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)?

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Comments (12)

  • Analyst 2 in IB-M&A
Sep 14, 2021 - 5:18pm

I'd probably answer the other way considering we usually sell on Cash EBITDA, not just EBITDA. Seems like a deferred revenue related question 

  • Associate 2 in PE - LBOs
Sep 15, 2021 - 12:12am

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.

Sep 14, 2021 - 5:28pm

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.

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  • Prospect in IB-M&A
Sep 14, 2021 - 5:30pm

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.

Sep 15, 2021 - 10:50am

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. 

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  • Analyst 1 in IB-M&A
Sep 14, 2021 - 5:30pm

Bump. Would have answered w/EBITDA as well. Doesn't seem to be a deferred rev question, but would appreciate other thoughts here.

  • Associate 2 in HF - RelVal
Sep 14, 2021 - 11:43pm

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. 

Sep 15, 2021 - 8:45pm

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