Top 25 Private Equity Interview Questions and Answers in 2022

An investing company called private equity buys and sells company shares. A private equity firm wants to profit by selling the business for more money than it bought for it. Indeed, it’s a dream job for many people. A job interview is often required before you can work in a private equity company. The interviewer will question you on a wide range of questions on your experience, knowledge, and abilities throughout the interview. Find out what private equity professionals should have regarding abilities and attributes, what questions to anticipate, and how to respond to them. The top 25 popular private equity job interview questions and responses are included in this guide.

1. What Is An LBO Or Leveraged Buyout?

An LBO is the purchase of a privately owned or publicly listed business in which a substantial portion of the purchase price is financed by debt. The remaining sum is covered by equity contributions from the financial sponsor and, in certain situations, equity transfers made by the current management team of the business.

The purchased firm will have undergone a recapitalization and changed into a highly leveraged financial structure by the time the deal closes.

Usually, the sponsor will keep the money for five to seven years. The acquired firm will utilize the cash flows it produces from its activities to cover the necessary interest payments and reduce part of the loan principal throughout the holding term. When evaluating an investment, the financial sponsor typically aims for an IRR of at least 20 to 25 percent.

2. Describe The Steps Involved In Creating An LBO Model.

  • Entry valuation Calculating the implied entry value using the target firm’s entry multiple and LTM EBITDA is the first step in creating an LBO model.
  • Sources and Uses, The suggested transaction structure will be shown in the “Sources and Uses” section. The “Sources” side will describe how the purchase will be financed, while the “Uses” side will determine the overall amount of funds needed to accomplish the acquisition. The biggest issue that has to be resolved is: How much equity must the financial sponsor contribute?
  • Financial Projections Following completion of the Sources & Uses, it will forecast table, the company’s free cash flows (FCFs) based on operational assumptions, such as revenue growth, margins, interest rates on debt, and tax rate. The amount of cash available for debt amortization and the annual interest cost is determined by the FCFs produced, making them a crucial component of an LBO.
  • Calculating Returns The IRR and cash-on-cash return is calculated using the total proceeds received by the private equity firm in the final step, along with several sensitivity tables attached below. The exit assumptions of the investment are made in this step. They include the exit multiple and the date of exit.

3. What Fundamental Rationale Underlies The Use Of Debt In An LBO?

A significant proportion of borrowed money is often used to finance an LBO, and the private equity sponsor contributes just a modest amount of equity to the deal. The sponsor will be able to earn more money upon selling the investment since the debt’s principal will be reduced throughout the holding term.

Because the debt has a lower cost of capital than equity, it is advantageous for sponsors to invest less equity. The fact that debt is positioned higher in the capital structure and that the interest paid on it is tax deductible, creating an attractive “tax shield,” are two factors contributing to the lower cost of debt. As a result, the company may more easily exceed its return level thanks to the enhanced leverage. Stated the better the profits to the company, the lower the equity check the financial sponsor will have to write for the transaction.

To reduce the danger of bankruptcy, private equity companies optimize their use of leverage while maintaining a reasonable level of debt. A further advantage of employing more debt is that it provides the company with extra leftover cash, or “dry powder,” which may be utilized to make other investments or buy expansions for their portfolio firms.

4. What Does An LBO Model’s “Sources & Uses” Component Consist Of?

The amount needed to execute the transaction and how one will finance the suggested agreement are described in the “Sources & Uses” section.

Uses the side What does the company need to purchase, and how much will it cost, according to the “Uses” side? The purchase of equity from the current owners of the targets is the largest financial expenditure in an LBO. The payment of transaction fees to M&A consultants, financing costs, and often replacing existing debt are further applications. The Sources Side The “Sources” side, on the other hand, responds to the question: “Where are the funds coming from?”

Top 20 Capital Market Interview Que...
Top 20 Capital Market Interview Questions and Answers for 2022

5. What Are The Private Equity Companies’ Investment Exit Strategies?

A PE company will typically monetize its investment in one of the following ways:

  • Transaction with a Strategic Buyer The sale to a strategic buyer often results in the highest values and is the most convenient since strategics are ready to pay more for the possible synergies.
  • Secondary Buyout, often known as a Sponsor-to-Sponsor Deal Selling to another financial buyer, is another alternative. However, this is a less-than-ideal exit since financial purchasers cannot pay more for synergies.
  • IPO (Initial Public Offering) The portfolio company’s IPO and subsequent sale of its shares on the public market constitute the third way for a private equity firm to monetize its earnings; however, this option is only available to bigger businesses, such as mega-funds or club transactions.

6. What Are The Main Lbo Return-Generating Levers?

  • Deleveraging – As more loan principal is paid down over time using the cash flows produced by the acquired business, the value of the equity held by the private equity firm increases.
  • EBITDA Growth Increasing EBITDA may be done by adopting new growth strategies to boost revenue, making accretive add-on acquisitions, and making operational changes to the company’s margin profile, such as cost-cutting and pricing increases.
  • Multiple Expansion A financial sponsor ideally wants to buy a business at a low entry multiple, or “going in cheap,” and sell it at a greater multiple. The relevant industry’s investor attitude, the economy, and favorable transaction dynamics, such as a competitive selling process headed by strategic purchasers, may improve, boosting the exit multiple. Most LBO models, however, use the cautious assumption that one would sell the company at the same EV/EBITDA multiple that one bought it at. The rationale is that the future transaction climate is uncertain, making it riskier to depend on several expansions to satisfy the return criterion.

7. What Qualities Characterize The Perfect LBO Applicant For A Business?

A candidate for an LBO should possess the majority of the following qualities, if not all of them:

  • Consistent, Reliable Cash Flow Generation
  • Operates in an Established Sector with a Supportable Market Position
  • A business plan that includes recurring revenue
  • Solid, Reliable Management Team
  • Multiple Revenue Streams with Low Cyclicity
  • Working capital requirements and low capex requirements
  • Low-Purchase Multiple, currently undervalued by the market

8. Which Sectors Saw The Highest LBO Transaction Activity?

Private equity investors often show greater interest in mature, affluent, moderately expanding, and non-cyclical businesses. Due to their high barriers to entry, businesses in these sectors are more likely to provide predictable income with lower chances of being disrupted by new competitors or technology breakthroughs.

The ideal sector should see steady growth over the next years and benefit from favorable tailwinds that provide the potential for Expansion. Usually, sectors predicted to decline or are vulnerable to change are avoided. While certain PE firms, including Vista Equity Partners and Thoma Bravo, focus on high-growth industries, their investments tend to lean more toward growth equity than traditional buyouts.

Additionally, if the company’s investment strategy revolves around roll-up acquisitions, the PE firm would search for fragmented sectors where the consolidation method, or “buy-and-build,” would be more practical given the market’s plenty of possible add-on targets.

9. What Kind Of Goods Or Services Should A Prospective LBO Target Be Selling?

  • Mission Critical The perfect good or service is required by the clientele. In other words, cessation should hurt the customers’ ability to continue doing business, have a significant financial impact, or harm their image. In the event of a security breach and the loss of private customer information, for instance, a data center’s decision to terminate its contract with the provider of its security solutions (such as video surveillance and access control) may harm the data center’s relationships with its current clients.
  • High Switching Expenses – Customers should be discouraged from switching to a rival by the high costs associated with doing so. Or, to put it another way, switching should be more expensive than it would be advantageous.
  • Recurring Income Component Given the higher level of revenue predictability, products and services that need maintenance and have recurring revenue components are more attractive. Customers often prefer the care and other associated services from the company they originally bought the product from.

10. What Capital Structure Do LBO Transactions Typically Use?

There has been a structural change from debt-to-equity ratios of 80/20 in the 1980s to about 60/40 in recent years. The capital structure in an LBO tends to be cyclical and swings depending on the financing climate.

Leveraged loans, revolver and term loans, senior notes, subordinated notes, high-yield bonds, and mezzanine financing are some of the many debt tranches. Before using riskier kinds for funding, most of the debt generated will be senior, secured loans by banks and institutional investors.

The most significant source of LBO equity in terms of equity is the financial sponsor’s contribution. In certain circumstances, the current management team will roll over a portion of their equity to join the sponsor in sharing any possible gains. Additionally, while most LBOs keep the current management team in place, sponsors often reserve between 3% and 20% of the entire equity to reward the management team for achieving financial goals.

11. Which Credit Ratios Would You Use When Evaluating A Borrower’s Financial Situation?

Leverage ratios link a company’s debt holdings to a specific cash flow indicator, often EBITDA. The financing climate and the industry will significantly impact the leverage ratio parameters; nonetheless, the overall leverage ratio in an LBO varies from 4.0x to 6.0x, with the senior debt ratio typically around 3.0x.

  • Debt to EBITDA ratio
  • EBITDA / Senior Debt
  • EBITDA/Net Debt

Interest coverage ratios determine a company’s capacity to use cash flows to fulfill its interest obligations.

Generally, the greater the interest coverage ratio, preferably >2.0x, the better.

  • Interest expense and EBITDA
  • Capital expenditures
  • Interest expense

12. Mention A Few Warning Signs You Would Watch Out For While Evaluating An Investment Deal.

  • Industry Cyclicality: A potential LBO candidate should provide steady cash flows. Therefore, investment is less appealing from a risk perspective when it has highly cyclical revenue and demand variations dependent on the current economic circumstances – or other external variables.
  • Customer Concentration: As a general rule, no one customer should represent more than 5–10% of total revenue as the risk of losing that crucial customer due to unanticipated events or the customer’s refusal to continue doing business with them – i.e., decides not to renew their contract – presents a significant risk.
  • Customer / Staff Turnover: While each situation will be unique, high customer and employee churn rates are often seen as a lousy indicator since they need ongoing new customer acquisitions. In contrast, poor employee retention indicates problems with the target’s organizational structure.

13. Why Is It Essential To Include The Internal Rate Of Return, Or IRR, And The Cash-On-Cash Return When Calculating Returns?

Since the cash-on-cash multiple, unlike the IRR calculation, does not take the time value of money into the account, it cannot be used as a standalone statistic.

For instance, achieving a 3.0x multiple in five years could be noteworthy. The cash-on-cash multiple is the same whether it takes five or thirty years to obtain those revenues.

The cash-on-cash multiple is more significant during shorter periods than IRR. However, having a multiple IRR over more extended periods is preferable. On the other hand, since it is so timing-sensitive, IRR is a flawed standalone metric.

For instance, collecting a dividend immediately after the purchase boosts the IRR and could be deceiving in the short run. But these two measures are related, and investors often use both to precisely gauge returns.

14. What Are Some Effective Levers To Boost An LBO’s IRR?

  • Earlier receipt of proceeds. Dividend recapitalization, earlier exit than anticipated, choice of cash interest over PIK interest, and yearly sponsor consulting fees.
  • Higher FCF Production – Achieved by Growing Revenue and EBITDA and a Better Margin Profile
  • Exiting at a higher multiple than the purchase multiple, or “buy low, sell high,” is referred to as multiple expansion.

15. Calculate The IRR For A Private Equity Company That Has Quadrupled Its Original Investment In Five Years.

The IRR would be 24.6% if the original investment quadrupled in five years.

It is strongly advised that you remember the most popular IRR estimations, which are included in the table, since it is unlikely that you will be given a calculator to do this calculation.

16. Would The Rewards To The Financial Buyer Be Higher If An LBO Target Had No Outstanding Debt On Its Closing Balance Sheet?

It effectively erased the current capital structure once an LBO was completed and recapitalized utilizing the sources of money that one generated. The pre-investment debt level of the firms does NOT directly affect returns when calculating the IRR and cash-on-cash returns.

17. Which Two Variables, If Any, Would You Use To Make An LBO Model More Sensitive?

The entrance and exit multiples would most significantly impact the returns from an LBO.

The most beneficial outcomes are obtained when a financial sponsor purchases the target at a lower multiple and then sells it at a higher multiple.

Although the returns will be impacted by sales growth, profit margins, and other operational changes, this influence will be significantly smaller than that of the buy and exit assumptions.

18. What Exactly Is Rollover Equity, And Why Is It A Good Thing?

In certain circumstances, the current management team may transfer all or a portion of its equity to the newly acquired firm and make a separate capital contribution in addition to the financial sponsor.

Rollover equity is the second source of funding that lowers the amount of leverage and financial sponsor equity participation required to close the transaction.

Generally speaking, if a management team is ready to transfer some equity into the new business, they believe their risk is worthwhile, given the possible rewards. The management team’s “skin in the game” and tightly matched incentives are ultimately advantageous for all parties engaged in the agreement.

19. What Does “Tax Shield” Mean In The Context Of An LBO?

The “tax shield” in an LBO refers to the highly leveraged capital structure’s decreased taxable income.

Private equity companies are further encouraged to increase the leverage they can get for their purchases since interest payments on loans are tax deductible.

Leaders may entice private equity companies not to pay back the loan before the maturity date if the prepayment is voluntary or a “cash sweep” due to the tax advantages associated with debt financing.

20. What Interests Pik?

The term “paid-in-kind” (PIK) interest refers to a kind of non-cash interest where the borrower compensates the lender via adding new debt instead of cash.

Because there is a greater risk to the investor with PIK interest, which means that delayed payments reduce the certainty of payment, the interest rate is often higher.

By choosing PIK, the borrower saves money during the current period, which amounts to a non-cash add-back on the CFS.

However, the PIK interest charge is a cost that annually accumulates and accrues toward the loan total payable in the final year.

21. How Are Financing Costs Handled In An LBO Model Different From Transaction Fees?

  • Financial Fees – Financial fees may be capitalized and amortized throughout the loan’s lifespan, typically 5-7 years. They are associated with raising debt or issuing equity.
  • Transaction Costs – On the other hand, transaction fees cover the legal and M&A advising fees paid to attorneys and business brokers. Transaction fees are considered one-time charges that are subtracted from a company’s retained profits since they cannot be amortized.

22. How Is Goodwill Affected If An Acquisition Increases The Value Of Target’s Intangible Assets?

Intangible assets like patents, copyrights, and trademarks are often valued higher during an LBO.

A more excellent write-up indicates that the assets being acquired are worth more since goodwill is just an accounting term used to “plug” the difference between the purchase price and fair value of the assets in the closing balance sheet.

Therefore, it will produce less goodwill if intangible assets are written more highly on the transaction date.

23. What Exactly Is An Add-On Purchase, And How Does It Provide Value?

A private equity firm’s portfolio company, referred to as the “platform,” purchasing a smaller business is an add-on purchase. The add-on will complement the platform firms’ current product/service offerings, allowing the company to gain synergies and penetrate new end markets. This is the strategic justification for bolt-on acquisitions.

The acquisition target will often be priced at a lower multiple than the acquirer, making the deal accretive, which is one of the reasons add-ons are a prevalent tactic used in private equity.

For instance, if a more prominent firm valued at 15.0x EBITDA buys a smaller one for 7.5x EBITDA, one should theoretically love the add-on target’s profits at 15.0x post-closing. As soon as the deal is concluded correctly, the platform company’s multiple will be applied to the newly acquired company’s cash flows, thereby adding value to the merged firm.

The roll-up approach allows platform firms to compete more effectively with strategic purchasers throughout the selling process.

24. What Is A Recapitalization Of Dividends?

A private equity business engages in a dividend recapitalization when it obtains extra debt to pay a dividend to the equity owners.

Recaps are used to monetize investment gains before a complete departure and have the advantage of raising the fund’s internal rate of return (IRR) since revenues are received early.

An LBO is often seen as doing better than first expected, and the acquired firm has the financial stability to absorb the extra debt created. Therefore, completing one should only do a dividend recap in these circumstances.

25. Why Is A “Floor Value” For An LBO Study Often Used?

When determining what the financial sponsor can afford to pay for the target while still obtaining the customary 20%+ IRR, an LBO model gives the venture a “floor value.”

In other words, the issue being addressed is: “What is the greatest amount that we can pay while still satisfying our fund’s return hurdle?” from the viewpoint of the private equity investor.


Instead of only looking for individuals who can execute deals, private equity companies search for applicants who can think like investors. The hiring process for PE is substantially more rigorous, and the business is searching for different candidates than an investment bank. Although preparing for a PE interview is reasonably comparable to an investment banking interview, the actual PE interview is far more challenging. There are a few easy measures you may take to get ready:

  • Plan and keep in mind what you put on the resumes.
  • Consider the specialty of the job or the field you wish to enter.
  • Consider the size or kind of private equity fund you want to invest in (mega/large or medium market), the location of the PE company, and the sort of investment you want to make (buyout, growth capital, etc.).
  • Practice the interview questions with others to be ready.