PE LBO Modeling Test

Just a few questions regarding typical PE interview LBO modeling tests, specifically:

1) Typically how much time is alloted to build a model?

2) Given time contraints, how much is detail should you provide ?(i.e. is it better to be detailed and include PIK toggles, many different debt tranches, use several worksheets, etc. but not finish, or is it better to keep it simple and finish in tiee with a working model?)

What are some strategies that have been used by those of you who have gone through this? Any tips and insight would be much appreciated. Thanks!

 

Generally you will get anywhere from 30-60 minutes up to a few hours depending on whether or not they want you to JUST build an LBO model or also do a case study of a company along with it. Some firms also have you do the work beforehand and then just present it to the partners on the day of the interview.

I would strongly recommend keeping it very, very simple. Don't worry about PIK, different debt tranches, multiple scenarios etc. unless they specifically ask for it. Basically they want to know whether or not you know how to build an LBO model, because a surprising number of IBD analysts cannot actually create one from scratch.

I would start with the bare minimum in terms of assumptions (purchase price, % debt/equity, and then have simple operational assumptions like rev. growth, margins etc). Do a basic sources & uses.

Then you can project out the statements but again I would keep it very simple... depending on what they're looking for you could skip the BS and just do IS, CFS and debt schedules to take a shortcut.

Then you want to do some type of returns calculation and maybe a simple sensitivity at the bottom.

1 key to making this work is practice... start with a blank Excel spreadsheet, give yourself 30 minutes and try to create everything from scratch. Do that repeatedly until you can do everything without trouble, shouldn't take that long if you are already familiar with LBO models.

Keep in mind the above applies under the assumption that they are not asking you to do anything more advanced with PIK, equity rollovers etc. - if there's anything like that involved you do need to make it more complex. But I would stay focused on the basics and make sure you can do those flawlessly in a max of 30 minutes.

 

Thanks for the feedback - Very useful indeed! Do you know of a good source to find some good simple examples? I've built out some pretty complex models but want to get a feel for a clean, concise model. Thanks again.

 

I think you are on the right track on the modeling - really you will just quickly spread the financials and then you can do your projections based on the relevant ratios. On the growth assumptions however, I think you need to be a bit more comfortable on having a feeling for how to gauge a company's prospects without relying on a CIM/mgm't forecast - and ability to justify/defend those. It doesn't have to be "right" (there is no one correct answer) but you need to show that you can come up with sound reasoning.

If you have no idea at all about the target industry/prospects you at least will have a little time to scan through the MD&A - that should help with forming a bottom-up view. On the top-line projections you should try to have a view on how the economy is doing, how cyclical is your target industry (at entry AND at exit), competition etc. Try to perform a sanity check on where your returns are coming from - leverage, multiple expansion and business growth/improvement - to make sure you weren't too aggressive on any one of those factors.

 

Agree with what kingb said -- the open-endedness isn't a complete negative but more of a double-edged sword. If you have a decent grip on the macro backdrop, even if you don't know the company, you can attempt to make some educated/informed projections and explain them. Even if your view is wrong, your interviewers will appreciate that MUCH more than a lazy "we average growth from the past 3 years and held margins constant."

As for the leverage question...shouldn't you know this if you're in banking? Though it'll depend on the industry I would definitely keep under 6x, and even that is pretty aggressive.

 

I just did one of these for a fund interview.

Practice practice practice - start from blank sheet and time yourself and tick off how long it takes to make the IS, BS, CF in that order, then make a debt schedule and maybe a PPE/Depreciation if necessary (can also just hold capex/depr constant or grow at some assumption.

Don't kill yourself if it doesn't balance perfectly - get it running 95% and make sure you do everything they ask for.

Also I don't mess with the days payable/receivable formulas - just make it a percent of revenue and it makes the calculation 50 times faster for me at least.

Think hard about the drivers for each line item - have some good questions to ask them. In my interview they basically wanted to know you understood the fundamentals of the business, and where you would look if you had a full day to work on it.

It will be a discussion about cash flow and what will drive that, and ultimately is this a good investment - so have a thesis, talk upside as well as risks, show conviction, and be ready to discuss it like a pro - the interview should run like a good conversation.

if you like it then you shoulda put a banana on it
 

Many thanks, all great responses.

If I'm not dealing with a cyclical company, I would just assume entry multiple equals the exit multiple, so that none of the return is being generated from multiple expansion.

There is a lot of uncertainty in 2013 regarding the fiscal cliff: i.e. we could see another year of positive GDP growth or it could turn negative. If I'm analyzing a company like Zale that sells diamonds, how would I take into account the global macro? Let me know your thoughts on something like this: there is a lot of competition in the diamond retail space, so Zale will probably have to rely on volume increases rather than price increases for sales growth in the foreseeable future, especially given the economy is still recovering and diamond sales have not been particularly strong in the last couple of months. In addition, price cuts could fuel volume increases, but this may or may not net to increases in revenue. Given the fiscal cliff uncertainty in 2013, perhaps I could factor in low-single digit growth in 2013 and then higher growth in 2014 until exit. What are your thoughts on the macro backdrop (more broadly speaking than just with respect to the diamond industry)?

There should be a discussion on the industry and the company's competition in the 10-k. I can read this to get a better idea of the company's prospects in relation to its competition when I justify my assumptions. I can also read the risk factors to get a sense for not only the industry's risks but also the risks more specific to the company. This will help me set a sort of upside cap for my growth rates so I'm not too aggressive. It'll also give me something to talk about when I go over the model with the fund afterward.

Mrb87, yes leverage will depend on the industry (cyclicality, etc). I agree 6.0x is pretty high. That said, if you look at some service companies that have no debt, they trade at 13.0x EV / 2013 EBITDA, which is pretty high. For these companies arguably more than 6.0x leverage could be put on the business (assuming, for example EV / LTM EBITDA was 10.0x, then 7.0x is 70% debt which is not inconceivable in an LBO).

I'm confident I can get the model to balance fully. The thing I usually run into is in three hours my model usually isn't perfectly formatted, but I think this is okay as long as it balances and my assumptions make sense.

It sounds like you'll wouldn't take the time to factor in quarterly financials aside from the latest balance sheet items.

 
basketballbanker:
Many thanks, all great responses.

If I'm not dealing with a cyclical company, I would just assume entry multiple equals the exit multiple, so that none of the return is being generated from multiple expansion.

There is a lot of uncertainty in 2013 regarding the fiscal cliff: i.e. we could see another year of positive GDP growth or it could turn negative. If I'm analyzing a company like Zale that sells diamonds, how would I take into account the global macro? Let me know your thoughts on something like this: there is a lot of competition in the diamond retail space, so Zale will probably have to rely on volume increases rather than price increases for sales growth in the foreseeable future, especially given the economy is still recovering and diamond sales have not been particularly strong in the last couple of months. In addition, price cuts could fuel volume increases, but this may or may not net to increases in revenue. Given the fiscal cliff uncertainty in 2013, perhaps I could factor in low-single digit growth in 2013 and then higher growth in 2014 until exit. What are your thoughts on the macro backdrop (more broadly speaking than just with respect to the diamond industry)?

There should be a discussion on the industry and the company's competition in the 10-k. I can read this to get a better idea of the company's prospects in relation to its competition when I justify my assumptions. I can also read the risk factors to get a sense for not only the industry's risks but also the risks more specific to the company. This will help me set a sort of upside cap for my growth rates so I'm not too aggressive. It'll also give me something to talk about when I go over the model with the fund afterward.

Mrb87, yes leverage will depend on the industry (cyclicality, etc). I agree 6.0x is pretty high. That said, if you look at some service companies that have no debt, they trade at 13.0x EV / 2013 EBITDA, which is pretty high. For these companies arguably more than 6.0x leverage could be put on the business (assuming, for example EV / LTM EBITDA was 10.0x, then 7.0x is 70% debt which is not inconceivable in an LBO).

I'm confident I can get the model to balance fully. The thing I usually run into is in three hours my model usually isn't perfectly formatted, but I think this is okay as long as it balances and my assumptions make sense.

It sounds like you'll wouldn't take the time to factor in quarterly financials aside from the latest balance sheet items.

I think when you do the LBO test there are two parts to it: (1) are you capable of doing the excel/finance part? There is a reason why PE generally recruits out of IB for junior positions - they want someone who can hit the ground and do the job independently and without unnecessary training/supervision. It is also a fairly effective tool to screen applicants who clearly inflate their modeling experience on their CV. I would say be well prepared if you haven't dont a lot of banking/modeling before as the modeling test is usually a good way to ding candidates who might have done well getting through fit questions but have questionable technical skills. (2) do you understand PE/principal investment and can you bring the required common sense to the table? The problem with treating the modeling test as just an excel exercise is that you're essentially just showcasing your typing skills. In the end of the day you should use this as an opportunity to demonstrate that you can easily spot/build/identify an investment thesis. As someone mentioned above - there is a lot more value in talking through your reasoning behind your growth rates than just using historical numbers.

While there is a "right" answer for the first part - that is your B/S balances, you completed everything in your time period, the formatting looks good, the valuation/accty formulas are correct - you can't really prepare for the second part. There is no right macro view that you can memorize and recite. If you know your target industry I suppose you can try to read up some analyst reports but in the end ideally you have your own ideas and follow the news/markets so that you are well prepared to come up with your own view on any number of scenarios. Maybe as you do the analysis you find that your IRR is terrible and you don't actually think it is a sensible investment - this might take some more balls but personally I would welcome this discussion a lot more than hearing a regurgitated speech on the projected growth rate of the US economy.

 

For formatting, just make sure the first thing you do is highlight/set print area and then put all the cells to comma format with one decimal and make it all Arial or Times. If you do one good set of rows with dates properly done, and then copy that for each schedule, it'll look fine and give you a roadmap of what you need to do. Just save 10 minutes for cleanup formatting at the end maybe (to do percent formats, italicize a few things etc).

For quarterly, I would just do a quick LTM revenue/EBITDA check to make sure nothing freaky has happened. It's a good gut check on your assumptions.

if you like it then you shoulda put a banana on it
 

If you balance sheet is consistently unbalanced (same unbalance in 2017 and 2018), probably an issue with your closing BS numbers and pre-closing adjustments. Go through your internal check list to make sure things make generally make sense: 1) Enable iterative calculations 2) closing balance sheet is balanced 3) working capital drivers are functioning correctly and being captured in the cash flow statement 4) other balance sheet items make sense in the projected periods....goodwill, net income, etc 5) review the cash flow statement to make sure all items are captured.

 
spyvspyder:

If you balance sheet is consistently unbalanced (same unbalance in 2017 and 2018), probably an issue with your closing BS numbers and pre-closing adjustments. Go through your internal check list to make sure things make generally make sense: 1) Enable iterative calculations 2) closing balance sheet is balanced 3) working capital drivers are functioning correctly and being captured in the cash flow statement 4) other balance sheet items make sense in the projected periods....goodwill, net income, etc 5) review the cash flow statement to make sure all items are captured.

^^^This. +1.
Winners bring a bigger bag than you do. I have a degree in meritocracy.
 

Candidates are always tested (unless you're not going to a real PE firm) on either the 2nd or third round, depending on the shop. Rarely would it happen on the first round.

The best way to prep is to actually do the models. As you don't have a banking background, you should just crack open a 10-k and begin modeling. Reading the manuals, etc, can only get you so far. Make sure to build a complete model, with opening balance sheets and all, as opposed to just the LBO simulation.

Practice would help you much better than just reading.

 
NoTears:
Candidates are always tested (unless you're not going to a real PE firm) on either the 2nd or third round, depending on the shop. Rarely would it happen on the first round.

The best way to prep is to actually do the models. As you don't have a banking background, you should just crack open a 10-k and begin modeling. Reading the manuals, etc, can only get you so far. Make sure to build a complete model, with opening balance sheets and all, as opposed to just the LBO simulation.

Practice would help you much better than just reading.

Not true. I would say only about 50% of the shops out there do the LBO test. And of the 50% some of them give you case studies or "take home tests" where you get a bank book and prepare the lbo model and a short presentation.

I'm not sure what a "real shop" is to you, but I consider Madison Dearborn and Vestar "real shops" who both do not test.

 

Thanks for the insights, NoTears and GameTheory. I generally anticipate that I'll get some form of questioning about LBO's in a second or third round interview, whether it's case questions, modeling tests, or just fundamental questions. As such, I'm making it a priority to learn as much about LBO's as possible.

Right now, I'm hoping to make my way into a mid-market private equity fund, and am reaching out to alums and recruiters who have both been pretty helpful in getting some initial leads for me. Through this process, however, I feel like just getting a gig in any respectable private equity shop is tough -- and even though I came from a top 5 school and currently work in equity research at a bulge bracket, I still feel like I'm pretty low in the "pecking order" when it comes to recruiting simply because there are so many bankers trying to get positions -- and because bankers have the transactional experience, it just seems like the majority of private equity shops just ask their recruiters to target bankers without considering what other candidates are out there. But still, it at least appears to be the case that my experience in research is less valuable than bankers coming out of second-tier and maybe even third-tier shops...but this could be more perception than reality.

Well, I don't have transactional experience, but hopefully my research skills together with some persistence and perseverance will eventually be good enough to land me a position in private equity. For now, I'll just keep my fingers crossed and keep on trying.

GameTheory, NoTears, and others: if you guys have any other advice for me as a non-traditional candidate trying to break into private equity, please feel free to msg me as I don't normally check these boards often. Likewise, I'd be happy to keep you guys posted on my progress (if any). Thanks again for the help and happy fourth of July.

​* http://www.linkedin.com/in/numicareerconsulting
 
WallStreetOasis.com:
looks good to me...could use some clean/up formatting and labels, but otherwise seemed right

Cheers for the quick input. I would SB but I haven't many left and i figure you've got enough,.....

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Oreos:
Hi chaps,

I've got an LBO modeling test this weekend (analyst lateral, M&A/RX advisory). Would appriciate your views on the link below.

it took me just under two hours, haven't bothered with formatting but am looking for a general sense of how it looks, anything i've missed etc..

http://sharesend.com/19kg6

Many thanks,

O

haven't dug into this much, but the debt at exit used in your irr calc doesn't seem to be right at first glance...

take your 175 debt repayment in the fifth year... where is that cash coming from? looks like what needs to be financed is drawing from the revolver, and looking at the RCF on your balance sheet, my assumption is confirmed...

when looking at your returns analysis at the bottom, your "total debt outstanding" is only including TLA and TLB... shouldn't it also be inclusive of the RCF? or am i missing something... to say that you have 75 in debt the 5th year, after starting with 336 and generating 160 in cash flow post interest over those 5 years doesnt make much sense... 336-160 = 176.... not 75... point is, i think your total debt in the returns analysis should include the revolver balance. I haven't taken more than 5 minutes to look at this and is a pretty easy mistake to catch, hopefully you can revise that before sending it out...

 
oR3DL1N3o:
Oreos:
Hi chaps,

I've got an LBO modeling test this weekend (analyst lateral, M&A/RX advisory). Would appriciate your views on the link below.

it took me just under two hours, haven't bothered with formatting but am looking for a general sense of how it looks, anything i've missed etc..

http://sharesend.com/19kg6

Many thanks,

O

haven't dug into this much, but the debt at exit used in your irr calc doesn't seem to be right at first glance...

take your 175 debt repayment in the fifth year... where is that cash coming from? looks like what needs to be financed is drawing from the revolver, and looking at the RCF on your balance sheet, my assumption is confirmed...

when looking at your returns analysis at the bottom, your "total debt outstanding" is only including TLA and TLB... shouldn't it also be inclusive of the RCF? or am i missing something... to say that you have 75 in debt the 5th year, after starting with 336 and generating 160 in cash flow post interest over those 5 years doesnt make much sense... 336-160 = 176.... not 75... point is, i think your total debt in the returns analysis should include the revolver balance. I haven't taken more than 5 minutes to look at this and is a pretty easy mistake to catch, hopefully you can revise that before sending it out...

you're right, cheers, missed the RCF on the IRR calc. I built it in at the end so wasn't fully intergrated.

this isn't to be sent out anywhere, just doing a few models prior to the test.

as noted in the OP, this is just for practice, hence poor / no formatting

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 

I'm getting a circular reference error (is anyone else seeing this?)

Looks like your error is:

L48 -> L152 L152 -> K153 K153 -> F36 F36 -> F30 F30 -> F28 F28 -> F15 F15 -> L50 L50 -> L48

Has this already been fixed? Or is it me?

"My caddie's chauffeur informs me that a bank is a place where people put money that isn't properly invested."
 

OMGeee, i'm panicking, the MD at GS didn't return my phone call, i wore cufflinks to an interview, my GPA was rounded, are black suits okay, can i expense taxis, how long am i allowed to spend in the bathroom, how do i print preview?

in seriousness, i'm taking it my model is the effin' beast then? no more comments?

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
USCstudent26:
how did you do? were u able to get the lateral spot?

yup, working through HR atm.

model was "best by a multiple"

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 

OP, was your test in house or provided by a third party?

Interested you because I've started hearing about a third party provider along the lines of SHL that provides modeling tests to PE firms interviewing candidates.

 
F. Ro Jo:
OP, was your test in house or provided by a third party?

Interested you because I've started hearing about a third party provider along the lines of SHL that provides modeling tests to PE firms interviewing candidates.

Interesting...

I'm talking about liquid. Rich enough to have your own jet. Rich enough not to waste time. Fifty, a hundred million dollars, buddy. A player. Or nothing. See my Blog & AMA
 

SEO has them, though they take fewer than 10 people every year into their fellowship program.

My analyst class also has older ones passed down from generation to generation. We all got an email with a ZIP file from the 2nd year analysts when we started.

 
gdxx:
SEO has them, though they take fewer than 10 people every year into their fellowship program.

My analyst class also has older ones passed down from generation to generation. We all got an email with a ZIP file from the 2nd year analysts when we started.

what, like the sex book in American Pie?
"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Matrick:
SEO has LBO Modeling Tests? I didn't even know they do PE recruiting.

Yes, SEO has a small alternative assets (PE) program for current banking analysts, and, yes, they have lbo model test training that includes tests similar to what you'd actually get in PE interviews (probably does include some cases that have actually been used by PE firms before). The SEO program is co-sponsored by some large PE firms (think maybe KKR and TPG).

If you want to prepare for these cases, you should really just grab a 10k and build a one-page LBO model on a blank excel sheet. You need to practice actually getting the model to work correctly under time constraints, and making assumptions for your drivers that are reasonable based on what's in the 10K. Nobody's going to expect you to be an expert on the company you present, but they're going to ask you questions to make sure that you're smart and that you thought through the assumptions. You probably also want to be able to say whether or not you think it's a good LBO candidate based on your model and based on qualitative characteristics of the company and industry. It would probably be smart to practice coming up with investment strengths/highlights and risks/weaknesses along with your practice model. Depending on the shop you interview with, the presentation part of the case may be more involved.

In my experience, most PE cases are at the offices of the PE firm and are more focused on making sure the analyst can do the model correctly with reasonable assumptions. The focus is less on the candidate actually thinking a lot about the investment and whether it's good or bad. I've seen a lot more of the take-home type cases for hedge fund interviews. Those take a lot more work and they expect you to be able to speak a lot more intelligently about the company. I assume this is because a lot more of your hedge fund job will be analyzing/screening investment ideas, whereas PE is a lot more about going through a process (i.e., model, diligence, memo, investment committee, bidding and more diligence, documentation, investment committee, closing process or not...rinse and repeat).

 

SEO would make sense given this guy was a minority. I didn't know SEO did PE recruiting. I was thinking he graduated from an Ivy League which had some sort of alumni program that passed around old modeling exams.

My modeling exam was held at the office of the fund for which I was interviewing.

Oreos, would you be willing to share the older exams you have?

 

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"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 

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