The Top 25 Private Equity Interview Questions covered in our comprehensive interview guide are intended to help prepare candidates for the competitive recruiting process and improve their odds of receiving an offer.
Unlike investment banking interviews where you'll likely get a lot of technical interview questions, private equity interviews will stress the Paper LBO and LBO Modeling Test to confirm you've got the technicals down.
However, you are likely to still encounter private equity interview questions in the earlier rounds of the interview process, so we've compiled the most common technical interview questions that you absolutely must know the answer to.
The types of questions asked in a private equity interview can be broken into four categories:
Understanding the fundamental LBO concepts is essential to perform well on the LBO modeling and case study portions of the interview, as well as to showcase your judgment during investment rationale and deal discussions in the later stages of the recruiting process.
Generally, the standard technical questions are most applicable to interviewees from non-traditional backgrounds and are less common for more experienced candidates. Nevertheless, the following article still should serve as a helpful refresher for those that have completed a stint in investment banking.
Let's move on straight to the top private equity interview questions now.
Private equity interviews are known for their intensity, requiring candidates to demonstrate both technical modeling expertise and strategic thinking. Artificial intelligence revolutionizes interview preparation by identifying commonly tested concepts, simulating realistic case prompts, and offering personalized feedback. Through the AI for Business & Finance Certificate Program—created by Wall Street Prep in collaboration with Columbia Business School Executive Education—professionals learn how to use AI-powered interview simulations to elevate their interview preparation with confidence and clarity.
An LBO is the acquisition of a company, either privately held or publicly traded, where a significant amount of the purchase price is funded using debt. The remaining portion is funded with equity contributed by the financial sponsor and in some cases, equity rolled over by the company’s existing management team.
Once the transaction closes, the acquired company will have undergone a recapitalization and transformed into a highly leveraged financial structure.
The sponsor will typically hold onto the investment for between 5 to 7 years. Throughout the holding period, the acquired company will use the cash flows that it generates from its operations to service the required interest payments and pay down some of the debt principal.
The financial sponsor will usually target an IRR of approximately ~20-25%+ when considering an investment.
Level up your career with the world’s most recognized private equity investing program. Enrollment is open for the upcoming cohort.
The typical transaction structure in an LBO is financed using a high percentage of borrowed funds, with a relatively small equity contribution from the private equity sponsor. As the principal of the debt is paid down throughout the holding period, the sponsor will be able to realize greater returns upon exiting the investment.
The logic behind why it is beneficial for sponsors to contribute minimal equity is due to debt has a lower cost of capital than equity. One of the reasons the cost of debt is lower is because debt is higher up on the capital structure – as well as the interest expense associated with the debt being tax-deductible, which creates an advantageous "tax shield". Thus, the increased leverage enables the firm to reach its returns threshold easier.
Private equity firms, therefore, attempt to maximize the amount of leverage while keeping the debt level manageable to avoid bankruptcy risk.
Another side benefit of using higher amounts of debt is that it leaves the firm with more unused capital (i.e. "dry powder") that could be used to make other investments or to acquire add-ons for their portfolio companies.
The “Sources and Uses of Funds” section of an LBO model outlines the amount of capital required to complete the transaction and how the proposed deal will be funded.
Example "Sources & Uses" Table from the BMC Case Study (Wall Street Prep LBO Modeling Course)
The most common ways for a PE firm to monetize its investment are:
Buyout Exits by Channel (Bain 2020 Private Equity Report)
An ideal LBO candidate should have most (or all) of the following characteristics:
The industries that tend to attract higher amounts of interest from private equity investors are those that are mature, growing at a moderate rate, and non-cyclical. The companies found in these types of industries are more likely to generate predictable revenue with fewer disruption risks from technological advancements or new entrants due to having high barriers to entry.
The ideal industry should exhibit stable growth in the upcoming years and have positive tailwinds that present growth opportunities. Typically, industries expected to contract or prone to disruption are avoided. Some PE firms do specialize in high-growth sectors (e.g. Vista Equity Partners, Thoma Bravo), but drift more so onto the side of growth equity than traditional buyouts.
Furthermore, if the investment strategy of the firm is based around roll-up acquisitions – the PE firm will look for fragmented industries where the consolidation strategy (i.e. “buy-and-build”) would be more viable since there are more potential add-on targets in the market.
Ultimately, there are various avenues that you can go down when answering this question and it would be best to tailor your response based on the specific types of portfolio companies the firm owns and their investment strategy.
The capital structure in an LBO tends to be cyclical and fluctuates depending on the financing environment, but there has been a structural shift from Debt to Equity ratios of 80/20 in the 1980s to around 60/40 in more recent years.
The different tranches of debt include leveraged loans (revolver, term loans), senior notes, subordinated notes, high-yield bonds, and mezzanine financing. The vast majority of the debt raised will be senior, secured loans by banks and institutional investors before riskier types of debt are used.
In terms of equity, the contribution from the financial sponsor represents the largest source of LBO equity. In some cases, the existing management team will roll over a portion of their equity to participate in the potential upside alongside the sponsor. Also, because most LBOs retain the existing management team, sponsors will usually reserve anywhere between 3% to 20% of the total equity as an incentive for the management team to meet financial targets.
Buyout Leverage Multiples Historical Trends (Bain 2020 Private Equity Report)
Leverage ratios compare the amount of debt held by a company to a specific cash flow metric, most often EBITDA. The leverage ratio parameters will be highly dependent on the industry and the lending environment; however, the total leverage ratio in an LBO ranges between 4.0x to 6.0x with the senior debt ratio typically around 3.0x
Interest coverage ratios examine a company’s ability to cover its interest payments using its cash flows.
As a general rule of thumb: the higher the interest coverage ratio, the better (ideally >2.0x)
The cash-on-cash multiple cannot be a standalone metric as it does not consider the time value of money, unlike the IRR calculation.
For instance, a 3.0x multiple may be impressive if achieved in five years. But whether it took five years or thirty years to receive those proceeds, the cash-on-cash multiple remains the same.
Over shorter time frames, the cash-on-cash multiple is more important than IRR – however, over longer time frames, it is better to achieve a higher IRR.
On the other hand, IRR is an imperfect standalone measure because it is highly sensitive to timing.
For example, receiving a dividend right after the acquisition immediately increases the IRR and could be misleading for near-term time frames.
Nonetheless, these two metrics are interlinked, and both are widely used by investors to assess returns accurately.
If the initial investment tripled in five years, the IRR would be 24.6%.
Since it is very unlikely for you to be handed a calculator to solve this calculation, it is highly recommended that you memorize the most common IRR approximations as shown in the table below:
Upon the completion of an LBO, the firm essentially wiped out the existing capital structure and recapitalized it using the sources of funds that were raised. When calculating the IRR and cash-on-cash returns, the companies’ debt balance pre-investment does NOT have a direct impact on returns.
The entry and exit multiples would have the most significant impact on the returns in an LBO.
The ideal scenario for a financial sponsor is to purchase the target at a lower multiple and then exit at a higher multiple, as this results in the most profitable returns.
While the revenue growth, profit margins, and other operational improvements will all have an impact on the returns, it is to a much lesser degree than the purchase and exit assumptions.
In some cases, the existing management team may roll over some or all of its equity into the newly acquired company and may even contribute additional capital alongside the financial sponsor.
Rollover equity is an additional source of funds and it reduces the amount of leverage necessary and the equity contribution from the financial sponsor to complete the deal.
Generally, if a management team is willing to roll over some equity into the new entity, it implies the team is doing so under the belief that the risk they are undertaking is worth the potential upside in it for them. It is overall beneficial for all parties involved in the deal for the management team to have “skin in the game” and altogether have closely aligned incentives.
In an LBO, the “tax shield” refers to the reduction in taxable income from the highly levered capital structure.
As interest payments on debt are tax-deductible, the tax savings provides an additional incentive for private equity firms to maximize the amount of leverage they can obtain for their transactions.
Because of the tax benefits attributable to debt financing, private equity firms can be incentivized to not repay the debt before the date of maturity assuming the prepayment is optional (i.e. "cash sweep").
PIK interest (“paid-in-kind”) is a form of non-cash interest, meaning the borrower compensates the lender in the form of additional debt as opposed to cash interest.
PIK interest typically carries a higher interest rate because it has a higher risk to the investor (i.e. delayed payments result in less certainty of being paid).
From the perspective of the borrower, opting for PIK conserves cash in the current period and thus represents a non-cash add-back on the CFS.
However, PIK interest expense is an obligation that accrues towards the debt balance due in the final year and compounds on an annual basis.
During an LBO, intangible assets such as patents, copyrights, and trademarks are often written up in value.
Goodwill is simply an accounting concept used to “plug” the difference between the purchase price and fair value of the assets in the closing balance sheet – so, a higher write-up means the assets being purchased are actually worth more.
Therefore, a higher write-up of intangible assets means less goodwill will be created on the date of the transaction.
Note: Goodwill cannot be amortized by publicly traded companies under US GAAP – however, private companies can opt to amortize goodwill for tax reporting purposes. This question is in reference to the purchase accounting on the closing date of the transaction.
An add-on acquisition is when a portfolio company of a private equity firm (called the “platform”) acquires a smaller company. The strategic rationale for bolt-on acquisitions is that the add-on will complement the platform companies’ existing product/service offerings – thus, enabling the company to realize synergies, as well as enter new end markets.
One of the reasons that add-ons are a common strategy employed in private equity is because the acquisition target will more often than not be valued at a lower multiple than the acquirer (and thus be an accretive transaction).
For example, if a company valued at 15.0x EBITDA purchases a smaller company for 7.5x EBITDA, the earnings of the add-on target will automatically be priced at 15.0x post-closing in theory. Once the transaction has successfully closed, the cash flows of the newly acquired company will immediately be valued at the multiple of the platform company – instantly creating value for the combined entity.
Another positive consequence provided by the roll-up strategy is that it allows platform companies to better compete with strategic buyers in sale processes.
A dividend recapitalization is when a private equity firm raises additional debt with the sole purpose of issuing themselves (i.e. the equity shareholders) a dividend.
Recaps are done to monetize profits from an investment before a complete exit and have the benefit of increasing the IRR to the fund due to the earlier receipt of proceeds.
Completing a dividend recap is often considered to be a risky action that should only be undertaken when an LBO is proceeding better than originally anticipated and the acquired company has the financial stability to take on the additional leverage raised.
An LBO model provides a "floor valuation” for an investment as it is used to determine what the financial sponsor can afford to pay for the target while still realizing the typical 20%+ IRR.
In other words, the question being answered from the perspective of the private equity investor is: "What is the maximum amount that we can pay while still meeting our fund's return hurdle?"
For question: “What are some positive levers to increase the IRR on an LBO?” Why does using cash interest increases IRR? I would assume that using PIK would increase IRR as you can use the increased FCF for dividend repayments or other levers to increase IRR.
Hi, Claudius,
If you use the cash that would have paid interest to pay dividends instead, then it may indeed increase IRR, but there are often restrictions on this, and the cash is required to be used to make optional prepayments on term loans before dividends can be paid. So, with that in mind, paying cash interest on a note might increase IRR over accruing PIK interest at a higher interest rate.
BB
Thanks Brad. I’m still not sure why this should lead to an earlier receipt of proceeds. In general, yes it increases IRR if you pay less interest on debt. You should always opt for the cheapest debt options. But why should it affect earlier proceeds?
I would even assume that in the short-term, you would increase FCF by using PIK, and thus decrease IRR.
Hi, Claudius,
Dividends would lead to earlier receipt of proceeds, but I’m not assuming you can pay them. So not sure what you mean by earlier proceeds. What I am saying is that if you opt for PIK interest at a higher rate rather than negotiating a lower rate and paying cash interest on your notes, rather than making optional prepayments on lower-interest rate term loans, then you will likely increase IRR to equity.
BB