Private Equity Preparation

These pages are dedicated towards modeling / case study prep. I want to limit repetitive information you can find elsewhere online. For detail about what is PE, different types of PE strategies, and what the associate role looks like ---scroll to the bottom.

8 Private Equity LBO Models Available for Premium Subscribers under the 'Models & Case Studies' filter!

Modeling / Case Studies:

The LBO. Every single PE interview will require you to build out an LBO model. After all, buying companies with leverage is the crux of the job. To get start with prep, I'd recommend cranking through a few Paper LBOs. Check out our free Paper LBO prompt and answer key here: Paper LBO

Next, you'll need to start building full 3-statement LBOs in excel. We have plenty of real case studies with answers from firms like Oaktree, Apollo, Blackstone, and more ---all available to Premium Subscribers.

Below, I will detail some key components to know to crush your PE case studies. Readers of my undergraduate banking / consulting recruiting newsletter: The Pulse will recognize many of these points!

Components of a Good LBO Candidate:

Stable and predictable free cash flow generation and a high retention customer base
A deep competitive mote and a semi-monopolistic business model providing a critical need
Strong industry tailwinds
Reasonable leverage profile
Strong management team

How the LBO Process Works:

Significant diligence and assessment of comparative valuations to determine the relative value of the business in question
Draft assumptions of the purchase price by applying an LTM EBITDA multiple or adding a premium to the stock price (if the company is public)
Create a Sources & Uses to assess the amount of financing needed for the transaction (want as much leverage as possible to boost your return)
Spread out the Income Statement over the forecasted period plugging in assumptions for relevant line items
Project out cash flows over the hold period using all excess cash to pay down debt
Calculate a closing and new balance sheet to use for the balance sheet projections. Make sure all sources & uses + other balance sheet adjustments, such as write-ups, are accounted for
Build a debt schedule using the newly added debt to assess debt paydown throughout the forecasted period
Project a balance sheet throughout the forecasted period using your 'new' balance sheet as the year 0 basis
Build a returns analysis by applying an exit multiple to last year's EBITDA and then pay off all outstanding debt. Your end value is your exit equity value
Calculate the net gain, MOIC, and IRR from year 0 (equity check written) to the final year of the investment (equity check expected to be received). Compare the calculated IRR with your fund's hurdle rate to determine the viability of the investment (PE funds typically look for 20-25% IRRs)
Conduct a sensitivity analysis testing IRR & MOIC by stressing key inputs such as entry multiple and exit multiple

Key Scenarios to Account for:

Management Earnout: A portion of the exit equity value is sanctioned to incentivize the management to perform exceptionally
Dividend Recap: Borrow more debt at a point throughout the life of the investment to pay yourself a dividend
PIK Interest: Interest accrues to the principal balance of the loan and is not a periodic cash outflow
OID and Financing Fees: Capitalized on the balance sheet, amortized throughout the life of the loan, and treated as add-backs for FCF
Asset Write-Ups / Write-Downs: Added to the respective assets impacted and deducted from goodwill on the balance sheet, amortized over their useful lives on the income statement, and added back to FCF

MOIC & IRR Math:

2.0x MOIC = 15% IRR
2.5x MOIC = 20% IRR
3.0x MOIC = 25% IRR
3.5x MOIC = 30% IRR

Please note that these are approximations and ONLY work for 5-year investments with NO intermittent cash flow. Thankfully, most cases are based on a 5-year horizon

Levers for Juicing Returns:

Multiple Expansion: Sell a company for a greater multiple than what you bought it
Dividend Recap: Borrow more debt to pay yourself a dividend
Convert Cash to PIK: Allows you to recognize intermittent cash flows and enhance the time value of money
Operational Synergies: Cut costs or expand revenue to enhance value
Rapid Debt Paydown: Repay debt quickly to boost the equity value at exit
Roll-Up: Buy similar businesses for cheap to dominate markets and grow the consolidated value

A Little Bit About PE:

This is going to be brief, I do not want to waste time on areas you can just Google.

Private equity is the buying and selling of cash-flowing businesses using debt to enhance returns. Buying a company with a bunch of debt is called a leveraged buyout (LBO). On paper, PE firms have the ability to manage a company and change operations. In reality, there is very little time spent on operationally enhancing a portfolio company.

A fund raises capital from Limited Partners (LPs) such as insurance companies, endowments, and pension funds to buy companies and sell them within a 5-7 year horizon. PE is a lucrative business model because most funds deploy a 2/20 model (2% management fee on all AUM, 20% on excess returns from investments). Funds sell businesses to a). other funds, b). to strategic buyers, or c). to public markets investors by taking the company through an IPO. Most sales involve a sale to another fund.

Large funds tend to buy large companies. Small funds tend to buy small companies. Everyone tries to make a 20-25% IRR on their investments.

Different Types of PE:

Also, will not spend a ton of time here because you can find this detail on Google.

Private equity is broadly split across Mega-Fund ($100bn+ AUM), Upper-Middle Market ($500mm - $1bn AUM), Middle Market ($250mm - $500mm AUM), and Lower-Middle Market strategies (less than $250mm AUM).

Different Strategies:

Buyout (LBOing companies)--most PE roles are buyout
Tech (purely focused on investing in tech companies, may include some growth equity-style investments)
Buy & Build (focus on making operational improvements--will see this in funds with longer-term capital)
Distressed / Special Situations (buying companies that are not performing well or making hybrid debt / equity investments)
Secondaries (investing in other funds)
Infrastructure / Real Estate (buying real assets)

The Associate Role:

PE is often referred to as banking 2.0---this is largely true at the junior level. Being an associate in private equity is basically the same as being an analyst in banking, except you have more responsibility and are expected to perform at a higher level of intensity.

Your core responsibilities include:

Once again, you're doing the grunt work. However, there is no room for error. These are investments that your bosses may have substantial money invested via carry. So, they care about every little detail and rely on you to do things right without being told twice / needing hand-holding.

Most sourcing work, board meetings, LP conversations, and investment ideas are taken care of by seniors at the fund.

So, why even go into PE if it is basically banking 2.0?

You need to take a long-term view here. Do you want to be your banking MD pitching shit all day to generate advisory fees? Or do you want to be your PE principal working to source deals and generate a paycheck from buying and selling businesses?

The latter tends to be more interesting work for most people. In PE, even as an associate, you get to wear an investor's hat. You get to look at companies and form a view on whether or not they are good to invest in. In banking, you just do what the client tells you and the bank puts very little money at risk.

^If you want to stick around in finance for a while, investing tends to be the better place to be in terms of money / lifestyle / interesting work. If you know you want to be an entrepreneur or leave finance, then I don't think PE is really going to teach you anything critical or do much more for your resume than banking would.