Response to "My Private Equity Recruiting Process"

Mod Note (Andy): This comment by @Northsider was posted in direct response to @Candor's post "My Private Equity Recruiting Process"

Having been through PE recruiting on both sides of the table now, I have a few reactions:

1. I heartily disagree with the idea that having a closed deal at all differentiates you as a candidate - especially the suggestion that you're better off postponing recruiting if you haven't announced a deal by recruiting season. If you feel unprepared for the process, that's one thing; and, insofar as navigating a deal from start-to-finish buttresses your understanding, I wouldn't contest that the experience is valuable. That said, being able to list the names of the parties involved because it's announced offers you no edge, ipso facto.

After interviewing dozens of candidates and debriefing with others on still more dozens, I can report that I've never once heard an interviewer credit a candidate for having completed a transaction. You're 7 months on the job: the lion's share of candidates (even from top groups) haven't had the opportunity to close a deal, and for many I interviewed, the deals they had announced weren't the ones in which they were most involved (due to double-staffing) or that were best to discuss in an interview setting. Literally the only time I heard deal experience mentioned by an interviewer was an occurrence in which a candidate had been staffed on a transaction involving one of our portfolio companies.

2. Not being long-winded can't be stressed enough. Most candidates for PE are near-professional status with respect to buzz word memorization. Nothing will derail your interview more than a palaverous answer. Keep it short, mention the most essential details and let the interviewer determine whether more investigation is necessary. If you don't understand the question, ask for clarification rather than pontificating and hoping to cover your bases.

3. There is a huge proportion of interviewees with significant mistakes in the model test. Even candidates who reported confidence at the beginning of the interview (I always ask how they felt about the model) often had calculation errors, errata on signs (please, please, please use negative presentation - it will save you from countless embarrassing gaffes), miscues on returns waterfalls and omissions or double-counts on their S&Us. Generally, if it was clear the candidate understood the concepts and was slipped up by time pressure, it wasn't a 'ding', but those who submitted a perfect model undoubtedly differentiated themselves.

Separately:

@Candor: You should be able to look at a case and say, "A is a great business, it has B, C, D, E & F going for it and given my preliminary read through it seems like it'd make for a compelling investment. That said, X, Y and Z are things I'd want to diligence further before I'd actually make a bid for the company." Obviously your answer should be more fleshed out than that.

For example in one of the case studies, I said "This telecommunications business looks great, it has a really strong growth profile, its revenues are growing at 6% a year, their EBITDA margins are incrementally improving, their business requires very little fixed costs, their FCF profile is very attractive, and these assumptions seem reasonable/conservative." And that was one of the points I raised among 5 or 6 other.

Although I agree with your outline and sentiment, your illustrative answer blunders into a category I would describe as "I can read numbers". If I give a candidate a case study that includes historical growth information, reporting that information back to me will score them no points. Quite the contrary, that kind of answer suggests to me that you aren't "thinking as an investor", as it were.

The most frequently attributed reason for snubbing a candidate is "P&L cathexis", if you will. For instance, when I ask candidates, "If you could only have one statistic to assess investment attractiveness, what would it be?" A plurality of banking analysts mention growth rate. Alternatively, if I present a simple comparison, "Company A with 15% EBITDA margins and Company B with 10% EBITDA margins, in which would you rather invest?" A frustrating portion of interviewees have a knee-jerk preference for Company A. In short, I would submit that the example answer you provided is negatively correlated with receiving an offer.

Now, obviously some candidates demonstrate their judgment when pushed further in the interview; clearly you gave plenty of satisfying answers, given your results. That said, I think the "top candidates" generally offer more thoughtful answers out-of-the-gate. For example (granting that I know nothing of the specifics in your telecom case study), "A telecom company growing at 6% organically with expanding EBITDA margins in a GDP-growth industry is clearly taking share and will likely trade at a steep multiple. However, its defensive end market exposure should mitigate cyclicality and provide juice on leverage. Given its strong cash flow conversion, even at market-clearing multiple the company should offer a solid pro forma FCF yield. And, if I think about what kind of businesses I would want to buy in this environment, I'd rather pay up for and hence over-equitize a business with defensive demand drivers that will have air-tight coverage if we hit a down-cycle during the hold. Couple that with an out-executing management team, we can probably accelerate share gains in a recession, use our high FCF yield to push out the exit a year or two without compromising IRR and grow into an exit multiple that still results in attractive returns."

That answer is a bit longer, but it sticks to the essential details, avoids rambling and demonstrates second-order investment judgment without requiring your interviewer to pressure test your thesis. The problem with your answer is that it makes no headway re: whether the business is an attractive investment. Strong growth, expanding margins, strong FCF conversion and reasonable projections are all nice in a vacuum, but some of the least attractive LBO candidates out there exhibit all four. If you're going to point to expanding margins, I'd prefer you frame it as a diligence point: "One thing that gives me pause is the rate of margin expansion on what should be a fairly variablized cost structure. Perhaps management is pushing through price increases with limited volume growth and is at risk of ceding share to lower-cost providers in the future or being unable to maintain its growth trajectory. Alternatively, perhaps this company has fat corporate overhead expenses and there's an opportunity for cost take-out to bump margins up to industry standard. Either way, it's a key point of diligence."

Lest I seem like I'm being unnecessarily critical, I want to reiterate that I found your post very informative and I agree with the majority of the advice you propose.

Comments (15)

Mar 19, 2015

As much as I appreciate both posts, this is the best advice and insight I've read since starting my recruiting on how to genuinely think and challenge myself intellectually rather than just memorizing a formula to get through the process.

Mar 19, 2015

As much as I appreciate both posts, this is the best advice and insight I've read since starting my recruiting on how to genuinely think and challenge myself intellectually rather than just memorizing a formula to get through the process.

Mar 19, 2015

Had to re-read that model answer about 25 times to understand it. Nice writeup.

Mar 20, 2015
7xEBITDA:

Had to re-read that model answer about 25 times to understand it. Nice writeup.

Can you please explain? I still don't understand it

Mar 19, 2015

great write up

p.s. well done on the use of "palaverous"

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Mar 20, 2015

I don't understand your use of 'ipso facto' in the opening paragraph.

"Elections are a futures market for stolen property"

Mar 20, 2015

Just because you can officially name parties involved in a transaction does mean you have an edge. Naming these facts in itself is not that advantageous.

Mar 20, 2015
fearandloathinginca:

Just because you can officially name parties involved in a transaction does mean you have an edge. Naming these facts in itself is not that advantageous.

Ipso facto means a truth or a fact onto itself. Thus, the way that he used it implies that an advantage, by fact, is not a direct consequence of having deal experience in PE recruitment. This is not fact and it is not implied a priori. It is an assertion, an unsubstantiated one at that, made by the OP and which requires meaningful support.

"Elections are a futures market for stolen property"

Mar 21, 2015
Esuric:

Ipso facto means a truth or a fact onto itself. Thus, the way that he used it implies that an advantage, by fact, is not a direct consequence of having deal experience in PE recruitment. This is not fact and it is not implied a priori. It is an assertion, an unsubstantiated one at that, made by the OP and which requires meaningful support.

The misunderstanding is likely a consequence of hastily written sentences with unclear syntax.

As intended: "The act of reciting names of transaction counterparties does not, in and of itself, confer advantages to the agent."

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

Mar 22, 2015

Great points on PE recruiting process, I agree the original post was off-base on certain key issues

Mar 22, 2015

This is great thanks.

I'm trying to understand the "P&L Cathexis" part. Had to research the definition of cathexis, the fixation on a particular idea, esp to an unhealthy degree.

So what you're trying to point out is that candidates, to an unnecessary degree, focus on growth, but contradict themselves later by instinctively choosing a company with a 15% EBITDA margin over 10% without considering growth?

I'd really appreciate if you could expound further on this concept...especially if it's one of the main reason candidates get knocked out of the pool.

"Everyone has a plan until they get punched in the face."

Mar 23, 2015

I think what he's trying to say is that it's important to look at the company as a whole and the drivers of its strong EBITDA/FCF margins. You should understand the assumptions these high cash flows are based off of. Knowing your investment has a moat and solid fundamentals that allow it to survive in a broad spectrum of economic conditions will justify a higher valuation. Fixating on companies that appear cheap on a multiple/growth basis may lead one to overlook downside protection.

Mar 23, 2015

In very broad strokes, I think the structure of your answer could go something like this. "Here is what the P&L tells me; the company appears to generate strong EBITDA margins and has had good organic growth. Reasons for the strong P&L and growth are based on premium product, fixed cost structure, unsaturated market, etc. If these attributes continue into the future, I think the company can be worth X times. Potential risk factors include new entrants into the market, lower revenues in economic downturns, and companies that can be more agile with variable cost structures. These risks are mitigated by the company's strong brand name, and experience in the markets in which it competes. For example, in bad scenarios we can simply ride it out due to good cost control, un-unionized workers, and low maintenance cost of our fixed assets.

Mar 24, 2015

Wow. This took the other post to a whole new level. Thanks.

PS - The entertainment value of seeing users commenting/dissecting your dissection of the original post is very welcome. I, too had to look up palaverous and cathexis.

Stamp collecting has always been a means to an end for me.

Mar 25, 2015

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