PE Interview Question
For a PE interview, I was asked: would you rather have an extra dollar of EBITDA or an extra dollar of FCF?
I answered EBITDA because of the multiplier, but shouldn't an increase in FCF also mean an increase in EBITDA? Or do we assume that the extra dollar of FCF comes from something that doesn't impact EBITDA (e.g. less capex, NWC, taxes, interest)?
I’d probably answer the other way considering we usually sell on Cash EBITDA, not just EBITDA. Seems like a deferred revenue related question
Do you gross margin affect cash EBITDA? I haven't seen people do this but it doesn't make sense to take EBITDA + Change ST DR. Why would you not GM affect the change in ST DR? Seems like overstatement.
FCF, it might not be higher EBITDA but can mean less in other items such as nwc or capex. Either way, this is more tangible “cash” to the business.
Yes, it's more tangible cash but doesn't EBITDA have a greater impact on the exit valuation in an LBO? I believe most standard interview guides say EBITDA, but couldn't find an eloquent explanation for it.
Yes but you have to remember the amount of FCF also helps determine the exit multiple, i.e. a business with 10m in EBITDA but 8m in Capex will have a lower multiple than a business with 8m in EBITDA and 2m in capex.
could it be FCF because EBITDA is pre tax?
Bump. Would have answered w/EBITDA as well. Doesn't seem to be a deferred rev question, but would appreciate other thoughts here.
I would say FCF because it’s post-tax, and if you’re looking to exit to a sophisticated investor, they’ll buy on the basis of a FCF valuation. The exit multiple is just a heuristic that has FCF assumptions embedded.
FCF. EBITDA has many issues— it’s a trailing metric in terms of capital spend. You need to adjust for real capex, especially for maintenance capex which is required to maintain revenues. You likely will need some growth capex too. If you’re going to expand, you have a use of cash for ramping operating NWC. EBITDA does not convert 100% into FCF… therefore, you’re going to prefer a $1 FCF increase over a $1 EBITDA increase, much like you’d prefer a price increase over a volume increase all-else-equal.
This. The fact that free cash flow conversion is not always 100% is the easy answer to this question.
Would say EBITDA because of the multiplier effect upon exit. A one unit increase in FCF means you are only paying down one more dollar of debt.
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