LBO (PE Questions) with 100% Correct
Answers
Can you walk me through how you might make an investment decision based on the
output from an LBO model? ✅1) Determine investment criteria (IRR and MoM multiple)
2) Build projections and look at LBO model output for Base Case. If numbers work, build
projections for Downside Case
3) Back up decision with qualitative criteria.
Why might you recommend AGAINST a deal even if the IRRs and MoM multiples are
favorable in the Downside, Base, and Upside cases? ✅You might recommend against
a deal if there's a problem with the industry, such as a lack of good exit strategies, or
credit markets that won't support the deal.
Why might you decide IN FAVOR of a deal even if the IRRs and MoM multiples are
NOT favorable across the different cases? ✅You might recommend a deal if the
numbers are "borderline," and you believe there's an easy way to boost them above the
thresholds.
How does a Returns Attribution Analysis for an LBO affect your investment decision?
✅This analysis makes an impact because certain returns sources are considered more
favorable than others.
If a deal is predicated on Multiple Expansion, you should be very skeptical because
Multiple Expansion is highly speculative and often fails to materialize. If a deal depends
mostly on EBITDA Growth, it's more credible because it's easier to grow a company's
business than to increase its multiple. Debt Paydown and Cash Generation is
somewhere in the middle - it indicates that the deal depends on financial engineering
more than core business growth.
What makes an industry more appealing or less appealing to invest in? ✅An industry
is more appealing if it's growing quickly and highly fragmented, and the company is a
clear leader (in the top 2-3 positions) in the industry. PE firm can acquire other
companies.
An industry is less appealing if it's highly consolidated, in decline, or if it's highly
speculative. A high rate of technological change and low barriers to entry also make an
industry less appealing because cash flows are unlikely to be stable.
If a company has $10 million in revenue and $5 million in EBITDA, is it most appealing
as an investment candidate if it plans to grow by selling 20% more units, raising its
prices by 20%, or cutting its expenses by 20%? ✅It's most appealing if it grows by
raising prices by 20%. If the company does this, everything will "flow through" to
, EBITDA: The $2 million in extra revenue will result in an additional $2 million of
EBITDA.
If the company sells 20% more units, it will incur higher variable costs, and its EBITDA
will increase by less than $2 million. Expense reduction of 20% will result in only $1
million of additional EBITDA, which makes less of an impact than the price increase.
Investors tend to favor companies with significant pricing power because it means they
have less serious competition and can grow with less friction.
How might a PE firm reduce its downside risk if a leveraged buyout does not perform
well? ✅Much of the risk in leveraged buyouts comes from multiple contraction: The
Exit Multiple might be lower than the Purchase Multiple.
The best way to reduce this risk is to avoid acquiring companies trading at relatively
high multiples and to focus on companies that are undervalued in some way.
Other methods: companies with Tangible Assets to sell off, use more Debt, acquire
smaller stake, improve company operations.
How would you review a Confidential Information Memorandum (CIM) or other
marketing materials and decide whether to pursue an acquisition of a company?
✅Read Executive Summary then skip to financials to see if LBO math works.
If it does, read market//industry overview section, look at the industry growth rates, the
competitors, and assess how this company stands out from others.
After reading a company's CIM, you decide to meet with the CEO. What are the top 3
questions you would ask him/her? ✅You'd focus on questions that are not answered in
the CIM, so the best questions depend heavily on the company, its industry, and how
much information is disclosed in the CIM.
How might you convince the management team of a company to agree to a leveraged
buyout? ✅The company could take its time to execute long-term plans away from the
scrutiny of quarterly earnings calls and the public markets, the management could own
a higher percentage through incentives (Equity Rollover, options), offer a high price.
How would you present an investment recommendation on a potential LBO candidate?
✅You'd start by giving a clear "Yes" / "No" recommendation and stating the 3-4 main
reasons that explain your decision.
Then, go into the qualitative and market factors and the numbers that support your
recommendation, including a summary of output from the LBO model; you would also
demonstrate that the deal works even in Downside cases.
Answers
Can you walk me through how you might make an investment decision based on the
output from an LBO model? ✅1) Determine investment criteria (IRR and MoM multiple)
2) Build projections and look at LBO model output for Base Case. If numbers work, build
projections for Downside Case
3) Back up decision with qualitative criteria.
Why might you recommend AGAINST a deal even if the IRRs and MoM multiples are
favorable in the Downside, Base, and Upside cases? ✅You might recommend against
a deal if there's a problem with the industry, such as a lack of good exit strategies, or
credit markets that won't support the deal.
Why might you decide IN FAVOR of a deal even if the IRRs and MoM multiples are
NOT favorable across the different cases? ✅You might recommend a deal if the
numbers are "borderline," and you believe there's an easy way to boost them above the
thresholds.
How does a Returns Attribution Analysis for an LBO affect your investment decision?
✅This analysis makes an impact because certain returns sources are considered more
favorable than others.
If a deal is predicated on Multiple Expansion, you should be very skeptical because
Multiple Expansion is highly speculative and often fails to materialize. If a deal depends
mostly on EBITDA Growth, it's more credible because it's easier to grow a company's
business than to increase its multiple. Debt Paydown and Cash Generation is
somewhere in the middle - it indicates that the deal depends on financial engineering
more than core business growth.
What makes an industry more appealing or less appealing to invest in? ✅An industry
is more appealing if it's growing quickly and highly fragmented, and the company is a
clear leader (in the top 2-3 positions) in the industry. PE firm can acquire other
companies.
An industry is less appealing if it's highly consolidated, in decline, or if it's highly
speculative. A high rate of technological change and low barriers to entry also make an
industry less appealing because cash flows are unlikely to be stable.
If a company has $10 million in revenue and $5 million in EBITDA, is it most appealing
as an investment candidate if it plans to grow by selling 20% more units, raising its
prices by 20%, or cutting its expenses by 20%? ✅It's most appealing if it grows by
raising prices by 20%. If the company does this, everything will "flow through" to
, EBITDA: The $2 million in extra revenue will result in an additional $2 million of
EBITDA.
If the company sells 20% more units, it will incur higher variable costs, and its EBITDA
will increase by less than $2 million. Expense reduction of 20% will result in only $1
million of additional EBITDA, which makes less of an impact than the price increase.
Investors tend to favor companies with significant pricing power because it means they
have less serious competition and can grow with less friction.
How might a PE firm reduce its downside risk if a leveraged buyout does not perform
well? ✅Much of the risk in leveraged buyouts comes from multiple contraction: The
Exit Multiple might be lower than the Purchase Multiple.
The best way to reduce this risk is to avoid acquiring companies trading at relatively
high multiples and to focus on companies that are undervalued in some way.
Other methods: companies with Tangible Assets to sell off, use more Debt, acquire
smaller stake, improve company operations.
How would you review a Confidential Information Memorandum (CIM) or other
marketing materials and decide whether to pursue an acquisition of a company?
✅Read Executive Summary then skip to financials to see if LBO math works.
If it does, read market//industry overview section, look at the industry growth rates, the
competitors, and assess how this company stands out from others.
After reading a company's CIM, you decide to meet with the CEO. What are the top 3
questions you would ask him/her? ✅You'd focus on questions that are not answered in
the CIM, so the best questions depend heavily on the company, its industry, and how
much information is disclosed in the CIM.
How might you convince the management team of a company to agree to a leveraged
buyout? ✅The company could take its time to execute long-term plans away from the
scrutiny of quarterly earnings calls and the public markets, the management could own
a higher percentage through incentives (Equity Rollover, options), offer a high price.
How would you present an investment recommendation on a potential LBO candidate?
✅You'd start by giving a clear "Yes" / "No" recommendation and stating the 3-4 main
reasons that explain your decision.
Then, go into the qualitative and market factors and the numbers that support your
recommendation, including a summary of output from the LBO model; you would also
demonstrate that the deal works even in Downside cases.
