (2013, then 2014, etc.). Many PE professionals
have spent late nights in the office trying to recover from an accidental error introduced into a circular LBO
model formula!
 To compute the changes in Debt balances, calculate LFCF (the framework for this started already on the
Statement of Cash Flows). This determines how much debt is going to be paid down (both discretionary and
non-discretionary).
 The non-discretionary portion is the required amortization payments made on debt (in this case, there is only
required pay-down for subordinated debt).
 The discretionary portion is the sweep portion of the remaining LFCF less required amortization. Since we are
assuming a 100% cash flow sweep, all of the LFCF is used to pay down debt—first the Senior Credit Facility,
then the Subordinated Debt. The cash flow sweep and required payments will help you calculate the beginning
and ending balances of both of the debt tranches.
31
 The Senior/Revolving Credit Facility (S/RCF) is the first priority to be paid off via the cash flow sweep. It
should be completely paid off before later tranches receive any discretionary principal repayment in the Debt
Schedule.
 Also, note that we need to include a fee for the availability of the unused portion of the RCF, even if the
business never uses it—this is a typical, annual commitment fee arrangement for revolving credit facilities.
 The interest rate on the debt is a floating rate (this means an interest rate that is dependent on LIBOR, according
to the assumptions provided). We need to calculate interest based on this rate times the average S/RCF balance
over the year.
 Subordinated debt is the second priority to be paid off through the cash flow sweep. Other than required
amortization, none of the Subordinated Debt is paid off before the S/RCF is fully paid off.
 The 8% cash interest is calculated based upon the average of the debt balance, just like with the S/RCF.
 However, the 4% PIK (non-cash) interest will accrue based upon the beginning debt balance, not the average.
 Because of this difference (and the fact that one source of interest uses cash and the other does not), we need
to make sure we are using separate line items for the two types of Interest Expense.
 We also need to be aware of the mandatory amortization payment of $1 million per year, provided in the
assumptions. This amount will be paid down out of LFCF no matter what.
 Interest Income on Cash is fairly easy to calculate—it is the Cash interest rate (1%) times the average balance
throughout the year. This amount will increase Cash.
 When we have finished with these calculations, we need to link these line items to various line items in the
integrated financial statement.
 Total Interest needs to be linked to the Income Statement.
 Non-Cash Interest needs to be added back to Net Income in the Statement of Cash Flows to assist in deriving
LFCF (it is a non-cash expense).
 Any LFCF that is not used to pay down Debt needs to link to the Cash line item of the Balance Sheet. (In this
model, none will, but you should include this measure in case the model is later used either to relax the 100%
cash sweep assumption, or to project financials beyond the point at which all debt has been paid off).
 All Debt balances paid down by LFCF need to link to the Debt line items on the Balance Sheet.
STEP 9: RETURNS CALCULATIONS
In the final step of the LBO test, build out the Returns calculation required in the Exercises section.
32
 The last portion of the model to complete is the Equity Returns schedule. This is essentially a simple calculation
based upon the outputs generated by rest of the model.
 For each year, we simply take EBITDA multiplied by a range of purchase multiples to get to a total Exit Value
for the company (Transaction Enterprise Value, or TEV).
 Next, we subtract out Net Debt (which is dependent on the 3-statement model you just created) to get to Equity
Value.
 Next, we calculate the portion of the Equity Value that belongs to the management and the sponsor by using
the initial equity breakdown for each party.
 From there it is important to calculate both the internal rate of return (IRR) and the cash-on-cash returns (also
known as the Multiple of Money or Multiple of Invested Capital). The only tricky part of this calculation is to
make sure that you are calculating IRR correctly, by using the correct Net Present Value or IRR formula and
that, very importantly, you are discounting by the right number of years! After all the mental energy you have
expended to get to this point, it is easy to make this mistake.
 Put simply, the IRR is equal to the cash-on-cash returns compounded by the number of years, minus 1. Thus,
for example, for the 5-year, 5.0x Exit Multiple scenario:
33
LBO CASE STUDY: CONCLUSION AND FINAL COMMENTS
We hope that this case study provides some insight into all of the considerations that need to be made in building a
realistic LBO model based on a case study in a Private Equity interview, and that the 9-step breakdown helps you
simplify the task into easy-to-replicate and easy-to-execute steps.
No one becomes an expert LBO modeler overnight, so the key to doing well in this portion of the process is practice,
practice, and more practice. With enough sample LBO cases, you should be able to master the steps needed to
confidently build a fully functioning, professional LBO model on interview day.
34
Additional Information
RECOMMENDED READING
General
 Barbarians at the Gate; John Helyar and Bryan Burrough

 The New Financial Capitalists: Kohlberg Kravis Roberts and the Creation of Corporate Value; George P.
Baker and George David Smith
 King of Capital; David Carey
 Den of Thieves; James B. Stewart
 Margin of Safety; Seth Klarman
 Fooling Some of the People All of the Time; David Einhorn
 The Intelligent Investor; Benjamin Graham
 Thinking Fast and Slow; Daniel Kahneman
Technical
 Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions; Joshua Rosenbaum and
Joshua Pearl
 Private Equity as an Asset Class; Guy Fraser-Sampson
 Distressed Debt Analysis: Strategies for Speculative Investors; Stephen G. Moyer
35

Private Equity Interview Guide

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Private Equity Interview Guide

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PRIVATE EQUITY INTERVIEW GUIDE

Private Equity Overview ........................................................................................................................................2

Types of Private Equity ..........................................................................................................................................3

On The Job ...............................................................................................................................................................5

Career Path .............................................................................................................................................................6

Preparing For the Interview ....................................................................................................................................9

General Questions ..................................................................................................................................................9

Technical Questions .............................................................................................................................................10

LBO On Computer ......................................................................................................................................19

Additional Information ..........................................................................................................................................35

Recommended Readings ......................................................................................................................................35

PRIVATE EQUITY OVERVIEW

TYPES OF PRIVATE EQUITY FIRMS

Source: Street of Walls

Source: Street of Walls

Source: Street of Walls

Preparing For the Interview

 Why do you want to work in private equity?

 Why our firm?

 Are you interested in [add private equity firm’s industry expertise]?

 Why did you choose investment banking/consulting?

 5 years from now, where do you see yourself? 10 years?

 What do you like to do in your spare time?

 What is the most recent book you have read?

 What would your study group say about you?

 What do you feel are your greatest strengths? Greatest weaknesses?

 What motivates you?

 Why should we hire you?

 What is the biggest risk you took in your life?

General Technical Questions

- Do you think it was a good deal? Did the acquirer overpay?

- Why did the deal happen?

- Where did the synergies come from?

 Tell me about 2 industries/stocks that you like

 Tell me about 2 industries/stocks that you do not like

 What is your view on the global, European, British economy?

 How would you motivate management?

 Give an example of an industry with high Capex, with no Capex.

Private Equity or Finance-specific questions

 What makes a good LBO candidate?

 Walk me through the mechanics of an LBO model

 Walk me through the calculation of free cash flow

 How do you model in PIK notes?

Sample Presentation Output Structure

1. Summary slide stating investment recommendation and brief overview

i. Common pages: Assumptions, Sources & Uses, simple Income Statement/Balance

Source: Mergers & Inquisitions

 Give me 4 reasons why they trade at different multiples

 What is the EBITDA growth of company A?

Business / Accounting Case

 What are the costs involved in the production of products A and B?

 Where and how these costs would be allocated to a P&L?

Example (Source: Street of Walls)

Given LBO Parameters and Assumptions

 The debt-to-equity ratio for the LBO acquisition will be 60:40.

 Assume the weighted average interest rate on debt to be 10%.

 Revenue is expected to increase by 10% year-over-year (y-o-y).

 Capital expenditures are expected to equal 15% of sales each year.

 Operating working capital is expected to increase by $5 million each year.

 Depreciation is expected to equal $20 million each year.

 Assume a constant tax rate of 40%.

1. CALCULATE THE PURCHASE PRICE OF ABC.