Unit Economics / Capital Structure Interview Questions

Hope everyone is safe from the snow or the rain -

I was looking for some advice on popular DD/credit interview questions:

  1. When you are asked to figure out the unit economics of a certain business, does this mean think about the revenue/costs down to the unit level (per subscriber, per bottle, per ounce of gold) and spread out items like G&A across the total unit base?
    1. Any tips or DOs/DON'Ts for this part?
    2. Any tips on what to do when you encounter a business you've literally never heard of or thought about?
  2. If you look at a cap stack and have to explain where you would invest (if at all), what are some key points to think about? 
    1. Where does value break? Appropriate multiple for the business? What is the duration to catalyst (e.g. maturity)?
    2. What is the value of the collateral? Is the tranche secured? How much are you expected to know about debt docs in a 3,4-hour case study?
    3. Anything else?
  3. How do you quantify and compare risks vs. yield? Should you try to evaluate probability-weighted asymmetry in worst-case scenario vs. best case scenario? Any rule of thumb or dos/don'ts for interview purposes?

Sorry for the long-winded question. Happy Tuesday!

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Comments (2)

Most Helpful
  • Associate 2 in PE - Other
Feb 2, 2021 - 6:47pm

1) Yes, you generally have it correct. I would make note of what aspects of unit economics are fixed vs. variable, and also note any meaningful cash flow variance when considering corporate G&A. If you encounter a business you've never had experience with, I would just try thinking through things logically to the extent you can. You should still be able to identify high level characteristics such as if the Company is in the widget making business, subscriber business, etc., and once you understand the particular business model you should be able to back in to rough unit economics / margin characteristics. I think this sort of thing is more about thought process for an interviewer. 

2) I'd focus on general credit metrics such as leverage through tranches based on EBITDA and EBITDA - Capex, asset coverage, obvious catalysts such as maturity dates, coupon dates for low liquidity companies, covenant step downs, asset sales, etc., and also focus on free cash flow...in particular, how does a company finance itself? Can it sustain itself from operations without any benefit from asset sales or taping capital markets? A serial equity / debt issuer that lacks meaningful cash flow can quickly become in trouble once the market closes, its like musical chairs. How much liquidity run way does a company have? Running out of cash in the next couple quarters is certainly a catalyst. For a 3-4 hour case study, I would look to understand high level covenants such as any quarterly / annual financial covenant tests, debt incurrence capacity, maybe any nuance between parent / downstream guarantees for a complicated capital structure. However, for the debt docs its best to keep a running list of future items you'd like to diligence because its very easy to fuck yourself up by trying to turn an in office case study into a complicated covenant trade idea that is most likely wrong, just given the time constraints. Definitely construct an asset coverage and associated waterfall model. Depending on the amount of time you have and knowledge of a firms strategy, you may be able to take it a step further and make some exit capital structure assumptions and figure which creditors get cash/debt or equity recoveries...some firms don't like to play the fulcrum angle, or it could be a situation where it is just a bad business and you can say you'd pass even with solid asset coverage because you wouldn't want to be the new equity owner of a bad business or something like that. 

3) You can do relative value things such as consider yield per turn of leverage, or compare yields to whatever your favorite HY index if you'd like. I have probability weighted scenarios in a case study before to arrive at a "probability weighted" IRR or frame the trade as something like 3pts of ups for every 1 down. Something like that is fine. 

I think above all for interviewing purposes don't try to reinvent the wheel or try to shoot the lights out with super out of the box thinking. Especially if you're looking at a junior sort of role most people just want to make sure you know how to look at a business through a credit / distressed lens and be able to find a trade within a given structure. My worst case studies were the ones where I tried to be covenant analysis hero when the "right" answer the interviewer was looking for was the very first thing that came to my mind when looking at the structure. 

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