Top 5 trending Private Equity Questions

Case Study 1 

A company with a P/E of 12x is acquiring a company trading at 10x P/E in a 100% stock deal. At what premium to the current price would the deal be break-even (EPS neutral)?

The Trap: Most candidates immediately say the deal is accretive because 10x is cheaper than 12x. 

But that’s not always true  what actually matters is the purchase P/E, not the trading P/E. If the acquirer pays too big a premium, the deal can become neutral or even dilutive. 

To find the break-even premium, we solve for the price that would imply a 12x purchase P/E — the same as the acquirer’s multiple. Let’s say the target earns $1/share and trades at $10 (implying a 10x P/E). Paying 12x means paying $12/share. That’s a 20% premium to the current price.

💵 So the break-even premium here is 20%. The deal is EPS  accretive if the premium is less than 20%, neutral at 20%, and dilutive above that.

💡 Key takeaway: It’s not about the trading multiple — it’s about the multiple you’re actually paying. Always ask: “What’s the purchase price including the premium?”

In a 100% stock deal, EPS neutrality (break-even) occurs when the implied P/E paid for the target equals the acquirer’s P/E.

Rule of thumb (EPS-neutral premium):

Interpretation:

Paying up to a 20% premium keeps the deal EPS neutral

Paying more than 20% → EPS dilutive

Paying less than 20% → EPS accretive

This is a classic P/E arbitrage situation where the higher-multiple buyer can overpay (to a limit) without hurting EPS.

Case Study 2

A company has negative EBITDA, but it was just acquired at a premium valuation. How is that possible?

Yes, it happens. And it’s not as crazy as it sounds.

Here’s why:

Valuation Is Based on Future, Not Current EBITDA

EBITDA is a point-in-time metric. Acquirers value the business on:

Forward EBITDA (2–5 years out)

DCF with strong cash-flow inflection

Path to profitability

If the company is temporarily loss-making due to scale-up, R&D, or market expansion, current negative EBITDA is irrelevant.

EBITDA Is Negative Due to Intentional Investment

Common EBITDA-negative drivers:

Heavy sales & marketing spend

R&D capitalization strategy

Front-loaded operating costs

Underutilized capacity

Accounting vs Economic Reality

EBITDA can be distorted by:

One-time costs

Aggressive expensing

Conservative revenue recognition

Buyers adjust to “economic EBITDA”.

The buyer may normalize EBITDA post-acquisition.

Bonus Insight:

📌 This kind of deal is common in strategic M&A, less so in traditional PE—unless it’s a growth equity deal. Remember that in the end, all valuation is based on cash flow, but that cash flow might occur very far into the future so there may not be much focus on today’s cash flow.

Case Study 3

A company decides to issue dividends worth $50K. How will this decision impact the three financial statements?

Issuing $50K dividends: Income Statement (IS) is unaffected; dividends aren’t expenses. Balance Sheet (BS) shows a $50K decrease cash as well as a decrease in retained earnings. Cash Flow Statement (CFS) records a $50K outflow in financing activities.

Dividends reduce cash and retained earnings by the same amount, appear as a financing cash outflow, and have no impact on net income

1. Income Statement ❌ (No Impact)

Dividends are not an expense

Net income does not change

2. Cash Flow Statement

Dividends appear under Cash Flow from Financing Activities.

Cash outflow: −$50K

Net cash decreases by $50K

3. Balance Sheet

Two changes occur:

Assets

Cash ↓ $50K

Equity

Retained Earnings ↓ $50K

Why:

Dividends are a distribution of profits, reducing retained earnings.

Case Study 4

During due diligence for an acquisition, Commercial DD shows strong market growth and competitive positioning, but Financial DD flags aggressive revenue recognition and rising working capital needs.

How should an investor interpret this, and how would it impact valuation and deal structure?

This indicates a good business with accounting and cash-flow risks.

Commercial DD supports the top-line story and long-term growth assumptions.

Financial DD suggests:

Earnings quality risk

Potential overstatement of EBITDA

Cash conversion may be weaker than reported profits

Implications:

Normalize EBITDA (adjust revenue, working capital)

Use lower near-term cash flows in DCF

Apply a higher discount rate or valuation haircut

Protect downside via:

Earn-outs

Escrows

Deferred consideration

One-Line Interview Summary

“Strong Commercial DD validates the growth thesis, but weak Financial DD requires EBITDA normalization, conservative cash-flow assumptions, and structural protections in the deal.”

Case Study 5

A company is being acquired in an LBO with Senior Debt, Mezzanine Debt, and Equity.

How do different debt tranches affect risk, returns, and leverage capacity, and why wouldn’t the sponsor use only the cheapest debt?

1. Risk, Returns, and Leverage Capacity by Tranche

The primary tranches differ based on their priority in the repayment hierarchy, which directly impacts their risk and cost profiles: 

Senior Debt:

Risk: Lowest. It has "first-priority" claim on assets and cash flows and is typically secured by collateral.

Returns: Lowest interest rates (e.g., 5%–8%), often floating based on benchmarks like SOFR.

Leverage Capacity: Limited by strict bank regulations and maintenance covenants (e.g., maximum Debt/EBITDA ratios).

Mezzanine Debt:

Risk: Medium-High. It is subordinated to senior debt and often unsecured.

Returns: Higher yields (e.g., 8%–14%) to compensate for risk. It often includes "equity kickers" (warrants) that allow lenders to participate in the company's upside.

Leverage Capacity: Fills the "funding gap" by allowing total leverage to exceed what senior lenders are willing to provide.

Equity:

Risk: Highest. Repaid only after all debt obligations are met.

Returns: Highest potential return (IRR). Leverage amplifies these returns because any increase in company value after fixed debt is paid accrues entirely to equity holders. 

2. Why Sponsors Don't Use Only the Cheapest (Senior) Debt

While senior debt is the least expensive, a sponsor cannot fund a deal entirely with it for several reasons:

Lender Limits: Banks are highly regulated and conservative; they will only lend up to a certain multiple of EBITDA (typically 3x–4x) to ensure the company can survive a downturn.

Repayment Schedules: Senior debt often requires "amortization" (mandatory principal repayments) over 5–7 years, which strains short-term cash flow.

Restrictive Covenants: Using only senior debt would subject the company to very tight financial maintenance covenants, limiting operational flexibility.

Maximizing Leverage: To minimize the equity check and boost IRR, sponsors need to tap into more expensive, subordinated layers (like mezzanine) that are willing to accept higher risk and longer "bullet" repayment terms (paying everything back only at maturity).