16 PE Interview Questions

A sponsor buys a company using a mix of debt and equity: Enterprise Value = EBITDA × Entry Multiple, financed by (say) 60% debt / 40% equity. The company's own free cash flow pays down debt over the hold period (typically 3–7 years), which, combined with EBITDA growth and any multiple expansion, grows equity value faster than the purchase price grew. At exit, the company is sold (or IPO'd) at Exit EBITDA × Exit Multiple; debt is paid off first, and whatever's left is the sponsor's exit equity. Returns come from three levers: deleveraging (paying down debt), EBITDA growth, and multiple expansion/compression. Always be able to attribute a deal's return across those three.

Exit Equity Value ≈ Entry Equity + (EBITDA growth contribution) + (multiple expansion contribution) + (debt paydown contribution). Concretely: EBITDA growth contributes (Exit EBITDA − Entry EBITDA) × Entry Multiple; multiple expansion contributes Exit EBITDA × (Exit Multiple − Entry Multiple); deleveraging contributes Entry Debt − Exit Debt. Summing those three deltas plus entry equity roughly reconciles to exit equity (ignoring cash generated along the way, which is a fourth, usually smaller, bucket). Interviewers use this to test whether you understand that a 3x MoIC can come from very different deals (pure deleveraging on a flat-growth business vs. multiple expansion on a hot sector) and that the first is far more repeatable than the second.

Uses: Purchase Enterprise Value, plus refinancing of existing debt (if any), plus transaction fees (financing fees, advisory fees), plus a minimum cash requirement. Sources: senior secured debt (revolver + Term Loan, sized off a leverage multiple like 4.0–5.0x EBITDA or a lender's max leverage covenant), subordinated/mezzanine debt if the capital structure needs it, management rollover equity (existing management reinvesting a slice of their proceeds), and sponsor equity as the plug. Sponsor Equity = Total Uses − Total Debt − Rollover Equity. Always size debt first off a leverage constraint or DSCR/coverage covenant, then plug equity last, the same discipline as a real estate sources & uses.

A cash sweep directs some or all of a company's excess free cash flow (after mandatory amortization, capex, and interest) toward voluntarily prepaying the most senior, cheapest-to-prepay debt tranche (usually the Term Loan) ahead of schedule. Excess Cash Flow = EBITDA − Capex − Change in NWC − Cash Taxes − Cash Interest − Mandatory Amortization; the sweep percentage (often 50–100%, frequently stepping down as leverage falls) of that number pays down debt. This is why LBO debt schedules are often circular: interest expense depends on the debt balance, but the debt balance (via the sweep) depends on free cash flow, which depends on interest expense. Models resolve this either with a circular reference and iterative calculation turned on, or by approximating with average-balance interest.

PIK (payment-in-kind) interest accrues to the principal balance of a debt tranche instead of being paid in cash: the balance compounds each period rather than requiring a cash outflow. It's common on subordinated/mezzanine tranches in highly levered deals where cash interest coverage is tight, letting a company preserve cash for operations or senior debt paydown in the early years. The tradeoff: PIK debt grows the balance owed at exit (often at a materially higher rate than cash-pay debt, to compensate the lender for deferred cash and subordination), which eats directly into sponsor exit equity. In a model, PIK principal each period = beginning balance × PIK rate, added to ending balance rather than expensed as a cash interest line.

A QoE report, typically prepared by an accounting firm during diligence, normalizes reported EBITDA into a 'true' recurring EBITDA: adding back one-time items (litigation, restructuring), removing non-recurring revenue, and scrutinizing management's own adjustments (add-backs) for legitimacy. Since Purchase Price = EBITDA × Multiple, every dollar of inflated or illegitimate EBITDA add-back directly overpays the purchase price by the multiple: a $1M unjustified add-back at an 8x multiple is $8M of overpayment. Interviewers want you to know QoE sits alongside (not instead of) a full diligence process (legal, commercial, tax), and that sponsors negotiate purchase price adjustments off QoE findings.

Rollover equity (management reinvesting a portion of their sale proceeds back into the new equity structure) aligns incentives: management now has real skin in the game in the same security the sponsor holds, motivating them to hit the business plan that drives the sponsor's own return. It also reduces the sponsor's required equity check (rollover is a 'source' in sources & uses) and can be a signal to lenders and co-investors that the people who know the business best believe in the deal. Typical rollover ranges from 10–30% of management's proceeds, sometimes with an additional management incentive pool (a promote-like structure, often called a management option pool) layered on top to further reward outperformance.

Enterprise Value at exit is unchanged by capital structure: it's still Exit EBITDA × Exit Multiple. But Equity Value = Enterprise Value − Net Debt. If the company pays down $50M of debt over the hold with EBITDA and the multiple unchanged, exit equity is $50M higher than it would otherwise be, entirely funded by the company's own free cash flow rather than sponsor capital. Since entry equity is unchanged, that $50M flows straight through to MoIC. This is 'deleveraging' as a return driver, which is why highly cash-generative, low-capex businesses with stable EBITDA make attractive LBO candidates even with modest growth: the debt paydown alone can deliver a solid return.

Strong, predictable free cash flow generation (to service and pay down debt); low ongoing capex requirements relative to EBITDA; a defensible market position with stable-to-growing demand (lenders won't finance a business at risk of secular decline); low existing leverage (financing headroom); a fragmented industry offering a bolt-on / roll-up strategy; and a credible path to margin improvement or operational upside the sponsor can execute (cost-out, pricing, add-on M&A). Cyclical, capital-intensive, or highly competitive commodity businesses are generally poor candidates because covenant-breach and refinancing risk rise sharply in a downturn when leverage is already high.

Strategic sale (to a corporate acquirer, often at a premium for synergies), sponsor-to-sponsor sale (secondary buyout to another PE firm), an IPO (public listing), or a dividend recapitalization that returns partial capital to LPs without a full exit (re-levering the company to fund a special dividend, keeping ownership). Choice depends on market conditions (IPO windows open and close), the size and maturity of the business (strategics often pay the highest price for platform assets), and fund-life considerations (a fund nearing its end may need liquidity even at a lower price). Always be ready to discuss which exit a given deal profile suits best and why.

A leverage covenant (e.g., maximum Net Debt / EBITDA of 5.5x) is a condition in the credit agreement the borrower must maintain, tested quarterly. A breach is a technical default: the lender can demand immediate repayment, refuse further draws, or (more commonly in practice) negotiate a waiver or amendment (often for a fee and/or tighter terms) rather than force bankruptcy, since lenders generally prefer a going concern to a fire-sale recovery. Covenant headroom shrinks in a downturn (EBITDA falls while debt is fixed), which is why sponsors stress-test leverage ratios under a downside case before closing, not just the base case.

A platform company acquires smaller competitors (add-ons) at a lower entry multiple than the platform itself trades at (multiple arbitrage) while also capturing synergies (cost takeout, cross-selling, purchasing scale) that grow consolidated EBITDA. At exit, the whole combined platform can often be sold at the platform's (higher) multiple, not a blended average, since strategic and financial buyers pay for scale and market position. This is now one of the most common REPE-adjacent and corporate PE playbooks precisely because it combines two return levers (multiple arbitrage and EBITDA growth) without relying purely on organic growth or market multiple expansion.

A dividend recap has the portfolio company raise new debt (or increase existing debt) specifically to fund a special dividend paid out to the sponsor (and rollover management), without selling the company. It returns capital to LPs early (improving the fund's IRR by pulling distributions forward) while the sponsor retains upside in the still-owned business. The tradeoff is re-levering the company, which increases financial risk and can compress the eventual exit equity if performance falters, and reduces the cushion available before covenants bind. Distinguish this clearly from a full exit: ownership doesn't change, only the capital structure and cash position of the company do.

The revolver is a working-capital backstop, not typically a source of permanent financing: it's drawn when short-term cash needs exceed available cash (seasonal working capital swings, a temporary EBITDA dip, or funding a bolt-on before permanent financing is arranged) and repaid as cash flow normalizes. In a model, the revolver usually sits first in the debt waterfall: drawn when cash flow before financing is negative, and the first tranche the cash sweep repays when free cash flow turns positive again, ahead of the term loan. It typically carries a commitment fee on the undrawn balance and a modestly higher spread than the term loan on any drawn balance.

Cash interest expense depends on the debt balance; but under a cash sweep, the debt balance depends on free cash flow, which is net of cash interest expense: a genuine circular reference (interest → cash flow → debt paydown → interest). Two standard fixes: (1) enable iterative calculation in Excel and let the model converge on its own, adding a small 'circularity breaker' switch (a cell that can force interest to zero) so a broken formula doesn't produce a #REF error loop that's hard to debug; or (2) avoid the circularity structurally by calculating interest off the beginning-of-period debt balance only (rather than an average of beginning and ending balance), which sacrifices a small amount of precision for a cleaner, non-circular model, common in quick 'paper LBO' exercises.

Compare IRRs, not just MoIC, since IRR annualizes for time and captures opportunity cost of capital: a 2.0x over 3 years (≈26% IRR) usually beats a 3.0x over 8 years (≈15% IRR) for a fund that can redeploy capital into new deals. But funds also care about MoIC in absolute dollar terms for LP reporting and because redeployment isn't frictionless (finding the next deal takes time and has its own diligence/closing costs): a fund late in its investment period with dry powder to deploy may prefer the faster IRR; a fund earlier in its life with a longer runway may be more MoIC-tolerant. Always state which metric you're optimizing for and why, given the fund's stage.