Investment Banking Interview Questions (Introduction – 400 Interview Q)

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I see you’ve done mostly journalism and research internships before. Can you discuss your quantitative skills?

You should respond by discussing specific times when you had to analyze numbers and/or use logic. Good examples might include: your personal portfolio, any math/science classes you’ve taken, any type of budgeting process you’ve been through, any type of research you’ve done that involved numbers.

In your last internship, you analyzed portfolios and recommended investments to clients. Can you walk me through your thought process for analyzing the returns of a client portfolio?

The key is to break everything down into steps and be very specific about what you did. So you might say that "Step 1" was getting a list of when they bought each investment and how much they invested/how many shares they acquired; "Step 2" was finding a list of when they sold each investment, and what they sold them for; and "Step 3" was aggregating this data over the years in-between for each investment to calculate the compound return.

Can you tell me the process you used to analyze space requirements for the building designs you worked on this past summer?

Break it into steps and start by discussing how you made the initial estimates, then how you refined them and made them more exact over time while staying within budget and collaborating with your team.

You’ve been working as a lawyer for the past 3 years – what initiative have you taken on your own to learn more about finance?

You should either present a list of self-study courses such as the CFA that you’ve obtained, or speak about your own work studying independently from textbooks, self-study courses and other sources. Be conservative with how much you claim to know – re-iterate that you’re "not an expert" but that you have taken the initiative to learn something on your own.

You were an English major – how do you know you can handle the quantitative rigor required in investment banking?

The key is to use specific examples rather than just saying, "I got a high math SAT score!" Personal financial experience, classes, self-study courses and independent study work well.

Can you tell me about a time when you submitted a report or project with misspellings or grammatical mistakes?

It’s unrealistic to claim that you’re perfect and have never done this. Instead, briefly mention a time when you made a careless mistake and then spend the majority of time in your answer discussing what you learned and how you improved, citing another specific example of how you improved the second time around.

What’s the most number of classes you ever took at once and how well did you do in each of them?

Once again, it’s best to point to something specific – "During my junior year, I was taking 5 classes at once as well as working part-time and running my business fraternity – and I still got A’s in all of them." Not everyone has a perfect answer, but try to think about the most stressful time in your academic life and use that as a reference for your answer. State the "challenge" first, then how you responded, and then how well you did.

How well can you multi-task?

In keeping with our theme of specificity, give a concrete example of a time when you were working on multiple projects at the same time – work, school, or activities work equally well for this one. Also emphasize that despite the considerable demands, you pulled off everything successfully. Anything involving teamwork or collaboration is also good to use in this response.

Have you ever worked on a project or report that was shown to a large number of people?

A journal, student publication or anything similar could be good to mention here, as could anything shown to a client or multiple clients in your work experience or in an internship. If you don’t have something like this, the best approach is to come as close as possible by saying, for example, "I haven’t worked on a widely circulated publication, but I did work on such-and-such…, which required that all the details were perfect and that there were no mistakes…" You could even cite lab or medical work – even if it wasn’t widely circulated, anything requiring strong attention to detail suffices.

Walk me through your resume.

Start at "the beginning" – if you’re in college, that might be where you grew up or where you went to high school. For anyone in business school or beyond, it might be where you went to undergraduate, your first job, or even where you went to business school. Then, go through how you first became interested in finance/business, how your interest developed over the years via the specific internships/jobs/other experiences you had and conclude with a strong statement about why you’re interviewing today. Aim for 2-3 minutes – if you go on longer than this, the interviewer may get bored or impatient. Also, do not look at your resume when going through your "story." The 4 most important points: 1. Be chronological 2. Show how each experience along the way led you in the direction of finance. 3. State why you’re here interviewing today. 4. Aim for 2-3 minutes.

What are the most common mistakes with the "Walk me through your resume" question?

1. Going out of order chronologically. 2. Too much exposition – don’t start off by saying, "I’ve had a lot of great experiences." 3. Being too short (under 1 minute) or too long (over 5 minutes). 4. Not sounding certain you want to do banking/finance. 5. Listing your experiences rather than giving a logical transitions between each one. Go through all the video tutorials on this very questions – because your "story" is the most important part of any interview:

Why did you attend [Your University/Business School]? I’m sure you had many options. / Why did you transfer to [University Name]?

Say that you looked at a lot of places, but settled on wherever you went due to its excellent academic reputation, its strong business/ finance/ economics program, or something of that nature. If you were interested in something specific it offered (e.g. you were an athlete and went to Stanford on scholarship, or you went to UChicago because of its excellent liberal arts program) you can mention that as well. Try to sound like you made a thoughtful decision rather than deciding randomly. If you transferred elsewhere, a similar strategy applies but make sure to emphasize it was for academic reasons. For example, don’t say you wanted to get out of Massachusetts and move to southern California for an "improved lifestyle!"

I noticed you studied abroad in [Location]. Can you tell me about that experience and why you went there?

Emphasize you did a lot academically rather than partying 24/7. Many study abroad programs do, in fact, involve partying 24/7, but you don’t want to admit this. You can mention something about the fun you had, trips you went on, and anything interesting you did (climbing Mt. Fuji, starring in a Korean soap opera, excavating ruins in Troy, etc.) but don’t over-do it and make them think you did nothing constructive while you were there. Think "Work hard and play hard" for this one.

Why did you major in [Your Major]?

If it was something related to business/economics, you can discuss your interest in those fields; for other majors, you can emphasize how you liked the challenge and/or had a personal interest in the field, but also took the time to learn the basics of business/finance on your own.

Where else did you apply for school? Did you get in anywhere else?

You applied to a number of top schools and got in at other places, but you went through a careful decision-making process and settled on your school for a very good reason. Show that you’re "in-demand" by others and you always become more attractive – whether it’s to the bank you’re interviewing at or to the schools you’re applying to.

I see you wrote here that you’re fluent in [Language]. Can you tell me about your most recent internship in [Language]?

Be prepared for this if you list any common languages on your resume (Spanish, French, Italian, German, Chinese, Japanese, etc.) or if you happen to "get lucky" and your interviewer is a native speaker in one of the languages you’ve listed. I would suggest some practice discussing your work experience in whatever language(s) you’ve listed and making sure you can speak intelligently, at least briefly, about what you’ve done. If you really don’t much, just tell them upfront rather than making a fool of yourself and trying to talk about EBITDA when you don’t know the word for it – I speak from experience on this one.

What do you do for fun?

Obviously, don’t say anything illegal or questionable/controversial. If you have anything interesting or not very common (hang gliding, directing movies, bungee jumping) you should bring that up. Otherwise, just be honest and if you really like watching football (North American football for international readers) or other sports, just talk about your interest in those.

What was your favorite class in college/business school?

I would not say anything economics/finance-related – it sounds too artificial. Tell them about something you were actually interested in – even if it’s not directly related to banking. They want to see who you are as a person, not whether or not you know all the Excel shortcuts in the book.

What are your favorite movies/books?

There are 2 common mistakes: 1. Saying something like Wall Street, American Psycho, or Liar’s Poker that indicates you’re a boring person. 2. Saying something like Harry Potter that indicate you’re borderline illiterate. Pick something in the middle – above pop literature/film but not something that has to do with finance specifically. That just sounds weird.

Tell me something interesting about you that’s not listed on your resume.

Again, don’t say anything illegal/inappropriate – use common sense. Talking about that trip to Easter Island or your Brazilian Jiu-Jitsu championship both work well.

You’ve had tons of engineering experience and you’ve worked at many tech companies. Why do you want to be an investment banker now?

Talk about how you dislike the limited advancement opportunities and how your work didn’t affect the world at large – only what that specific company was doing. You want to do finance because you like the business aspect of technology more than the technology aspect of technology and because you want to make an impact with your work and become an investor or advisor one day.

You’ve done Big 4 accounting for the past year – why would you want a job that’s a lot more stressful with twice the hours?

Because your accounting work was boring and mundane, and because there were limited advancement opportunities. Finance is faster-paced and you’ve realized that after speaking with a lot of friends and doing your own research that it’s just more suited to your personality.

I see you’ve practiced law at Wilson Sonsini for the past 4 years – if you’ve been there that long, you’re probably on Partner-track by now. Why would you want to leave a lucrative career in law and go back to being an entry-level Associate in banking?

Emphasize how business people never respect lawyers and view them as nuisances rather than as a critical part of the team – as a banker, you’d be making deals happen and actually advising companies rather than just proofreading documents and doing "Find-and-Replace" in Word. Of course, you do a lot of this in banking anyway but this angle still works because bankers really do look down on lawyers.

I see you worked at McKinsey one summer and then went to Citi investment banking the next year. Are you sure you want to do investment banking?

Yes. Although you worked at McKinsey, you realized you didn’t like consulting because of the wishy-washy nature of the work (making reports and billing by the hour rather than billing by the result) and the constant travel and lack of quantitative skills/learning. You enjoyed your Citi internship much more and realized you wanted to be in banking rather than consulting.

Wow. I must be honest, I rarely see people who have accomplished as much as your have at your age. You sold your own company for over $1 million within 2 years of starting it, and became a leading real estate investor in Asia at the same time. Why would you ever want to work for other people in banking if you’ve been so successful on your own?

You don’t view things in those terms. Although you did well, there’s always room to learn and banking would be a great learning opportunity for you. You’ve spoken with many friends in the industry and have been impressed by what you’ve heard, and you want to broaden your experience and knowledge so that you can move into higher-stakes business.

You’ve worked at a few prop trading firms and also in Sales & Trading. They get paid pretty well and work market hours – so they have it a lot better than us. Why would you want to switch to investment banking?

You didn’t like the culture of trading, and wanted to have more of an impact by advising companies on major strategic decisions rather than just making small trades and investments each day. Banking excites you more because of the broader range of opportunities and experiences it gives you.

Where else are you interviewing? Is it just banking? Consulting? Other companies?

Just banking. You’re not interested in consulting/other options and don’t want to waste recruiters’ time. You need to say this even if you’re so uncertain that you’re deciding between opening a zebra ranch, going on a spiritual journey to Nepal, going back to McKinsey or starting a laundromat with your roommate’s uncle.

Are you mostly interviewing at larger banks like us? What kinds of options within banking are you considering?

Mostly larger banks, but you have received some interest from other places so you’re looking at a couple options. If you can mention specific names, that makes your answer even better. If you’re interviewing in a group like M&A or Healthcare, talk about how you’re mostly speaking with similar groups to show you’re serious about that one area.

Before you entered business school, I see you switched jobs about once a year. How do I know that you’re here to stay for the long-term?

Although you switched jobs pre-MBA, it’s quite common to move when better opportunity arises. However, you’ve done a lot of research, spoken with friends, alumni and other connections and are certain banking is for you after doing your own due diligence. You’ve actually looked into other career options and nothing is as attractive to you as banking.

Recently some Analysts and Associates have left "early" and jumped to hedge funds or private equity. If the opportunity comes up, why would you stay here instead?

You looked into investing by realized you don’t like the nature of the work – there’s too much due diligence and "looking at deals" rather than taking action and actually doing deals. As a result, after all your research speaking with alumni and other connections, you’re set on banking.

Tell me a bout a time when you failed to honor a commitment.

The key with this type of question is to bring up a "failure" briefly and then to spend most of your time talking about what you’ve learned from it and how you’ve improved rather than dwelling on the failure itself.

If I gave you an offer right now on the spot would you take it?

"Yes, show me the dotted line and I’d sign it right now." Even if this is a lie, you still have to say it in an interview or you won’t get an offer.

Let’s say that we were to give you an offer – how long would you need to decide whether or not to accept it?

"Show it to me and I’ll sign and accept it right now." Some people think this is "unethical" if you’re really not certain, but keep in mind that until you’ve signed something in writing you can do whatever you want. No, they won’t like you if you verbally accept and then renege, but it’s not the end of the world – just the end of your relationship with that bank.

You spent this last summer working at Morgan Stanley’s investment banking division. It seems like you’d be crazy not to go back – why would you want to work fora smaller firm in our M&A group?

You’re most likely to get this one if you didn’t get a return offer – let’s be honest, who really goes from Morgan Stanley to a boutique? It’s a tough sell, but you’ll have to emphasize how you like the smaller environment where you get more responsibility and work more closely with clients. The banker probably won’t believe you, but it’s better than outright admitting you didn’t get an offer. If the topic does arise, just say your lack of offer was because they were not hiring, because the group did poorly or because of the general economic climate.

Since you worked at Bank of America this past year, you probably have the chance to go to a lot of different large banks – why are you interested in us specifically?

There’s rarely a "great" way to answer this question, so I would recommend either referencing someone you’ve spoken with at the bank and what they’ve told you OR if you don’t have any kind of experience like that, you can just give the usual generic reason given for each bank. This question often reflects a lazy interviewer more than anything else – the real reason you’re interviewing with any bank is because they’ve given you an interview!

When you were working at that boutique this past summer, you mentioned how you like the smaller team and more hands-on environment. Why not just go back there? Why do you want to move to a large bank?

It’s always good to be positive about your experience, but at the same time you also want to give a good reason as to why you’re moving elsewhere. If you’re moving from a smaller bank to a large one, you want to emphasize learning about how larger/major deals happen, how you want to learn from the best and perhaps even how bankers at your old firm recommended that you go somewhere bigger at the beginning of your career.

Why are you interested in our M&A division rather than our industry groups? Our Tech, Healthcare and Energy teams have been really successful this year.

Say that you want to gain solid technical and modeling skills and be exposed to a wide variety of industries and different markets. Depending on the interviewer, it may also be appropriate to mention your interest in private equity (if you’re planning to go that route) and how M&A will get you there. M&A bankers love to think they’re superior to others because of their "in-depth technical knowledge and negotiation skills," so you should play off that and use it to your advantage.

Why do you want to work in Capital Markets? There’s hardly any market activity these days.

With this type of question – whenever a certain area is depressed at the moment or is not doing well – you want to highlight your long-term view of the market and how things recover in time. For Capital Markets specifically, you can talk about your interest in the markets since you were much younger and how you’ve always been fascinated by IPOs, secondary offerings and such – as always, specific examples are the key to success.

What do you think our bank’s greatest weaknesses are?

This is a silly question, but I can’t say I’ve never heard it before. In a normal "weaknesses" question it’s best to say something real and then indicate how you’ve improved on it, but in this case it’s better to say something more innocuous and maybe point to a "weakness" like not being strong in Europe/Asia, or not having as much experience in one industry as another bank – but then indicate how it doesn’t matter to you because you’re more concerned with other aspects of the firm.

Which of our competitors do you admire the most?

This is another silly question that is designed to test your knowledge of the industry more than anything else. The best way to answer: briefly point to a competitor and state a widely known train about them that you admire and then explain how the bank you’re interviewing with also has that quality and might even be better at it. For example, Goldman Sachs is known for its "one firm" culture and emphasis on teamwork, while the former Bear Stearns was known for its more "entrepreneurial" environment. You could reference these types of qualities and then state how they’re also seen in the bank you’re interviewing with.

I realize it’s still early in your career – you haven’t even graduated yet – but have you given any thought to your long-term plans? Do you think you’ll stick with investment banking?

If you’re interviewing for an Analyst position, you can be more uncertain about your future and just state you don’t know 100% where you’ll be yet, but banking is what excites you most and is what will give you the skills you need to succeed. For prospective Associates, you need to be more certain about your career path and show some commitment – indicate you’ve done your homework, spoken with many people and really want to make a career out of it.

You’ve had quite diverse experience prior to business school. After you complete your degree, where do you think you’ll be going in the long-term?

Since this question is given to an MBA candidate, you’ll want to be more certain and show more direction in terms of your plans. State that you do want to pursue investment banking as a career, after having done extensive research on your own (and hopefully, having had a previous internship or other experience in the field that you can point to).

What is your career goal?

This might be my least favorite question of all time, but some lazy interviewers will ask you anyway. Again, at the undergraduate level you can afford to be more vague and just indicate you want to do something in business/finance and advance to a high level; MBA candidates should indicate that they’re in banking for the long-term.

Looking into the future 10 years, do you think you’ll still be an investment banker?

Analysts can, and arguably should, be more uncertain, while business school graduates need to be confident about their career choice.

In your internship this past summer, what feedback did you receive?

This is a variant of the "strengths and weaknesses" question. The most common mistake is being vague and just saying you performed well and they liked you, and then failing to give weaknesses/areas for improvement. The right way to answer this question is to state specific qualities about you that they liked – such as ambition, drive, attention to detail, or willingness to go the extra mile for the team – and then give some specific examples of times when you demonstrated those qualities. Your all-nighters, the times you stayed the weekend working on a presentation, or the time you caught mistakes someone else above you missed are all good to mention. The other critical part is mentioning weaknesses/areas for improvement as well – talk about real weaknesses and how you’ve worked to improve them.

What were a few areas that your team said you should try to improve upon?

The 2 most important points to remember with the "weaknesses"/ "failure" question: 1. Give a real weakness rather than saying you "work too hard." 2. Show how you improved on it, using specific examples. What are "real" weaknesses you could give? Maybe you weren’t as communicative with the team as you should have been at the start; maybe you got lost in the details sometimes and failed to see the big picture; maybe you were too impatient with others or did not delegate tasks appropriately. The point is to say something that is a real weakness but which is also not a "deal-breaker" – like saying you don’t like to work hard or can’t stand working in teams. After that, state how you’re working to improve your weakness. Perhaps you gave more regular updates to your superiors; or maybe you started leveraging other peoples’ knowledge or the administrative staff at your work more often.

Did you get an offer to return to where you worked last summer?

If you did get an offer, this is an easy questions: "yes." If you did not receive an offer, I would strongly recommend against lying about it – state that you did not receive an offer, and it was due to the economy, because your group was not hiring or due to other forces beyond your control. The danger with lying is that finance is a very small world and it’s quite easy to ask a friend or a friend of a friend what really happened.

After going through the accounting program at PricewaterhouseCoopers for the past year, what sort of end-of-year review did you get?

This is a disguised "tell me your strengths and weaknesses" question, so you should follow the advice given above. Since it’s in relation to a full-time position you’ve held, you should be a bit more thoughtful about what you say; generic answers won’t work as well if they ask about your performance in a specific job.

Let’s imagine that your best friend is describing you in 3 words – which words would he/she use and why?

This is just, "Tell me your strengths" in disguise, but you need to narrow it down to 3 words. Since it’s your friend describing you, you don’t want to say, "Driven, attentive to detail and a team player!" You do want to convey the same ideas – that you can work hard, play well in teams, and get things done no matter what obstacles you face – but you should pick your own language to get this across. For each word you list you should also give 1-2 sentences to back up what you say, using a specific example for each one.

Imagine that I’m speaking to someone with whom you have not gotten along in the past – what would he/she say about you?

This is just a disguised "weaknesses" question. However, since it involves someone else this time, it’s better to give a weakness such as being stubborn and holding too rigidly to your own views rather than some of the other faults you could state. Weaknesses related to team/group settings are better here. And once again, you need to emphasize how you’ve worked to improve whatever it is that you did not do well at the time. Don’t say something like, "I get a long with everyone!" as that sounds unrealistic.

Why would we decide not to give you an offer today?

This one is a bit tricky because it’s so direct. You could attempt to make a joke out of this one and say something like, "If you decided you weren’t hiring at all!" but that may not go well if your interviewer doesn’t appreciate humor. Otherwise, the best response may be to turn this around and say, "I see no reason why you wouldn’t – I’m your best choice because…." and then give your strengths instead. If they really press you on this, you can admit a weakness and then say how you’ve been working to improve it.

Tell me why we should hire you in 3 sentences.

This is yet another variation of the "strengths" question. But rather than giving generic strengths, you should highlight any unique experiences you’ve had. So maybe you haven’t had banking internships before – but you have had unique experience abroad, in an unusual setting, or doing something not many others have done, or you’ve overcome unusual hardship – and those make you particularly well-qualified. Try to make your answer some variant of "I’m smart because of [School/Academics], I can do the work because of [Internships/ Previous Jobs], and I’m an interesting person and fun to be around because of [Unique Experience]."

What was your greatest failure?

As with any "weaknesses" question, you need to use a specific story – such as an exam where you did not do well, a project that did not go as planned, or a work situation that did not turn out well – and show what you learned from it and how you’ve improved since then. Don’t say something fake like, "My greatest failure was getting into Yale and Princeton but not Harvard" – that makes you look silly. It’s better to give something real and then show how you’ve used the failure to develop.

Can you talk about a team project or some kind of group activity you’ve worked on before?

Ideally, you will talk about something that was a success rather than a failure. You should use the following 3-point structure for these questions: 1. State upfront what the problem was – Maximizing returns? Attracting more donors for your nonprofit? Winning more customers? 2. Talk about the team you worked in, who did what, and what your role was. Did you manage people or delegate tasks? Those are best, but if you were a "foot soldier" that can also work as long as you worked long hours, were attentive to detail and/or came through in the end to save the team in some way. 3. State the results – Did your brand awareness go up? Did you get more funding? More members for your organization? This is one of the fundamental questions that you need to be prepared for, because it will almost always come up in some form in interviews.

Can you describe a situation where a team did not work as intended? Whose fault was it?

This is another variant of the "failure" question. I would recommend starting with a situation where your team did work as intended and talk about how it wasn’t working at first and what you did to fix it. Never blame someone specific – instead, say that there were "personality conflicts" and that you worked to resolve them. To make things even easier, you could re-use the story you told in question #1 but instead position it as a failed team situation that turned into a successful one.

Can you discuss an ethical challenge you were confronted with and how you responded?

If you’ve already worked full-time, any ethical challenges you faced at work or any whistle-blowing you’ve done are best to discuss; otherwise, you could talk about how you stopped funds in a student group from being used illegally or how you caught someone cheating. Just make sure you don’t over-dramatize it – your life is not a soap opera and you shouldn’t go on for 10 minutes about your internal conflict deciding whether to turn someone in for their wrongdoing.

What was the most difficult situation you faced as a leader and how did you respond?

Point out how you stayed calm and collected in the face of a challenging situation and how your cool decision-making process led to a positive outcome. Maybe 2 of your subordinates couldn’t get along and you had to arbitrate; maybe you were 3 months behind on a project and had to get a team together to finish it in 2 weeks; maybe you were an RA in a dorm and you had to prevent 2 residents from harassing each other. Just make sure that it’s a real problem, as opposed to only getting an A- when you should have gotten an A.

Can you discuss a time when you had to sacrifice your time for the sake of a team project?

This is the classic "burn the midnight oil" question, and you should definitely have something prepared for this one. There are 2 key points: 1. Whatever you did had to involve long hours – 60-70 hours per week or more 2. It had to have been over an extended time period – so Final Exam week at school would be a poor example. Aim for something that took place over weeks or months instead. Maybe you were working full-time and also leading your volunteer group to build shelters; maybe you were taking 6 classes, running a fraternity, and then got called up to direct that huge Cinco de Mayo festival. It doesn’t matter too much what it was as long as your story is detailed and convincing.

Do you work better as a leader or a follower?

Resist the urge to say "leader" and instead talk about how you can function as both a leader and another member of the team, depending on what the situation calls for. You don’t want to hog the spotlight or do everything, but if leadership is required, you can step up and handle it. Specific examples to back up the above points are also required.

What is your leadership style?

A "moderate" answer works best here. You’re responsible and can make sure things get done, but at the same time you don’t annoy your teammates by micro-managing. If you’re interviewing for an Analyst or Associate position, you do want to be a bit more "hands-on" and point out that you often go in and correct mistakes to make sure everything’s perfect – since you’ll be spending around 50% of your time doing this. Again, a specific example is needed once you’ve state in general terms what your style is.

Does the leader make the team?

No, the team makes the team. The leader can provide direction and unify everyone, but 1 person alone is not a "team." A leader can make things better and turn around a dysfunctional team, but it’s equally important for everyone to pull their own weight. You can often re-use some of your other "leadership" or "team" stories you’ve used and spin them differently.

You’ve never worked in finance before. How much do you know about what bankers actually do?

You should acknowledge that although you haven’t worked in the field before, you’ve done a lot of research on your own and have spoken with many friends in the industry. Based on that, you know that bankers advise companies on transactions – buying and selling other companies, and raising capital. They are "agents" that connect a company with the appropriate buyer, seller, or investor. The day-to-day work involves creating presentations, financial analysis and marketing materials such as Executive Summaries.

Let’s say I’m working on an IPO for a client. Can you describe briefly what I would do?

First, you meet with the client and gather basic information – such as their financial details, an industry overview, and who their customers are. Next, you meet with other bankers and the lawyers to draft the S-1 registration statement – which describes the company’s business and markets it to investors. You receive some comments from the SEC and keep revising the document until it’s acceptable. Then, you spend a few weeks going on a "road show" where you present the company to institutional investors and convince them to invest. Afterwards, the company begins trading on an exchange once you’ve raised the capital from investors.

How much do you know about the lifestyle in this industry? Do you know how many hours you’re going to work each week?

Say that you’ve done your homework and you understand it’s going to be an 80-100 hour per week job. It helps if you can reference specific times when you worked that much and how you dealt with it, whether it was in a summer internship or a previous job you’ve held.

I see you were an English major in college, and had time to participate in a lot of different activities. Can you talk about a time when you had to work long hours and make sacrifices?

This is similar to many of the other questions we’ve been over – once again, emphasize that you not only worked long hours, but also did it over several weeks or several months. One point that makes this question different: because of the way it was framed, you probably want to discuss something outside extracurricular activities.

Can you tell me about the different product and industry groups at our bank?

This one is bank-dependent and will differ for boutiques, middle-market firms and bulge brackets – so you need to research it before your interview. Typical product groups include Mergers & Acquisitions (M&A), Leveraged Finance (LevFin) and Restructuring; you could also consider Equity Capital Markets and Debt Capital Markets "product groups" but that one is debatable. Common industry groups include Healthcare, Retail, Industrials, Energy, Natural Resources, Financial Institutions, Gamin, Real Estate and Technology, Media & Telecom (TMT). Not all banks are structured this way – Goldman Sachs, for example, does not have product groups and instead handles all types of deals in its industry groups. Meanwhile, most bulge bracket banks do not have Restructuring groups at all – that is something that only middle-market and boutique firms do. Finally, a lot of boutiques focus only on M&A and/or Restructuring and ones that are small enough are not even split into industry groups.

What’s in a pitch book?

It depends on the type of deal the bank is pitching for, but the most common structure is: 1. Bank "credentials" (similar deals they’ve done to "prove" their expertise). 2. Summary of a company’s options ("strategic alternatives" in banker-speak). 3. Valuation and appropriate financial models (for example, if you’re pitching for an IPO you might show where the IPO proceeds would go). 4. Potential acquisition targets (buy-side M&A deal) or potential buyers (sell-side M&A deal). This is not applicable for equity/debt deals. 5. Summary and key recommendations.

How do companies select the bankers they work with?

This is usually based on relationships – banks develop relationships with companies over the years before they need anything, and then when it comes time to do a deal, the company calls different banks it has spoken with and asks them to "pitch" for the business. This is called a "bake-off" and the company selects the "winner" afterward.

Walk me through the process of a typical sell-side M&A deal.

A typical sell-side M&A deal with many potential buyers would look like this: 1. Meet with company, create initial marketing materials like the Executive Summary and Offering Memorandum (OM), and decide on potential buyers. 2. Send out Executive Summary to potential buyers to gauge interest. 3. Send NDAs (Non-Disclosure Agreements) to interested buyers along with more detailed information like the Offering Memorandum, and respond to any follow-up due diligence requests from the buyers. 4. Set a "bid deadline" and solicit written Indications of Interests (IOIs) from buyers. 5. Select which buyers advance to the next round. 6. Continue responding to information requests and setting up due diligence meetings between the company and potential buyers. 7. Se another bid deadline and pict the "winner." 8. Negotiate terms of the Purchase Agreement with the winner and announce the deal.

Walk me through the process of a typical buy-side M&A deal.

1. Spend a lot of time upfront doing research on dozens or hundreds of potential acquisition targets, and go through multiple cycles of selection and filtering with the company you’re representing. 2. Narrow down the list based on their feedback and decide which ones to approach. 3. Conduct meetings and gauge the receptivity of each potential seller. 4. As discussions with the most likely seller become more serious, conduct more in-depth due diligence and figure out your offer price. 5. Negotiate the price and key terms of the Purchase Agreement and then announce the transaction.

Walk me through a debt issuance deal.

It’s similar to the IPO process: 1. Meet the client and gather basic financial, industry, and customer information. 2. Work closely with DCM/Leveraged Finance to develop a debt financing or LBO model for the company and figure out what kind of leverage, coverage ratios, and covenants might be appropriate. 3. Create an investor memorandum describing all of this. 4. Go out to potential debt investors and win commitments from them to finance the deal. The main differences vs. an IPO: there are fewer banks involved, and you don’t need SEC approval to do any of this because debt is not sold to the "general public" but rather to sophisticated institutional investors and funds.

How are Equity Capital Markets (ECM) and debt Capital Markets (DCM) different from M&A or industry groups?

ECM and DCM are both more "markets-based" than M&A. In M&A your job is to execute sell-side and buy-side transactions, whereas in ECM/DCM most of your tasks are related to staying on top of the market, following current trends, and making recommendations to industry and product groups for clients and pitch books. In ECM/DCM you go more in-depth on certain parts of the deal process, but you don’t get as broad a view as you might in other groups.

What’s the difference between DCM and Leveraged Finance?

They’re similar but Leveraged Finance is more "modeling-intensive" and does more of the deal execution with industry and M&A groups on LBOs and debt financings. DCM, by contrast, is more closely tied to the markets and tracks trends and relevant data. But there’s always overlap and some banks have just 1 of these groups, some have both, and some divide it differently altogether.

Explain what a divestiture is.

It’s when a company (public or private) decides to sell off a specific division rather than sell the entire company. The process is very similar to the sell-side M&A process above, but it tends to be "messier" because you’re dealing with a part of one company rather than the whole thing. Creating a "standalone operating model" for the particular division they’re selling is extremely important, and the transaction structure and valuation are more complex than they would be for a "plain-vanilla" M&A deal.

Imagine you want to draft a 1-slide company profile for an investor. What would you put there?

"Put the name of the company in the header, then divide the slide into 4 equal parts. The top-left is for the business description, headquarters, and key executives. Put a stock chart and the key historical and projected financial metrics and multiples on the top right. The bottom left can have descriptions of products and services, and the bottom right should have key geographies with a color-coded map to make it look pretty."

Let’s say you’re hired as the financial advisor for a company. What value could you add for them if they ask you about their suggested growth/M&A strategy?

At a high-level, first you’d want to see what their expansion goals are and how they can best achieve them – whether it’s by partnering with another company, expanding with a merger or acquisition, or expanding organically with new products. As the investment banker, you could provide value by making introductions to potential M&A targets and partners, and then advising on the best negotiation strategy, why companies would be most receptive, what type of price to expect, and how to manage the entire process.

Let’s say you had $10 million to invest in anything. What would you do with it?

Always ask for the investor’s goals first. Are they looking to have big capital gains over 30-40 years? Are they looking for tax-free retirement income? What types of assets interest them? Based on the response, you can give an appropriate answer. So if they’re investing over 30-40 years and going for high capital gains, a well-diversified portfolio is probably best; if they are more concerned with tax-free income, maybe you should tell them about municipal bonds.

If you owed a small business and were approached by a larger company about an acquisition, how would you think about the offer, and how would you make a decision on what to do?

The key terms to consider would be: 1. Price 2. Form of payment – cash, stock, or debt 2. Future plans for the company vis-a-vis your own plans. Of course, there is much more to an M&A deal than this – you could list literally hundreds of different terms. But those are the key ones. To make a decision you’d have to weigh each one – there’s no "magical" way to decide. You might also point out that if something is particularly important to you – such as retaining a role in the company – then a difference of intentions there could be a "deal-breaker."

We do most of our work with technology companies. Can you talk about a trend or company in the industry that has piqued your interest lately?

This is very common if you’re interviewing for any industry group – I recommend doing some research beforehand and being able to speak about trends in that market. It’s easy to find this information for Technology and anything that sells to consumers, but it’s a bit harder for something like Chemicals. Most interviewees make 3 mistakes with this question: 1. They describe something that is not recent or relevant. Don’t talk about the emergence of the Internet – talk about how companies are shifting their software to the Internet. 2. They don’t explain the "why" – they’re shifting to the web because it’s cheaper and lower maintenance for them. 3. They don’t explain the impact on the market as a whole – such companies are growing very quickly while more traditional companies are either struggling or shifting to that model.

Let’s say you could start any type of business you wanted, and you had $1 million in initial funds. What would you do?

You’ll want to ask follow-up questions to see if the interviewer is looking for something more specific, because this one is wide open. If no further direction is provided, you probably want to say that you’d think about some type of niche business with high margins that requires little startup capital ($1 million is not enough to build 10 factories) and ongoing maintenance – those make it harder to turn a profit and sell the business one day. (This is one reason why some private equity investors focus on software companies). It’s better to focus on a niche market because most broad, horizontal markets are already dominated by major companies (Microsoft, Goldman Sachs, Exxon Mobil, etc.). You should also explain your reasoning on why this type of business would be attractive and how it could grow with minimal future investment.

Can you talk about a company you admire and what makes them attractive to you?

Do not say something commonly known. Saying Google or Apple, for example, would be bad. Instead, go more obscure and pick a company no one knows so that they can tell you’ve done your research and so that they’re less likely to ask probing questions. You don’t necessarily need to give financial details, but if the company is public and you can easily find the information, it definitely helps. When you talk about what makes the firm attractive, emphasize qualities that investors would find appealing, such as a great and well-diversified customer base, a unique competitive advantage in the market or a high-margin business model. Don’t say that you like them because your new iPhone is awesome.

Let’s assume you are going to start a laundry machine business. How would you analyze whether it’s viable?

To assess whether it’s "viable," you have to determine whether you can make a profit with the business. For a laundry machine operation, you’d start by looking at the location (the most important part of any retail business), estimate how many customers you could get, how frequently they do laundry and how much they pay each time to do their laundry. Those variables give you an idea of monthly/annual revenue. On the expense side, the biggest cost would be the upfront construction and/or purchase of the building and the machines. You would probably need a loan for this unless you had a spare $500K in your bank account. You would also have to take into account the cost of maintaining and servicing the machines, building maintenance, and hiring someone to collect cash, clean, and open/close the building each day. Overall, location plays the biggest role in the success of this type of business – if you put your new company next to an apartment complex where everyone has laundry machines, you’re doomed from the beginning. Incidentally, laundry machines happen to be very profitable businesses if run correctly – mostly because they are not labor intensive and do not require huge investments after you’ve gotten started. So you could even use this as an example for the "What kind of business would you start with $1 million?" question.

Tell me about an M&A deal that interested you recently?

You want to say who the buyer and seller were – and include background information if they are not household names – as well as the price and the multiples (Purchase Price/Revenue, Purchase Price/EBITDA) if they are readily available. Read the relevant Wall Street Journal article on it, and discuss the dynamics of the deal – how it developed, if anyone else was interested, and what implications it has for the industry. You don’t need to be an expert, but you do need to sound intelligent and know the basics. If they start asking for information you don’t know, just admit upfront that you don’t know whatever they’ve asked for.

Pitch me a stock

You need to mention specific financial figures. Since the company is public, it shouldn’t be too hard to find those. Even if you can’t get Revenue or EBITDA multiples, looking up its P/E multiple and saying whether it’s higher or lower than competitors is a step in the right direction. The 2 most common mistakes: 1. Failing to list specific financial figures. 2. Saying how the company stacks up relative to its competition, and why its prospects are more favorable. Structure your answer with the following 5 points in mind: 1. Give the name and summarize what the company does. 2. Give a brief overview of its financials to indicate its size and how profitable it is. 3. State how it’s undervalued or more attractive than its rivals, due to any competitive advantages it has. 4. Say how there is a long-term trend in its favor – it’s not just looking good in the past month. 5. Talk about how the next 5-10 years will be really good for the company.

Can you explain to me, in simple terms, the subprime crisis?

In simple terms, banks made mortgage loans to people who were in no position to pay them off – or even meet monthly payments. Since interest rates were at historical lows borrowing was easy. At the same time, mortgages were no longer just loans made to individuals – they were sliced up, combined and "packaged" into securities that banks traded, acquired and sold to investors. A typical "package" might contain mortgages given to both "credible" borrowers as well as mortgages granted to more risky borrowers – the more risky ones were labeled "subprime." Banks acquired these "packaged" assets on the argument that even if one "piece" of the asset was risky or likely to default, the rest still had value. As it turns out, this was false and no one knew what any of these mortgage-related assets were worth – but as unqualified homeowners began defaulting, buyers disappeared overnight and the value of these assets plummeted to $0. As a result, the value of many banks also approached $0 and quite a few failed or went bankrupt in the process – all because the securities were so complex that no one understood their value or the true risks involved.

Do you agree with the $700 billion bank bailout?

Your specific answer doesn’t matter too much – just make sure you actually give an answer ("yes" or "no") and that you back it up with solid reasoning. These days, it’s probably better to say "yes" because, as we witnessed with the bankruptcy of Lehman Brothers, if a financial institution that’s large enough collapses, it can have ripple effects and bring down the rest of the company and financial markets along with it.

I see you have no relevant finance experience – why should we hire you over someone who’s had a previous banking internship?

Talk about how banking is about what skills you bring to the table and what kind of person you are rather than how many internships you’ve had. Discuss how you’ve worked long hours/in teams/paid attention to details before and succeeded at whatever you’ve done. If you’re feeling bold, you can also point out that although someone might have had a banking internship, that doesn’t mean he/she did well in it – and that you may be better equipped based on your own experience.

I see you’ve worked mostly in wealth management before – why are you looking to switch into banking now?

You want to understand the bigger picture and how and why large companies make decisions rather than just working with individual investors. Working on transactions and making an impact is more interesting to you than giving individual advice to high net worth individuals (or institutions).

You’re a smart guy/girl with a lot of options, and right now the economy is not doing well and lots of banks have failed. Why are you still interested in banking when you could do anything else?

Talk about your long-term view and how a downturn could be an even better time to enter the industry because you’ll know how to work when times are both good and bad. In addition, you’ve been interested in finance for a long time and are not going to let short-term difficulties deter you from entering the field – you’ve explored other options and concluded that this is the best one for you.

The economy has been improving lately, and more people are "getting interested" in finance. How do I know you’re serious and not just following everyone else?

State that you hold a long-term view and haven’t just become interested overnight. Being able to point to specific evidence of your interest – your own portfolio, the finance/business club you’re in, or even day trading – also helps.

Where did your interest in finance begin?

Almost anything could work for this one – just make sure it’s not too recent. Otherwise it looks like you became interested on a whim. Also be sure to explain how your initial interest led you into the internships, activities, or jobs you pursued and how those have led you to where you are today.

If you enjoyed your last internship and got an offer to come back, why are you trying to switch into investment banking now?

You’re looking for something faster-paced where there’s a better learning opportunity and more of a chance to make an impact. You’ve also been interested all along and realize you really do want to do it now, after having explored other alternatives and not liked them. If this is a small company to big company move (or vice versa) you can also say something about that, using the standard reasons we went through before – small means more responsibility and client interaction, and big means working on more major deals and learning more technical skills.

You’ve advanced into a high-paying position at your current company – why would you want to move here, take a pay cut, and work twice the hours?

This is the key question asked of many career changers and anyone else at the VP-level (or above) at a company who is looking to switch into banking as an Associate. Here are the major points to emphasize: 1. You’ve done your homework and spoken with a lot of people about this move – and you like the finance work you’ve done before. 2. Banking is faster-paced and appeals to you more because you make more of an impact. 3. You’re fine with the pay cut and additional hours because of the improved opportunities to make an impact and advance.

What’s your greatest fear about investment banking?

Do not give an actual, legitimate fear (losing your friends/significant other, gaining weight, working too much, hating your life, getting laid off, etc.). Instead, it’s best to go with something more innocuous like, "Doing a lot of work on deals and not always getting to see them through to the conclusions because anything could cause a large transaction to collapse" or having concerns about the deal flow if the market is poor.

What’s your "Plan B" if you can’t get into investment banking this year?

You’ll do something finance-related, in a field like corporate finance/ strategy or maybe something else at a bank/financial firm. You also want to point any offers you have, especially if they’re in finance or consulting. "If I have absolutely no way to get into banking at your firm this year, then I’d go work in the Valuations group at one of the Big 4 firms where I already have an offer – or to the 2 boutiques that keep inviting me in for interviews."

That guy over there has a 4.0 from Wharton/Harvard – why should I hire you over him, given that you’re much less impressive?

Bankers hire people who 1) Are smart 2) Can do the work and 3) Are likeable. In addition to meeting all of those criteria, you’ve also done well in the real-world and have stellar recommendations to back you up – plus, since you don’t come from a "blue-chip" background you’re more motivated to succeed than the Harvard guy. "He does have impressive credentials. But at a bank, you want someone who’s smart, can do the work, and is easy to get along with. I’ve done well in school and am working on an Honors Thesis right now, and I have great recommendations from my 2 previous bosses in my Sales & Trading internships. And I spend most of my free time sky diving and going on adventures in different countries. So while he may be qualified on paper, in banking it all comes down to real-world experience and what kind of camaraderie you have with everyone. I’m confident that I excel in both of those areas – and since I’m not from a privileged background, I’m even more motivated to succeed than someone who is."

Let’s say your MD is meeting with a client and you have been invited. As he’s presenting, you notice a mistake in the materials – do you point it out?

No – unless it happens to come up in the meeting, in which case you speak only if the MD asks you about it. In that case you should just briefly acknowledge it and then move to a different topic. It’s bad if you make a mistake like that, but it’s even worse if you embarrass your MD by pointing it out in broad daylight – chances are that no one will notice anyway since they barley read pitch books in meetings.

I see you have a big gap in your work experience over the past few months/few years/I see you have a gap of 2-3 years a few years ago – what happened there?

The key here is to spin whatever you’ve done in a positive light. So don’t just say you were out of work/laid off/looking for work at the time – just mention that briefly and then say that you were also doing something else constructive with your time, such as education, travel, volunteering, or a respectable hobby. If you’ve had some other type of gap because of school, economic hardship, or something similar, you need to find the strength in whatever weakness you had – this is really just a disguised "weakness" question. So if you had to wait tables for 1-2 years to pay for family expenses or support yourself/pay for tuition, talk about what that taught you in terms of work ethic and what you learned about yourself in the process. As with any other "Why don’t you have a blue-chip background?" question, you have to tie everything back to the "banker-like" qualities. "The truth is, my family went through some financial hardships back then and I was forced to take a leave of absence from school for awhile, and spend most of my time working to help them pay the bills. Initially I was pretty upset, but I learned a lot about time management, work ethic, and how to juggle 5 different major responsibilities at once. I lost some time on my peers, but I came out more motivated than before, helped my family get back on their feet, and got started with independent study to help myself catch up."

Why did you get a C in accounting? (Or other bade grade in highly relevant class)

Don’t even try to make up an excuse unless it’s a REALLY good one (e.g. your parents both passed away that semester) – just admit it and then point out what you’ve learned and how you’ve improved since then. Maybe you took it upon yourself to do additional self-study – or you changed your approach to studying and did much better in subsequent Accounting classes.

Why did you NOT receive an offer from your internship?

For this one it sounds like you’re making an excuse if you say something like, "The market was bad" or "They didn’t give out any offers" – even if both of those are true. It’s a better bet to say something like, "I did well in my internship and got positive reviews, but I didn’t fit in with the group’s culture. From those I’ve spoken with so far at your firm, I think this is a much better fit for me." It’s hard to argue with doing the work well but just not fitting in with the group.

You graduated last year and don’t have anything listed on your resume since then – what have you been doing, and did you participate in recruiting last year?

For this one, if it’s a bank you have NOT interviewed with before it’s best to say you haven’t participated in recruiting so they don’t see you as "damaged goods." But if you’re on the record as having interviewed there before, you need to admit the truth. You probably want to say something like, "I did some interviewing last year, but I was not focused 100% due to a family situation. I had to spend a few months after graduation attending to that, so I missed out on recruiting, but I did some independent study/additional research/[something else that sounds productive] and am now more focused than ever on banking." Remember, almost anything could be a "family situation" and no one will call you on it if you say something like this. You also want to convey that your time since graduating has not been unproductive and that you’re now better-prepared/more focused.

Why are we your first choice? Wouldn’t you like London or New York more?

Even if you really do prefer New York or London, you can’t say this in an interview with a regional office because your #1 goal has to be getting AN offer – not getting the perfect offer in the perfect location. It’s best to say something like, "I realize it is unusual and that other places are sometimes more popular, but I’m most interested in [Location] because it’s the best place for [Industry You Like], I have a lot of friends and family here, and on top of all that the cost of living also beats New York." This way you acknowledge their "objection" upfront but also point out solid reasons for picking this location.

Why are you so old? (State more tactfully)

"I realize I don’t fit the typical profile of someone applying to banking – but that also comes with some advantages. I’ve been around longer and explored different industries so I have a better idea of what I want, and I’m going to be more committed than someone just out of school. I’ve also had a lot more leadership experience and understand how to get things done in a large company – and I’ve climbed up steep learning curves plenty of times over the years." One of the interviewer’s key concerns for older candidates is how well you can learn new things and work long hours – so you should have specific examples on-hand to address both of these "objections."

What type of animal/vegetable would you be?

Some interviewees take this as a cue to tie your choice back to being a team player, hard worker, or such but that’s not the best approach. For "creativity"-type questions, interviewers want you to be…creative. So think about your real personality and say something that matches that. Example: Maybe you’d be a "hedgehog" because it looks like you have "spikes" on the outside to an observer, but you’re actually warm and fuzzy on the inside.

Let’s say that in the future your name turns up as the front page headline of a newspaper one day – what would the story be about?

With this type of question you can show more "banker-like" traits such as ambition and hard work – but you shouldn’t take it too seriously. So maybe the headline states that you climbed Mt. Everest, sold your company in an IPO, or became a best-selling author – you want "ambition + creativity/coolness" for this type of question. Hopefully the headline wasn’t about your indictment for insider trading.

Tell me a joke.

"Q: What was the best part of Playboy’s IPO? A: The pitch book." If you have a female interviewer or someone else who might get offended, then try the following corny but impossible to offend joke instead: "A dog goes into an investment banking job interview, and the banker says to him, ‘You’ve got the job, but only if you can do three things. First, you have to be able to complete an LBO model in 30 minutes.’ So the dog runs to a computer and astoundingly creates a full model in 30 minutes. That’s very nice! Next, you must be able to spread 10 comps manually in under an hour. Immediately, the dog sits down at the computer and completes everything in only 30 minutes. ‘That’s perfect! Lastly, you must be bilingual.’ So then the dog says, ‘Meow!’"

What’s your personal Beta?

"Beta" in the Capital Asset Pricing Model (CAPM) measures expected return and expected risk. Higher Beta means a higher potential return, but also more risk. You probably want to say above 1.0, but not too much above it – you’re much more ambitious than the average person, which causes you to try lots of new things and achieve quite a bit, so that inevitably carries some risk. But you’re not so reckless that you take careless risks – it’s all about moderation. Don’t go over 2.0. Bankers like to think of themselves as "entrepreneurial" even though banking is extremely different from entrepreneurship, so you should take advantage of this line of thinking and indulge them.

What’s the riskiest thing you’ve ever done?

Don’t say "cocaine" or any other drug/porn-like/illegal activity (this should be common sense but you wouldn’t believe the emails I get). But you also can’t say, "I sat next to the unpopular kid one day…" because that’s not risky at all. Try to discuss an internship or job experience you had that you never expected to get, or some type of extracurricular/leadership experience that was somewhat random and turned out to be great – and talk about how it was a calculated risk and that you got a lot out of the decision you made. If you can point to something you had to be proactive to get, this is a good time to bring it up.

Let’s say that you have $1 million, but you are NOT allowed to invest it or otherwise use it to create more money. What would you spend the capital on instead?

Don’t say, "I would start my own business…" or "I would invest it in…" – many people completely ignore the actual question here. It’s best to tie this back to whatever your interests and passions are – so you might use the money to support volunteer work you’ve done, extended travel that you’ve always wanted to take, or maybe even to buy that race car you’ve always wanted. Just make sure your answer is believable – if you have never worked at a non-profit or in a volunteer group in your life, don’t suddenly try to be a saint. If you love cars, say you would think about buying a car you’ve always wanted…among other things.

Walk me through one of the deals listed on your resume.

– Try to pick an M&A deal rather than an equity/debt financing and aim for more "unique" deal types like divestitures or distressed M&A; also try to pick something that’s either "high-profile" or a deal where you contributed a lot. – Don’t go into too much detail for an "opening question" like this – just give a brief overview and then let them ask the questions. – Describe the company, give approximate financial (revenue, EBITDA, market cap) figures, and say what they wanted to do. Here’s how you might describe a sell-side M&A deal you worked on: "One of the deals I worked on was the sale of a $1 billion market cap consumer retail company. They specialized in food and beverages and sold to the US and European markets. Their revenue was around $800 million with $200 million EBITDA, growing at around 5% per year. They were interested in selling because of a string of recent acquisitions in their market, and felt they could get a premium valuation. They engaged us to run a broad sell-side process with financial and strategic buyers." Here’s how you might describe an IPO: "One deal I worked on was the $200 million IPO of a Chinese Internet company on the Hong Kong stock exchange. They had revenue of around $50 million, EBITDA of $10 million, and were growing very quickly, around 50% per year. They were going public to raise funds so that they could expand beyond China and get into other markets, and we were the lead underwriter on the deal." After you finish your "introduction" the interviewer will start asking follow-up questions based on what you said.

Did you do anything quantitative for this deal? It looks like it just involved research.

This is a common scenario for summer interns or if you worked at a small boutique where financial modeling was not as common. Don’t say that you did nothing quantitative, but also don’t make it seem like you know everything there is to know about valuation or modeling. If you didn’t build the model yourself, just point out how you contributed to it. Here’s how you might respond: "A lot of what I worked on was qualitative and involved researching potential buyers to see what the best fit might be. Our team did some valuation and financial modeling work as well, but since I was an intern I supported the other Analyst and Associate by finding relevant facts and figures and then going through their models, figuring out how they worked, and then making sure the information was correct."

Why did the company you were representing want to sell?

Maybe they received an unsolicited offer, maybe there were a string of recent acquisitions in their market, maybe the founder wanted to exit the business, or maybe the PE firm that owned the company wanted to exit its investment. You might say something like the following: "They wanted to sell because larger companies in the market had recently acquired their closest competitors, and they felt that they could no longer thrive as a standalone entity. Additionally, they had received informal offers from a few of the larger companies before, and felt that the timing was right to explore a sale once again."

Why did the company you were representing want to buy another company?

For this one you need to talk about what specific type of other company they wanted to buy. Did they want to expand into new geographies? Get into a new industry? Pursue a "hot" start-up that was receiving a lot of attention? Here’s an example: "Our client was interested in expanding from midstream oil & gas production and wanted to get into the upstream markets as well, especially in North American. They had tried to do so before, but lacked the expertise and industry contacts – so they wanted to acquire a sizable company that had already done it so they could grow their top-line and also diversify their business."

Describe the deal process.

This one is completely dependent on what type of deal you worked on – but no matter what you say, don’t go into an excruciating level of detail here. Focus on whether it was a broad or targeted process for M&A deals, and what kinds of buyers/sellers you approached; for debt and equity financings just go through the key points in the registration statements or investor memos, and what the investor reaction was. "We ran a broad sell-side auction process for our client. They had in mind around 10-20 strategic buyers that might have been interested, and we added around 30 financial sponsors to their list. We got serious interest from about 5 of the companies we approached, which led to 1 strategic buyer and 1 financial sponsor ultimately competing to win the deal."

What were the major selling points of your client? What was attractive about it?

This one applies for both sell-side deals and equity/debt financings – good points to raise might include financial performance, market and industry trends, any competitive advantages it enjoyed, and anything positive about its customer base. Stay away from talking about the strength of the management team, because that is very difficult to "explain" in an interview. "The Swedish healthcare company we were representing had been growing at around 15% year-over-year, vs. 5% average growth for the industry as a whole. It also had higher margins than other companies in the industry because it focused on higher-end and more profitable medical care. The market as a whole was also very favorable because the Swedish population was aging and demand for healthcare could only rise in years to come."

What about its weaknesses? Why might investors be hesitant?

You could talk about unfavorable market trends, increased competition, uncertain financial projections, or the threat of new regulation harming the company. "Although our client had performed well in European healthcare market, its financial projections depended on expanding into the US and Asia, and it had no tract record there. Also, massive healthcare reform in the US might make it significantly more difficult to enter that market in the future."

What were the major obstacles to getting the deal done? What happened?

These could be anything from disagreements on price to legal issues to problems with retaining the management team. If you can point to any obstacles that you played a role in resolving bring them up here. "We rain into issues because the private equity firm we were in discussions with wanted to make the deal contingent on the debt financing, which the CEO could not go along with. We also ran into problems with valuation, because the PE firm discounted our projections by about 20%. Eventually we compromised on both points, and on the second issue I helped create a more detailed revenue model for the company that validated some of our assumptions, so the PE firm agreed to meet us halfway."

What kind of standalone operating model did you create for your client?

For this one, you don’t need to explain how to link the 3 statements together – focus on how you created the revenue model and the expense model. Usually you do this by looking at revenue in terms of units sold, factories, or production, and you analyze expenses by fixed costs and employees. "On the revenue side, we looked at our client’s existing, proven oil reserves and used their historical exploration & production figures to project how much they would be adding each year vs. what would be depleted. Then we combine that with projections for oil prices to estimate their yearly revenue. On the expense side, the majority of costs were tied to how many oil fields were operational, so we linked numbers for transportation, technology, and drilling costs to those."

What was the status of this deal when you left your bank?

Don’t feel "pressured" to say that the deal closed or that the IPO priced before you left. It’s fine to say that it was still up in the air – and even if the deal actually fell apart, you’re better off pretending that it’s still pending and that there hasn’t been an announcement yet (unless it was a huge deal that very publicly fell apart). "When I left, both sides did not agree 100% on price. They were moving closer and had resolved management retention and had come to agreement on the reps and warranties, but they were still locking down the final details, so the deal is pending right now."

What did you look at in the due diligence process?

The most important items here are the company’s financial statements, contract (with customers, employees, and suppliers), and then tax, legal, environmental, IP, and regulatory issues. Note that as an investment banker you don’t really "look at" much in the due diligence process for any deal – you just process requests. For IPOs, this changes and you’re responsible for conducting customer due diligence calls – so you need to talk about that and what customers told you directly. "We looked at all the standard items, including the company’s audit reports and financial statements, and then brought in specialists to look at the contracts, legal, and intellectual property issues. I came up with lists of questions for the customer due diligence calls we conducted, which was important because investors at the time were reluctant to invest in IPOs in emerging markets like Brazil – and by speaking with customers we were able to assess the risk for ourselves."

Tell me about the market your client was in.

Focus on the major trends and how the company you represented compared to the competition. Don’t go into every single detail – just pick the 1-2 major points and focus on how it affected the deal and/or valuation. "Our client was in the mainframe software market, which had existed for over 20 years and had consolidated significantly in recent years, with IBM acquiring many of the smaller independent vendors. It was a slow-growing market and most of the sales came from existing customers upgrading – as a result, we couldn’t find many interested strategic buyers, and most of the interest came from financial sponsors that were attracted to our company’s high margins and recurring revenue."

How did you narrow down potential targets (or potential investors)?

For potential targets, focus on financial, industry, and geographical criteria; for potential investors, talk about what they’ve invested in before, how much synergy or "fit" there is, and whether or not they have complementary portfolio companies (for PE firms). "We picked potential investors mostly based on size and acquisition activity in our market in the past. There were a lot of healthcare acquisitions recently, but we wanted to focus on firms that were active in the North American market specifically, and ones that had acquired firms worth over $500 million. We looked at some financial sponsors as well, but focused on ones that had sizable healthcare companies in their portfolios."

How did you value your client?

Just take the standard valuation methodologies and talk about how you applied them to the company you worked with. Note that for IPOs, you only care about public company comparables – for other types of deals you look at a wider range of methodologies. "We used public company comparables, precedent transactions, and a DCF. For public comps, we picked a set of software companies with over $1 billion revenue, for precedent transactions, we looked at software deals worth over $500 million, and we used the standard DCF but looked at a few different scenarios because our client’s projections were aggressive. We didn’t look at other methodologies because this was a standard M&A deal and they were almost certainly going to sell to a strategic buyer."

How did you personally contribute to this deal?

One of the most difficult and most important questions you can get. For this one, you have to be careful to not exaggerate too much and claim that you generated millions of dollars for your bank – but you should also try to say something more than, "I made these graphs look pretty in PowerPoint." Here’s an example: "As the intern, I helped some of the Analysts track down hard-to-find numbers to use for assumptions in our models. This played an important role in the deal, because buyers analyzed our operating model of the company and found everything more believable since we had laid out such detailed assumptions behind all the numbers."

How much do you know about what you actually do in Restructuring?

Restructuring bankers advised distressed companies – businesses going bankrupt, in the midst of bankruptcy, or getting out of bankruptcy – and help them change their capital structure to get out of bankruptcy, avoid it in the first place, or assist with a sale of the company depending on the scenario.

What are the 2 different "sides" of a Restructuring deal? Do you know which one we usually advise?

Bankers can advise either the debtor (the company itself) or the creditors (anyone that has lent the company money). It’s similar to sell-side vs. buy-side M&A – in one you’re advising the company trying to sell or get out of the mess it’s in, and in the other you’re advising buyers and lenders that are trying to take what they can from the company. Note that the "creditors" are often multiple parties since it’s anyone who loaned the company money. There are also "operational advisors" that help with the actual turnaround. You need to research which bank does what, but typically Blackstone and Lazard advise the debtor and Houlihan Lokey advises the creditors (these 3 are commonly as the top groups in the field).

Why are you interested in Restructuring besides the fact that it’s a "hot" area currently?

You gain a very specialized skill set (and therefore become more valuable/employable) and much of the work is actually more technical/interesting than M&A, for example. You also get broader exposure because you see both the bright sides and not-so-bright sides of companies. If you’re coming in with any legal background or have aspirations of doing that in the future, there’s a ton of overlap with Restructuring because you have to operate within a legal framework and attorneys are involved at every step of the process – so that can be one of your selling points as well.

How are you going to use your experience in Restructuring for future career goals?

In addition to the legal and "better technical skills" angles, you can also use the experience to work at a Distressed Investments or Special Situations Fund, which most people outside Restructuring don’t have access to. Or you could just go back to M&A or normal investing too, and still have superior technical knowledge to other bankers. There’s no "wrong" answer as long as you don’t say you have no interest in it in the future.

How would a distressed company select its Restructuring bankers?

More so than M&A or IPO processes, Restructuring/Distressed M&A requires extremely specialized knowledge and relationships. There are only a few banks with good practices, and they are selected on the basis of their experience during similar deals in the industry as well as their relationships with all the other parties that will be involved in the deal process. Remember that a Restructuring involves many more parties than a normal M&A or financing deal does – there are lawyers, shareholders, debt investors, suppliers, directors, management, and crisis managers, and managing everyone can be like herding cats. Lawyers can also be a major source of business, since they’re heavily involved with any type of Restructuring/Distressed scenario.

Why would a company go bankrupt in the first place?

Here are a few of the more common ones: – A company cannot meet its debt obligations/interest payments. – Creditors can accelerate debt payments and force the company into bankruptcy. – An acquisition has gone poorly or a company has just written down the value of its assets steeply and needs extra capital to stay afloat (see: investment banking industry). – There is a liquidity crunch and the company cannot afford to pay its vendors or suppliers.

What operations are available to a distressed company that can’t meet debt obligations?

1. Refinance and obtain fresh debt/equity. 2. Sell the company (either as a whole or in pieces in an asset sale). 3. Restructure its financial obligations to lower interest payments/debt payments, or issue debt with PIK interest to reduce the cash interest expense. 4. File for bankruptcy and use that opportunity to obtain additional financing, restructure its obligations, and be freed of onerous contracts.

What are the advantages and disadvantages of each option?

1. Refinance – Advantages: Least disruptive to company and would help revive confidence; Disadvantages: Difficult to attract investors to a company on the verge of going bankrupt. 2. Sale – Advantages: Shareholders could get some value and creditors would be less infuriated, knowing that funds are coming; Disadvantages: Unlikely to obtain a good valuation in a distressed sale, so company might sell for a fraction of its true worth. 3. Restructuring – Advantages: Could resolve problems quickly without 3rd party involvement; Disadvantages: Lenders are often reluctant to increase their exposure to the company and management/lenders usually don’t see eye-to-eye. 4. Bankruptcy – Advantages: Could be the best way to negotiate with lenders, reduce obligations, and get additional financing; Disadvantages: Significant business disruptions and lack of confidence from customers, and equity investors would likely lose all their money.

From the perspective of the creditors, what different strategies do they have available to recover their capital in a distressed situation?

These mirror the options that are available to the company itself in a distressed scenario: 1. Lend additional capital/grant equity to company. 2. Conditional financing – Only agree to invest if the company cuts expenses, stops losing money, and agrees to other terms and covenants. 3. Sale – Force the company to hire an investment bank to sell itself, or parts of itself. 4. Foreclosure – Bank seizes collateral and forces a bankruptcy filing.

How are Restructuring deals different from other types of transactions?

They are more complex, involve more parties, require more specialized/technical skills, and have to follow the Bankruptcy legal code – unlike most other types of deals bankers work on. The debtor advisor, for example, might have to work with creditors during a forbearance period and then work with lawyers to determine collateral recoveries for each tranche of debt. Also, unlike most standard M&A deals the negotiation extends beyond two "sides" – it’s not just the creditors negotiating with the debtors, but also the different creditors negotiating with each other. Distressed sales can happen very quickly if the company is on the brink of bankruptcy, but those are different from Bankruptcy scenarios.

What’s the difference between Chapter 7 and Chapter 11 bankruptcy?

A Chapter 7 bankruptcy is also known as a "liquidation bankruptcy" – the company is too far past the point of reorganization and must instead sell off its assets and pay off creditors. A trustee ensures that all this happens according to plan. Chapter 11 is more of a "reorganization" – the company doesn’t die, but instead changes the terms on its debt and renegotiates everything to lower interest payments and the dollar value of debt repayments. If we pretend a distressed company is a cocaine addict, Chapter 7 would be like a heart attack and Chapter 11 would be like rehab.

What is debtor-in-possession (DIP) financing and how is it used with distressed companies?

It is money borrowed by the distressed company that has repayment priority over all other existing secured/unsecured debt, equity, and other claims, and is considered "safe" by lenders because it is subject to stricter terms than other forms of financing. Theoretically, this makes it easier for distressed companies to emerge from the bankruptcy process – though some argue that DIP financing is actually harmful on an empirical basis. Some DIP lending firms are known for trying to take over companies at a significant discount due to the huge amount of collateral they have. One reason companies might choose to file for (Chapter 11) bankruptcy is to get access to DIP financing.

How would you adjust the 3 financial statements for a distressed company when you’re doing valuation or modeling work?

Here are the most common adjustments: – Adjust Cost of Goods Sold for higher vendor costs due to lack of trust from suppliers. – Add back non-recurring legal/other professional fees associated with the restructuring and/or distressed sale process. – Add back excess lease expenses (again due to lack of trust) to Operating Income as well as excess salaries (often done so private company owners can save on taxes). – Working Capital needs to be adjusted for receivables unlikely to turn into cash, overvalued/insufficient inventory, and insufficient payables. – CapEx spending is often off (if it’s too high that might be why they’re going bankrupt, if it’s too low they might be doing that artificially to save money).

Would those adjustments differ for public companies vs. private companies?

Most of the above would apply to public companies as well, but the point about excess salaries does not hold true – it’s much tougher for public companies to manipulate the system like that and pay abnormal salaries.

If the market value of a distressed company’s debt is greater than the company’s assets, what happens to it’s equity?

The SHAREHOLDER’S EQUITY goes negative (which is actually not that uncommon and happens all the time in LBOs and when a company is unprofitable). A company’s EQUITY MARKET CAP (which is different – that’s just shares outstanding * share price) would remain positive, though, as that can never be negative.

In a bankruptcy, what is the order of claims on a company’s assets?

1. New debtor-in-possession (DIP) lenders 2. Secured creditors (revolvers and "bank debt") 3. Unsecured creditors ("high-yield" bonds) 4. Subordinated debt investors (similar to high-yield bonds) 5. Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK) 6. Shareholders (equity investors) "Secured" means that the lender’s claims are protected by specific assets or collateral; unsecured means anyone who has loaned the company money without collateral. For more on the different types of debt, see the LBO section where we have a chart showing the differences between everything.

How do you measure the cost of debt for a company if it is too distressed to issue additional debt (i.e. investors won’t buy any debt from them)?

You’d have to look at the yields of bonds or the spreads of credit default swaps of comparable companies to get a sense of this. You could also just use the current yields on a company’s existing debt to estimate this, though it may be difficult if the existing debt is illiquid.

How would valuation change for a distressed company?

– You use the same methodologies most of the time (public company comparables, precedent transactions, DCF)… – Except you look more at the lower range of the multiples and make all the accounting adjustments we went through above. – You also use lower projections for a DCF and anything else that needs projections because you assume a turnaround period is required. – You might pay more attention to revenue multiples if the company is EBIT/EBITDA/EPS-negative. – You also look at a liquidation valuation under the assumption that the company’s assets will be sold off and used to pay its obligations. – Sometimes you look at valuations on both an assets-only basis and a current liabilities-assumed basis. This distinction exists because you need to make big adjustments to liabilities with distressed companies.

How would a DCF analysis be different in a distressed scenario?

Even more of the value would come from the terminal value since you normally assume a few years of cash flow-negative turnaround. You might also do a sensitivity table on hitting or missing earnings projections, and also add a premium to WACC to make it higher and account for operating distress.

Let’s say a distressed company approaches you and wants to hire your bank to sell it in a distressed sale – how would the M&A process be different than it would for a healthy company?

1. Timing is often quick since the company needs to sell or else they’ll go bankrupt. 2. Sometimes you’ll produce fewer "upfront" marketing materials (Information Memoranda, Management Presentations, etc.) in the interest of speed. 3. Creditors often initiate the process rather than the company itself. 4. Unlike normal M&A deals, distressed sales can’t "fail" – they result in a sale, a bankruptcy or sometimes a restructuring.

Normally in a sell-side M&A process, you always want to have multiple bidders to increase competition. Is there any reason they’d be especially important in a distressed sale?

Yes – in a distressed sale you have almost no negotiating leverage because you represent a company that’s about to die. The only real way to improve price for your client is to have multiple bidders.

The 2 basic ways you can buy a company are through a stock purchase and an asset purchase. What’s the difference, and what would a buyer in a distressed sale prefer? What about the seller?

In a stock purchase, you acquire 100% of a company’s shares as well as all its assets and liabilities (on and off-balance sheet). In an asset purchase, you can acquire only certain assets of a company and assume only certain liabilities – so you can pick and choose exactly what you’re getting. Companies typically use asset purchases for divestitures, distressed M&A, and smaller private companies; anything large, public, and healthy generally needs to be acquired via a stock purchase. A buyer almost always prefers an asset purchase so it can avoid assumption of unknown liabilities (there are also tax advantages for the buyer). A (distressed) seller almost always prefers a stock purchase so it can be rid of all its liabilities and because it gets taxed more heavily when selling assets vs. selling the entire business.

Sometimes a distressed sale does not end in a conventional stock/asset purchase – what are some other possible outcomes?

Other possible outcomes: – Foreclosure (either official or unofficial) – General assignment (faster alternative to bankruptcy) – Section 363 asset sale (a faster, less risky version of a normal asset sale) – Chapter 11 bankruptcy – Chapter 7 bankruptcy

Normally M&A processes are kept confidential – is there any reason why a distressed company would want to announce the involvement of a banker in a sale process?

This happens even outside distressed sales – generally the company does it if they want more bids/want to increase competition and drive a higher purchase price.

Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?

Technically, the answer is "it depends" but practically speaking most of the time the answer is "no." If a company is truly distressed, the value of its debts and obligations most likely exceed the value of its assets – so equity investors rarely get much out of a bankruptcy or distressed sale, especially when it ends in liquidation.

Let’s say a company wants to sell itself or simply restructure its obligations – why might it be forced into a Chapter 11 bankruptcy?

Ina lot of cases, aggressive creditors force this to happen- if they won’t agree to the restructuring of its obligations or they can’t finalize a sale outside court, they might force a company into Chapter 11 by accelerating debt payments.

Recently, there has been news of distressed companies like GM "buying back" their debt for 50 cents on the dollar. What’s the motivation for doing this and how does it work accounting-wise?

The motivation is simple: use excess balance sheet cash to buy back debt on-the-cheap and sharply reduce interest expense and obligations going forward. It works because the foregone interest on cash is lower than whatever interest rate they’re paying on debt – so they reduce their net interest expense no matter what. Many companies are faced with huge debt obligations that have declined significantly in value but which still have relatively high interest rates, so they’re using the opportunity to rid themselves of excess cash and cancel out their existing debt. Accounting-wise, it’s simple: Balance Sheet cash goes down and debt on the Liabilities & Equity side goes down by the same amount to make it balance.

What kind of companies would most likely enact debt buy-backs?

Most likely over-levered companies – ones with too much debt – that were acquired by PE firms in leveraged buyouts during the boom years, and now face interest payments they have trouble meeting, along with excess cash.

Why might a creditor might have to take a loss on the debt it loaned to a distressed company?

This happens to lower-priority creditors all the time. Remember, secured creditors always come first and get first claim to all the proceeds from a sale or series of asset sales; if a creditor is lower on the totem pole, they only get what’s left of the proceeds so they have to take a loss on their loans/obligations.

What is the end goal of a given financial restructuring?

A restructuring does not change the amount of debt outstanding in and of itself – instead, it changes the terms of the debt, such as interest payments, monthly/quarterly principal repayment requirements, and the covenants.

What’s the difference between a Distressed M&A deal and a Restructuring deal?

"Restructuring" is one possible outcome of a Distressed M&A deal. A company can be "distressed" for many reasons, but the solution is not always to restructure its debt obligations – it might declare bankruptcy, it might liquidate and see off its assets, or it might sell 100% of itself to another company. "Restructuring" just refers to what happens when the distressed company in question decides it wants to change around its debt obligations so that it can better repay them in the future.

What’s the difference between acquiring just the assets of a company and acquiring it on a "current liabilities assumed" basis?

When you acquire the assets of a distressed company, you get literally just the assets. But when you acquire the current liabilities as well, you need to make adjustments to account for the fact that a distressed company’s working capital can be extremely skewed. Specifically, "owed expense" line items like Accounts Payable and Accrued Expenses are often much higher than they would be for a healthy company, so you need to subtract the difference if you’re assuming the current liabilities. This results in a deduction to your valuation – so in most cases the valuation is lower if you’re assuming current liabilities.

How could a decline in a company’s share price cause it to go bankrupt?

Trick question. Remember, MARKET CAP DOES NOT EQUAL SHAREHOLDERS’ EQUITY. You might be tempted to say something like, "Shareholders’ equity falls!" but the share price of the company does not affect shareholders’ equity, which is a book value. What actually happens as a result of the share price drop, customers, vendors, suppliers, and lenders would be reluctant to do business with the distressed company – so its revenue might fall and its Accounts Payable and Accrued Expenses line items might climb to unhealthy levels. All of that might cause the company to fail or require more capital, but the share price decline itself does not lead to bankruptcy. In the case of Bear Stearns in 2008, overnight lenders lost confidence as a result of the sudden share price declines and it completely ran out of liquidity as a result – which is a big problem when your entire business depends on overnight lending.

What happens to Accounts Payable Days with a distressed company?

They rise and the average AP Days might go well beyond what’s "normal" for the industry – this is because a distressed company has trouble paying its vendors and suppliers.

Let’s say a distressed company wants to raise debt or equity to fix its financial problems rather than selling or declaring bankruptcy. Why might it not be able to do this?

– Debt: Sometimes if the company is too small or if investors don’t believe it has a credible turnaround plan, they will simply refuse to lend it any sort of capital. – Equity: Same as above, but worse – since equity investors have lower priority than debt investors. Plus, for a distressed company getting "enough" equity can mean selling 100% or near 100% of the company due to its depressed market cap.

Will the adjusted EBITDA of a distressed company be higher or lower than the value you would get from its financial statements?

In most cases it will be higher because you’re adjusting for higher-than-normal salaries, one-time legal and restructuring charges, and more.

Would you use Levered Cash Flow for a distressed company in a DCF since it might be encumbered with debt?

No. In fact, with distressed companies it’s really important to analyze cash flows on a debt-free basis precisely because they might have higher-than-normal debt expenses.

Let’s say we’re doing a Liquidation Valuation for a distressed company. Why can’t we just use the Shareholders’ Equity number for its value? Isn’t that equal to Assets minus Liabilities?

In a Liquidation Valuation you need to adjust the values of the assets to reflect how much you could get if you sold them off separately. You might assume, for example, that you can only recover 50% of the book value of a company’s inventory if you tried to see it off separately. Shareholders’ Equity is equal to Assets minus Liabilities, but in a Liquidation Valuation we change the values of all the Assets so we can’t just use the Shareholders’ Equity number.

What kind of recovery can you expect for different assets in a Liquidation Valuation?

This varies A LOT by industry, company and the specific assets, but some rough guidelines: – Cash: Probably close to 100% because it’s the most liquid asset. – Investments: Varies a lot by what they are and how liquid they are – you might get close to 100% for the ones closet to cash, but significantly less than that for equity investments in other companies. – Accounts Receivable: Less than what you’d get for cash, because many customers might just not "pay" a distressed company. – Inventory: Less than Cash or AR because inventory is of little use to a different company. – PP&E: SImilar to cash for land and buildings, and less than that for equipment. – Intangible Assets: 0%. No one will pay you anything for Goodwill or the value of a brand name – or if they will, it’s near-impossible to quantify.

How would an LBO model for a distressed company be different?

The purpose of an LBO model here is not to determine the private equity firm’s IRR, but rather to figure out how quickly the company can pay off its debt obligations as well as what kind of IRR any new debt/equity investors can expect. Other than that, it’s not much different from the "standard" LBO model – the mechanics are the same, but you have different kinds of debt (e.g. Debtor-in-Possession), possibly more tranches, and the returns will probably be lower because it’s a distressed company, though occasionally "bargain" deals can turn out to be very profitable. One structural difference is that a distressed company LBO is more likely to take the form of an asset purchase rather than a stock purchase.

Walk me through the 3 financial statements.

"The 3 major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement. The Income Statement gives the company’s revenue and expenses, and goes down to Net Income, the final line on the statement. The Balance Sheet shows the company’s Assets – its resources – such as Cash, Inventory and PP&E, as well as its Liabilities – such as Debt and Accounts Payable – and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity. The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company’s net change in cash."

Can you give examples of major line items on each of the financial statements?

Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income. Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders’ Equity. Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations; Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities; Dividends Issued; Cash Flow From Financing.

How do the 3 statements link together?

"To tie the statements together, Net Income from the Income Statement flows into Shareholders’ Equity on the Balance Sheet, and into the top line of the Cash Flow Statement. Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders’ Equity. The Cash and Shareholders’ Equity items on the Balance Sheet act as "plugs," with Cash flowing in from the final line of the Cash Flow Statement."

If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company – which statement would I use and why?

You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that’s the #1 thing you care about when analyzing the overall financial health of any business – its cash flow.

Let’s say I could only look at 2 statements to assess a company’s prospects – which 2 would I use and why?

You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have "before" and "after" versions of the Balance Sheet that correspond to the same period the Income Statement is tracking).

Walk me through how Depreciation going up by $10 would affect the statements.

Income Statement: Operation Income would decline by $10 and assuming a 40% tax rate, Net Income would go down by $6. Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4. Balance Sheet: Plans, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement. Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders’ Equity on the Liabilities & Shareholders’ Equity side is down by $6 and both sides of the Balance Sheet balance. Note: With this type of question I always recommend going in the order: 1. Income Statement 2. Cash Flow Statement 3. Balance Sheet This is so you can check yourself at the end and make sure the Balance Sheet balances. Remember that an Asset going up decreases your Cash Flow, whereas a Liability going up increases your Cash Flow.

If Depreciation is a non-cash expense, why does it affect the cash balance?

Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes are a cash expense, Depreciation affects cash by reducing the amount of taxes you pay.

Where does Depreciation usually show up on the Income Statement?

It could be in a separate line item, or it could be embedded in Cost of Goods Sold or Operating Expenses – every company does it differently. Note that the end result for accounting questions is the same: Depreciation always reduces Pre-Tax Income.

What happens when Accrued Compensation goes up by $10?

For this question, confirm that the accrued compensation is now being recognized as an expense (as opposed to just changing non-accrued to accrued compensation). Assuming that’s the case, Operating Expenses on the Income Statement go up by $10, Pre-Tax Income falls by $10, and Net Income falls by $6 (assuming a 40% tax rate). On the Cash Flow Statement, Net Income is down by $6, and Accrued Compensation will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and the Net Change in Cash at the bottom is up by $4. On the Balance Sheet, Cash is up by $4 as a result, so Assets are up by $4. On the Liabilities & Equity side, Accrued Compensation is a liability so Liabilities are up by $10 and Retained Earnings are down by $6 due to the Net Income, so both sides balance.

What happens when Inventory goes up by $10, assuming you pay for it with cash?

No changes to the Income Statement. On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations – it goes down by $10, as does the Net Change in Cash at the bottom. On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10, so the changes cancel out and Assets still equals Liabilities & Shareholders’ Equity.

Why is the Income Statement not affected by changes in Inventory?

This is a common interview mistake – incorrectly state that Working Capital changes show up on the Income Statement. In the case of Inventory, the expense is only recorded when the goods associated with it are sold – so if it’s just sitting in a warehouse, it does not count as a Cost of Good Sold or Operating Expense until the company manufactures it into a product and sells it.

Let’s say Apple is buying $100 work of new iPod factories with debt. How are all 3 statements affected at the start of "Year 1," before anything else happens?

At the start of "Year 1," before anything else has happened, there would be no changes on Apple’s Income Statement (yet). On the Cash Flow Statement, the additional investment in factories would show up under Cash Flow from Investing as a net reduction in Cash Flow (so Cash Flow is down by $100 so far). And the additional $100 worth of debt raised would show up as an addition to Cash Flow, canceling out the investment activity. So the cash number stays the same. On the Balance Sheet, there is now an additional $100 worth of factories in the Plants, Property & Equipment line, so PP&E is up by $100 and Assets is therefore up by $100. On the other side, debt is up by $100 as well and so both sides balance.

Now let’s go out 1 year, to the start of Year 2. Assume the debt is high-yield so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?

After a year has passed, Apple must pay interest expense and must record the depreciation. Operating Income would decrease by $10 due to the 10% depreciation change each year, and the $10 in additional Interest Expense would decrease the Pre-Tax Income by $20 altogether ($10 from the depreciation and $10 from Interest Expense). Assuming a tax rate of 40%, Net Income would fall by $12. On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a non-cash expense, so you add it back and the end result is that Cash Flow from Operations is down by $2. That’s the only change on the Cash Flow Statement, so overall Cash is down by $2. On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10 due to the depreciation, so overall Assets are down by $12. On the other side, since Net Income was down by $12, Shareholders’ Equity is also down by $12 and both sides balance. Remember, the debt number under Liabilities does not change since we’ve assumed none of the debt is actually paid back.

At the start of Year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements.

After 2 years, the value of the factories is now $80 if we go with the 10% depreciation per year assumption. It is this $80 that we will write down in the 3 statements. First, on the Income Statement, the $80 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $48. On the Cash Flow Statement, Net Income is down by $48 but the write-down is a non-cash expense, so we add it back – and therefore Cash Flow from Operations increases by $32. There are no changes under Cash Flow from Investing, but under Cash Flow from Financing there is a $100 charge for the loan payback – so Cash Flow from Investing falls by $100. Overall, the Net Change falls by $68. On the Balance Sheet, Cash is now down by $68 and PP&E is down by $80, so Assets have decreased by $148 altogether. On the other side, Debt is down $100 since it was paid off, and since Net Income was down by $48, Shareholders’ Equity is down by $48 as well. Altogether, Liabilities & Shareholders’ Equity are down by $148 and both sides balance.

Now let’s look at a different scenario and assume Apple is ordering $10 of additional iPod inventory, using cash on hand. They order the inventory, but they have not manufactured or sold anything yet – what happens to the 3 statements?

No changes to the Income Statement. Cash Flow Statement – Inventory is up by $10, so Cash Flow from Operations decreases by $10. There are no further changes, so overall Cash is down by $10. On the Balance Sheet, Inventory is up by $10 and Cash is down by $10 so the Assets number stays the same and the Balance Sheet remains in balance.

Now let’s say they sell the iPods for revenue of $20, at a cost of $10. Walk me through the 3 statements under this scenario.

Income Statement: Revenue is up by $20 and COGS is up by $10, so Gross Profit is up by $10 and Operating INcome is up by $10 as well. Assuming a 40% tax rate, Net Income is up by $6. Cash Flow Statement: Net Income at the top is up by $6 and Inventory has decreased by $10 (since we just manufactured the inventory into real iPods), which is a net addition to cash flow – so Cash Flow from Operations is up by $16 overall. These are the only changes on the Cash Flow Statement, so Net Change in Cash is up by $16. On the Balance Sheet, Cash is up by $16 and Inventory is down by $10, so Assets is up by $6 overall. On the other side, Net Income was up by $6 so Shareholders’ Equity is up by $6 and both sides balance.

Could you ever end up with negative shareholders’ equity? What does it mean?

Yes. It is common to see this in 2 scenarios: 1. Leveraged Buyouts with dividend recapitalizations – it means that the owner of the company has taken out a large portion of its equity (usually in the form of cash), which can sometimes turn the number negative. 2. It can also happen if the company has been losing money consistently and therefore has a declining Retained Earnings balance, which is a portion of Shareholders’ Equity. It doesn’t "mean" anything in particular, but it can be a cause for concern and possibly demonstrate that the company is struggling (in the second scenario). Note: Shareholders’ equity never turns negative immediately after an LBO – it would only happen following a dividend recap or continued net losses.

What is working capital? How is it used?

Working Capital = Current Assets – Current Liabilities. If it’s positive, it means a company can pay off its short-term liabilities with its short-term assets. It is often presented as a financial metric and its magnitude and sign (negative or positive) tells you whether or not the company is "sound." Bankers look at Operating Working Capital more commonly in models, and that is defined as (Current Assets – Cash & Cash Equivalents) – (Current Liabilities – Debt).

What does negative Working Capital mean? Is that a bad sign?

Not necessarily. It depends on the type of company and the specific situation – here are a few different things it could mean: 1. Some companies with subscriptions or longer-term contracts often have negative Working Capital because of high Deferred Revenue balances. 2. Retail and restaurant companies like Amazon, Wal-Mart, and McDonald’s often have negative Working Capital because customers pay upfront – so they can use the cash generated to pay off their Accounts Payable rather than keeping a large cash balance on-hand. This can be a sign of business efficiency. 3. In other cases, negative Working Capital could point to financial trouble or possible bankruptcy (for example, when customers don’t pay quickly and upfront and the company is carrying a high debt balance).

Recently, banks have been writing down their assets and taking huge quarterly losses. Walk me through what happens on the 3 statements when there’s a write-down of $100.

First, on the Income Statement, the $100 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $60. On the Cash Flow Statement, Net Income is down by $60 but the write-down is a non-cash expense, so we add it back – and therefore Cash Flow from Operations increases by $40. Overall, the Net Change in Cash rises by $40. On the Balance Sheet, Cash is now up by $40 and an asset is down by $100 (it’s not clear which asset since the question never state the specific asset to write-down). Overall, the Assets side is down by $60. On the other side, since Net Income was down by $60, Shareholders’ Equity is also down by $60 – and both sides balance.

Walk me through a $100 "bailout" of a company and how it affects the 3 statements.

First, confirm what type of "bailout" this is – Debt? Equity? A combination? The most common scenario here is an equity investment from the government, so here’s what happens: No changes to the Income Statement. On the Cash Flow Statement, Cash Flow from Financing goes up by $100 to reflect the government’s investment, so the Net Change in Cash is up by $100. On the Balance Sheet, Cash is up by $100 so Assets are up by $100; on the other side, Shareholders’ Equity would go up by $100 to make it balance.

Walk me through a $100 write-down of debt – as in OWED debt, a liability – on a company’s balance sheet and how it affects the 3 statements.

This is counter-intuitive. When a liability is written down you record it as a gain on the Income Statement (with an asset write-down, it’s a loss) – so Pre-Tax Income goes up by $100 due to this write-down. Assuming a 40% tax rate, Net Income is up by $60. On the Cash Flow Statement, Net Income is up by $60, but we need to subtract that debt write-down – so Cash Flow from Operations is down by $40, and Net Change in Cash is down by $40. On the Balance Sheet, Cash is down by $40 so Assets are down by $40. On the other side, Debt is down by $100 but Shareholders’ Equity is up by $60 because the Net Income was up by $60 – so Liabilities & Shareholders’ Equity is down by $40 and it balances. If this seems strange to you, you’re not alone – see this Forbes article for more on why writing down debt actually benefits companies accounting-wise:

When would a company collect cash from a customer and not record it as revenue?

Three examples come to mind: 1. Web-based subscription software 2. Cell phone carriers that cell annual contracts 3. Magazine publishers that sell subscriptions Companies that agree to services in the future often collect cash upfront to ensure stable revenue – this makes investors happy as well since they can better predict a company’s performance. Per the rules of the GAAP (Generally Accepted Accounting Principles), you only record revenue when you actually perform the services – so the company would not record everything as revenue right away.

If cash collected is not recorded as revenue, what happens to it?

Usually it goes into the Deferred Revenue balance on the Balance Sheet under Liabilities. Over time, as the services are performed, the Deferred Revenue balance "turns into" real revenue on the Income Statement.

What’s the difference between accounts receivable and deferred revenue?

Accounts receivable has not yet been collected in cash from customers, whereas deferred revenue has been. Accounts receivable represents how much revenue the company is waiting on, whereas deferred revenue represents how much it is waiting to record as revenue.

How long does it usually take for a company to collect its accounts receivable balance?

Generally the accounts receivable days are in the 40-50 day range, though it’s higher for companies selling high-end items and it might be lower for smaller, lower transaction-value companies.

What’s the difference between cash-based and accrual accounting?

Cash-based accounting recognizes revenue and expenses when cash is actually received or paid out; accrual accounting recognizes revenue when collection is reasonably certain (i.e. after a customer has ordered the product) and recognizes expenses when they are incurred rather than when they are paid out in cash. Most large companies use accrual accounting because paying with credit cards and lines of credit is so prevalent these days; very small businesses may use cash-based accounting to simplify their financial statements.

Let’s say a customer pays for a TV with a credit card. What would this look like under cash-based vs. accrual accounting?

In cash-based accounting, the revenue would not show up until the company charges the customer’s credit card, receives authorization, and deposits the funds in its bank account – at which point it would show up as both Revenue on the Income Statement and Cash on the Balance Sheet. In accrual accounting, it would show up as Revenue right away but instead of appearing in Cash on the Balance Sheet, it would go into Accounts Receivable at first. Then, once the cash is actually deposited in the company’s bank account, it would "turn into" Cash.

How do you decide when to capitalize rather than expense a purchase?

If the asset has a useful life of over 1 year, it is capitalized (put on the Balance Sheet rather than shown as an expense on the Income Statement). Then it is depreciated (tangible assets) or amortized (intangible assets) over a certain number of years. Purchases like factories, equipment and land all last longer than a year and therefore show up on the Balance Sheet. Employee salaries and the cost of manufacturing products (COGS) only cover a short period of operations and therefore show up on the Income Statement as normal expenses instead.

Why do companies report both GAAP and non-GAAP (or "Pro Forma") earnings?

These days, many companies have "non-cash" charges such as Amortization of Intangibles, Stock-Based Compensation, and Deferred Revenue Write-down in their Income Statements. As a result, some argue that Income Statements under GAAP no longer reflect how profitable most companies truly are. Non-GAAP earnings are almost always higher because these expenses are excluded.

A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen?

Several possibilities: 1. The company is spending too much on Capital Expenditure – these are not reflected at all in EBITDA, but it could still be cash-flow negative. 2. The company has high interest expense and is no longer able to afford its debt. 3. The company’s debt all matures on one date and it is unable to refinance it due to a "credit crunch" – and it runs out of cash completely when paying back the debt. 4. It has significant one-time charges (from litigation, for example) and those are high enough to bankrupt the company. Remember, EBITDA excludes investment in (and depreciation of) long-term assets, interest and one-time charges – and all of these could end up bankrupting the company.

Normally Goodwill remains constant on the Balance Sheet – why would it be impaired and what does Goodwill Impairment mean?

Usually this happens when a company has been acquired and the acquirer re-assesses its intangible assets (such as customers, brand, and intellectual property) and finds that they are worth significantly less than they originally thought. It often happens in acquisitions where the buyer "overpaid" for the seller and can result in a large net loss on the Income Statement (see: eBay/Skype). It can also happen when a company discontinues part of its operations and must impair the associated goodwill.

Under what circumstances would Goodwill increase?

Technically Goodwill can increase if the company re-assesses its value and finds it is worth more, but that is rare. What usually happens is 1 of 2 scenarios: 1. The company gets acquired or bought out and Goodwill changes as a result, since it’s an accounting "plug" for the purchase price in an acquisition. 2. The company acquires another company and pays more than what its assets are worth – this is then reflected in the Goodwill number.

How is GAAP accounting different from tax accounting?

1. GAAP is accrual-based but tax is cash-bashed. 2. GAAP uses straight-line depreciation or a few other methods whereas tax accounting is different (accelerated depreciation). 3. GAAP is more complex and more accurately tracks assets/liabilities whereas tax accounting is only concerned with revenue/expenses in the current period and what income tax you owe.

What are deferred tax assets/liabilities and how do they arise?

They arise because of temporary differences between what a company can deduct for cash tax purposes vs. what they can deduct for book tax purposes. Deferred Tax Liabilities arise when you have a tax expense on the Income Statement but haven’t actually paid that tax in cold, hard cash yet; Deferred Tax Assets arise when you pay taxes in cash but haven’t expensed them on the Income Statement yet. The most common way they occur is with asset write-ups and write-downs in M&A deals – an asset write-up will produce a deferred tax liability while a write-down will produce a deferred tax asset (see the Merger Model section for more on this).

Walk me through how you create a revenue model for a company.

There are 2 ways you could do this: a bottoms-up build and a tops-down build. – Bottoms-Up:Start with individual products/customers, estimate the average sale value or customer value, and then the growth rate in sales and sale values to tie everything together. – Tops-Down: Start with "big-picture" metrics like overall market size, then estimate the company’s market share and how that will change in coming years, and multiply to get to their revenue. Of these two methods, bottoms-up is more common and is taken more seriously because estimating "big-picture" numbers is almost impossible.

Walk me through how you create an expense model for a company.

To do a true bottoms-up build, you start with each different department of a company, the # of employees in each, the average salary, bonuses, and benefits, and then make assumptions on those going forward. Usually you assume that the number of employees is tied to revenue, and then you assume growth rates for salary, bonuses, benefits, and other metrics. Cost of Goods Sold should be tied directly to Revenue and each "unit" produced should incur an expense. Other items such as rent, Capital Expenditures, and miscellaneous expenses are either linked to the company’s internal plans for building expansion plans (if the have them), or to Revenue for a more simple model.

Let’s say we’re trying to create these models but don’t have enough information or the company doesn’t tell us enough in its filings – what do we do?

Use estimates. For the revenue if you don’t have enough information to look at separate product lines or divisions of the company, you can just assume a simple growth rate into future years. For the expenses, if you don’t have employee-level information then you can just assume that major expenses like SG&A are a percent of revenue and carry that assumption forward.

Walk me through the major items in Shareholders’ Equity.

Common items include: – Common Stock – Simply the par value of however much stock the company has issued. – Retained Earnings – How much of the company’s Net Income it has "saved up" over time. – Additional Paid in Capital – This keeps track of how much stock-based compensation has been issued and how much new stock employees exercising options have created. It also includes how much over par value a company raises in an IPO or other equity offering. – Treasury Stock – The dollar amount of shares that the company has bought back. – Accumulated Other Comprehensive Income – This is a "catch-all" that includes other items that don’t fit anywhere else, like the effect of foreign currency exchange rates changing.

Walk me through what flows into Retained Earnings.

Retained Earnings = Old Retained Earnings Balance + Net Income – Dividends Issued If you’re calculating Retained Earnings for the current year, take last year’s Retained Earnings number, add this year’s Net Income, and subtract however much the company paid out in dividends.

Walk me through what flows into Additional Paid-In Capital (APIC).

APIC = Old APIC + Stock-Based Compensation + Stock Created by Option Exercises If you’re calculating it, take the balance from last year, add this year’s stock-based compensation number, and then add in however much new stock was created by employees exercising options this year.

What is the Statement of Shareholders’ Equity and why do we use it?

This statement shows everything we went through above – the major items that comprise Shareholders’ Equity, and how we arrive at each of them using the numbers elsewhere in the statement. You don’t use it too much, but it can be helpful for analyzing companies with unusual stock-based compensation and stock option situations.

What are examples of non-recurring charges we need to add back to a company’s EBIT/EBITDA when looking at its financial statements?

– Restructuring Charges – Goodwill Impairment – Asset Write-Downs – Bad Debt Expenses – Legal Expenses – Disaster Expenses – Change in Accounting Procedures Note that to be an "add-back" or "non-recurring" charge for EBITDA/EBIT purposes, it needs to affect Operating Income on the Income Statement. So if you have one of these charges "below the line" then you do not add it back for the EBITDA/EBIT calculation. Also note that you do add back Depreciation, Amortization, and sometimes Stock-Based Compensation for EBITDA/EBIT, but that these are not "non-recurring charges" because all companies have them every year – these are just non-cash charges.

How do you project Balance Sheet items like Accounts Receivable and Accrued Expenses in a 3-statement model?

Normally you make very simple assumptions here and assume there are percentages of revenue, operating expenses, or cost of goods sold. Examples: – Accounts Receivable: % of revenue. – Deferred Revenue: % of revenue. – Accounts Payable: % of COGS. – Accrued Expenses: % of operating expenses or SG&A. Then you either carry the same percentages across in future years or assume slight changes depending on the company.

How should you project Depreciation & Capital Expenditures?

The simple way: project each one as % of revenue or previous PP&E balance. The more complex way: create a PP&E schedule that splits out different assets by their useful lives, assumes straight-line depreciation over each asset’s useful life, and then assumes capital expenditures on what the company has invested historically.

How do Net Operating Losses (NOLs) affect a company’s 3 statements?

The "quick and dirty" way to do this: reduce the Taxable Income by the portion of the NOLs that you can use each year, apply the same tax rate, and then subtract that new Tax number from your old Pretax Income number (which should stay the same). The way you should do this: create a book vs. cash tax schedule where you calculate the Taxable Income based on NOLs, and then look at what you would pay in taxes without the NOLs. Then you book the difference as an increase to the Deferred Tax Liability on the Balance Sheet. This method reflects the fact that you’re saving on cash flow – since the DTL, a liability, is rising – but correctly separates the NOL impact into book vs. cash taxes.

What’s the difference between capital leases and operating leases?

Operating leases are used for short-term leasing of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as operation expenses on the Income Statement. Capital leases are used for longer-term items and give the lessee ownership rights; they depreciate and incur interest payments, and are counted as debt. A lease is a capital lease if any one of the following 4 conditions is true: 1. If there’s a transfer of ownership at the end of the term. 2. If there’s an option to purchase the asset at a bargain price at the end of the term. 3. If the term of the lease is greater than 75% of the useful life of the asset. 4. If the present value of the lease payments is great than 90% of the asset’s fair market value.

Why would the Depreciation & Amortization number on the Income Statement be different from what’s on the Cash Flow Statement?

This happens if D&A is embedded in other Income Statement line items. When this happens, you need to use the Cash Flow Statement number to arrive at EBITDA because otherwise you’re undercounting D&A.

Why do we look at both Enterprise Value and Equity Value?

Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise Value represents its true value.

When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value?

Enterprise Value, because that’s how much an acquirer really "pays" and includes the often mandatory debt repayment.

What’s the formula for Enterprise Value?

EV = Equity Value + Debt + Preferred Stock + Minority Interest – Cash (This formula does not tell the whole story and can get more complex – see the Advanced Questions. Most of the time you can get away with stating this formula in an interview, though).

Why do you need to add Minority Interest to Enterprise Value?

Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance. So even though it doesn’t own 100%, it reports 100% of the majority-owned subsidiary’s financial performance. In keeping with the "apples-to-apples" theme, you must add Minority Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary.

How do you calculate fully diluted shares?

Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible debt or convertible preferred stock. To calculate the dilutive effect of options, you use the Treasury Stock Method (detail on this below).

Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each – what is its fully diluted equity value?

Its basic equity value is $1,000 (100*$10=$1,000). To calculate the dilutive effect of the options, first you note that the options are all "in-the-money" – their exercise price is less than the current share price. When these options are exercised, there will be 10 new shares created – so the share count is now 110 rather 100. However, that doesn’t tell the whole story. In order to exercise the options, we had to "pay" the company $5 for each option (the exercise price). As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares we created. So the fully diluted share count is 105, and the fully diluted equity value is $1,050.

Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each – what is its fully diluted equity value?

$1,000. In this case the options’ exercise price is above the current share price, so they have no dilutive effect.

Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?

The "official" reason: Cash is subtracted because it’s considered a non-operating asset and because Equity Value implicitly accounts for it. The way I think about it: In an acquisition, the buyer would "get" the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you’d really have to "pay" to acquire another company. It’s not always accurate because technically you should be subtracting only excess cash – the amount of cash a company has above the minimum cash it requires to operate.

Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?

In most cases, yes, because the terms of a debt agreement usually say that debt must be refinanced in an acquisition. And in most cases a buyer will pay off a seller’s debt, so it is accurate to say that any debt "adds" to the purchase price. However, there could always be exceptions where the buyer does not pay off the debt. These are rare and I’ve personally never seen it, but once again "never say never" applies.

Could a company have a negative Enterprise Value? What would that mean?

Yes. It means that the company has an extremely large cash balance, or an extremely low market capitalization (or both). You see it with: 1. Companies on the brink of bankruptcy. 2. Financial institutions, such as banks, that have large cash balances. These days, there’s a lot of overlap in these 2 categories…

Could a company have a negative Equity Value? What would that mean?

No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.

Why do we add Preferred Stock to get to Enterprise Value?

Preferred Stock pays out a fixed dividend, and preferred stock holders also have a higher claim to a company’s assets than equity investors do. As a result, it is seen as more similar to debt than common stock.

How do you account for convertible bones in the Enterprise Value formula?

If the convertible bones are in-the-money, meaning that the conversion price of the bonds is below the current share price, then you count them as additional dilution to the Equity Value; if they’re out-of-the-money then you count the face value of the convertibles as part of the company’s Debt.

A company has 1 million shares outstanding at a value of $100 per share. It also has $10 million of convertible bonds, with par value of $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?

This gets confusing because of the different units involved. First, note that these convertible bones are in-the-money because the company’s share price is $100, but the conversion price is $50. So we count them as additional shares rather than debt. Next, we need to divide the value of the convertible bones – $10 million – by the par value – $1,000 – to figure out how many individual bonds we get: $10 million/$1,000=10,000 convertible bonds. Next, we need to figure out how many shares this number represents. The number of shares per bond is the par value divided by the conversion price: $1,000/$50=20 shares per bond. So we have 200,000 new shares (20*10,000) created by the convertibles, giving us 1.2 million diluted shares outstanding. We do not use the Treasury Stock Method with convertibles because the company is not "receiving" any cash from us.

What’s the difference between Equity Value and Shareholders’ Equity?

Equity Value is the market value and Shareholders’ Equity is the book value. Equity Value can never be negative because shares outstanding and share prices can never be negative, whereas Shareholders’ Equity could be any value. For healthy companies, Equity Value usually far exceeds Shareholders’ Equity.

Are there any problems with the Enterprise Value formula you just gave me?

Yes – it’s too simple. There are lots of other things you need to add into the formula with real companies: – Net Operating Losses – Should be valued and arguably added in, similar to cash. – Long-Term Investments – These should be counted, similar to cash. – Equity Investments – Any investments in other companies should also be added in, similar to cash (though they might be discounted). – Capital Leases – Like debt, these have interest payments – so they should be added in like debt. – (Some) Operating Leases – Sometimes you need to convert operating leases to capital leases and add them as well. – Pension Obligations – Sometimes these are counted as debt as well. So a more "correct" formula would be Enterprise Value = Equity Value-Cash+Debt+Preferred Stock+Minority Interest-NOLs-Investments+Capital Leases+Pension Obligations… In interviews, usually you can get away with saying "Enterprise Value=Equity Value-Cash+Debt+Preferred Stock+Minority Interest" I mention this here because in more advanced interview you might get questions on this topic.

Should you use the book value or market value of each item when calculating Enterprise Value?

Technically, you should use market value for everything. In practice, however, you usually use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula – so you just take the numbers from the company’s Balance Sheet.

What percentage dilution in Equity Value is "too high?"

There’s no strict "rule" here but most bankers would say that anything over 10% is odd. If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check you calculations – it’s not necessarily wrong, but over 10% dilution is unusual for most companies.

What are the 3 major valuation methodologies?

Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis.

Rank the 3 valuation methodologies from highest to lowest expected value.

Trick question – there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it’s best to say that it’s more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions.

When would you not use a DCF in a Valuation?

You do not use a DCF if the company has unstable or unpredictable cash flows (tech or bio-tech startup) or when debt and working capital serve a fundamentally different role. For example, banks and financial institutions do not re-invest debt and working capital is a huge part of their Balance Sheets – so you wouldn’t use a DCF for such companies.

What other Valuation methodologies are there?

Other methodologies include: – Liquidation Valuation – Valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, equity investors receive – Replacement Value – Valuing a company based on the cost of replacing its assets – LBO Analysis – Determining how much a PE firm could pay for a company to hit a "target" IRR, usually in the 20-25% range – Sum of the Parts – Valuing each division of a company separately and adding them together at the end – M&A Premiums Analysis – Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth – Future Share Price Analysis – Projecting a company’s share price based on the P/E multiples of the public company comparables, then discounting it back to its present value

When would you use a Liquidation Valuation?

This is most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the company’s debts have been paid off. It is often used to advise struggling businesses on whether it’s better to see off assets separately or to try and sell the entire company.

When would you use Sum of the Parts?

This is most often used when a company has completely different, unrelated divisions – a conglomerate like General Electric, for example. If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division and a technology division, you should not use the same set of Comparable Companies and Precedent Transactions for the entire company. Instead, you should use different sets for each division, value each one separately, then add them together to get the Combined Value.

When do you use an LBO Analysis as part of your Valuation?

Obviously you use this whenever you’re looking at a Leveraged Buyout – but it is also used to establish how much a private equity firm could pay, which is usually lower than what companies will pay. It is often used to set a "floor" on a possible Valuation for the company you’re looking at.

What are the most common multiples used in Valuation?

The most common multiples are EV/Revenue, EV/EBITDA, EV/EBIT, P/E (Share Price/Earnings per Share), and P/BV (Share Price/Book Value).

What are some examples of industry-specific multiples?

Technology (Internet): EV/Unique Visitors, EV/Pageviews Retail/Airlines: EV/EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization & Rent) Energy: P/MCFE, P/MCFE/D (MCFE = 1 Million Cubic Foot Equivalent, MCFE/D = MCFE per Day), P/NAV (Share Price/Net Asset Value) Real Estate Investment Trusts (REITs): Price/FFO, Price/AFFO (Funds From Operations, Adjusted Funds From Operations) Technology and Energy should be straightforward – you’re looking at traffic and energy reserves as value drivers rather than revenue or profit. For Retail/Airlines, you often remove Rent because it is a major expense and one that varies significantly between different types of companies. For REITs, Funds From Operations is a common metric that adds back Depreciation and subtracts gains on the sale of property. Depreciation is a non-cash yet extremely large expense in real estate, and gains on sales of properties are assumed to be non-recurring, so FFO is viewed as a "normalized" picture of the cash flow the REIT is generating.

When you’re looking at an industry-specific multiple like EV/Scientists or EV/Subscribers, why do you use Enterprise Value rather than Equity Value?

You use Enterprise Value because those scientists or subscribers are "available" to all the investors (both debt and equity) in a company. The same logic doesn’t apply to everything, though – you need to think through the multiple and see which investors the particular metric is "available" to.

Would an LBO or DCF give a higher valuation?

Technically it could go either way, but in most cases the LBO will give you a lower valuation. Here’s the easiest way to think about it: with an LBO, you do not get any value from the cash flows of a company in between Year 1 and the final year – you’re only valuing it based on its terminal value. With a DCF, by contrast, you’re taking into account both the company’s cash flows in between and its terminal value, so values tend to be higher. Note: Unlike a DCF, an LBO model by itself does not give a specific valuation. Instead you set a desired IRR and determine how much you could pay for the company (the valuation) based on that.

How would you present these Valuation methodologies to a company or its investors?

Usually you use a "football field" chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number. As an example, see page 10 of this document (a Valuation done by Credit Suisse for the Leveraged Buyout of Sungard Data Systems in 2005):

How would you value an apple tree?

The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the value of the apple tree’s cash flows (intrinsic valuation). Yes, you could do a DCF for anything – even an apple tree.

Why can’t you use Equity Value/EBITDA as a multiple rather than Enterprise Value/EBITDA?

EBITDA is available to all investors in the company – rather than just equity holders. Similarly, Enterprise Value is also available to all shareholders so it makes sense to pair them together. Equity Value/EBITDA, however, is comparing apples to oranges because Equity Value does not reflect the company’s entire capital structure – only the part available to equity investors.

When would a Liquidation Valuation produce the highest value?

This is highly unusual, but it could happen if a company had substantial hard assets but the market was severely undervaluing it for a specific reason (such as an earnings miss or cyclicality). As a result, the company’s Comparable Companies and Precedent Transactions would likely produce lower values as well – and if its assets were valued highly enough, Liquidation Valuation might give a higher value than other methodologies.

Let’s go back to 2004 and look at Facebook back when it had no profit and no revenue. How would you value it?

You would use Comparable Companies and Precedent Transactions and look at more "creative" multiples such as EV/Unique Visitors and EV/Pageviews rather than EV/Revenue or EV/EBITDA. You would not use a "far in the future DCF" because you can’t reasonably predict cash flows for a company that is not even making money yet. This a very common wrong answer given by interviewees. When you can’t predict cash flow, use other metrics – don’t try to predict cash flow anyway!

What would you use in conjunction with Free Cash Flow multiples – Equity Value or Enterprise Value?

Trick question. For Unlevered Free Cash Flow, you would use Enterprise Value, but for Levered Free Cash Flow you would use Equity Value. Remember, Unlevered Free Cash Flow excludes Interest and thus represents money available to all investors, whereas Levered already includes Interest and the money is therefore only available to equity investors. Debt investors have already "been paid" with the interest payments they received.

You never use Equity Value/EBITDA, but are there any cases where you might use Equity Value/Revenue?

Never say never. It’s very rare to see this, but sometimes large financial institutions with big cash balances have negative Enterprise Values – so you might use Equity Value/Revenue instead. You might see Equity Value/Revenue if you’ve listed a set of financial and non-financial companies on a slide, you’re showing Revenue multiples for the non-financial companies, and you want to show something similar for the financials. Note, however, that in most cases you would be using other multiples such as P/E and P/BV with banks anyway.

How do you select Comparable Companies/Precedent Transactions?

The 3 main ways to select companies and transactions: 1. Industry classification 2. Financial criteria (Revenue, EBITDA, etc) 3. Geography For Precedent Transactions, you often limit the set based on date and only look at transactions within the past 1-2 years. The most important factor is industry – that is always used to screen for companies/transactions, and the rest may or may not be used depending on how specific you want to be. Here are a few examples: -Comparable Company Screen: Oil & gas producers with market caps over $5 billion – Comparable Company Screen: Digital media companies with over $100 million in revenue Precedent Transaction Screen: Airline M&A transactions over the past 2 years involving sellers with over $1 billion in revenue – Precedent Transaction Screen: Retail M&A transactions over the past year

How do you apply the 3 valuation methodologies to actually get a value for the company you’re looking at?

Sometimes this simple fact gets lost in discussion of Valuation methodologies. You take the median multiple of a set of companies or transactions, and then multiply it by the relevant metric from the company you’re valuing. Example: If the median EBITDA multiple from your set of Precedent Transactions is 8x and your company’s EBITDA is $500 million, the implied Enterprise Value would be $4 billion. To get the "football field" valuation graph you often see, you look at the minimum, maximum, 25th percentile and 75th percentile in each set as well and create a range of values based on each methodology.

What do you actually use a valuation for?

Usually you use it in pitch books and in client presentation when you’re providing updates and telling them what they should expect for their own valuation. It’s also used right before a deal closes in a Fairness Opinion, a document a bank creates that "proves" the value their client is paying or receiving is "fair" from a financial point of view. Valuations can also be used in defense analyses, merger models, LBO models, DCFs (because terminal multiples are based off of comps), and pretty much anything else in finance.

Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?

This could happen for a number of reasons: – The company has just reported earnings well-above expectations and its stock price has risen recently. – It has some type of competitive advantage not reflected in its financials, such as a key patent or other intellectual property. – It has just won a favorable ruling in a major lawsuit. – It is the market leader in an industry and has greater market share than its competitors.

What are the flaws with public company comparables?

– No company is 100% comparable to another company. – The stock market is "emotional" – your multiples might be dramatically higher or lower on certain dates depending on the market’s movements. – Share prices for small companies with thinly-traded stocks may not reflect their full value.

How do you take into account a company’s competitive advantage in a valuation?

1. Look at the 75th percentile or higher for the multiples rather than the Medians. 2. Add in a premium to some of the multiples. 3. Use more aggressive projections for the company. In practice you rarely do all of the above – these are just possibilities.

Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions?

There’s no "rule" that you have to do this, but in most cases you do because you want to use values from the middle range of the set. But if the company you’re valuing is distressed, is not performing well, or is at a competitive disadvantage, you might use the 25th percentile or something in the lower range instead – and vice versa if it’s doing well.

You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies – can you think of a situation where this is not the case?

Sometimes this happens when there is a substantial mismatch between the M&A market and the public market. For example, no public companies have been acquired recently but there have been a lot of small private companies acquired at extremely low valuations. For the most part this generalization is true but keep in mind that there are no exceptions to almost every "rule" in finance.

What are some flaws with precedent transactions?

– Past transactions are rarely 100% comparable – the transaction structure, size of the company and market sentiment all have huge effects. – Data on precedent transactions is generally more difficult to find than it is for public company comparables, especially for acquisitions of small private companies.

Two companies have the exact same financial profile and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction – how could this happen?

Possible reasons: 1. One process was more competitive and had a lot more companies bidding on the target. 2. One company had recent bad news or a depressed stock price so it was acquired at a discount. 3. They were in industries with different median multiples.

Why does Warren Buffet prefer EBIT multiples to EBITDA multiples?

Warren Buffet once famously said, "Does management think the tooth fairy pays for capital expenditures?" He dislikes EBITDA because it excludes the often sizable Capital Expenditures companies make and hides how much cash they are actually using to finance their operations. In some industries there is also a large gap between EBIT and EBITDA – anything that is very capital-intensive, for example, will show a big disparity.

The EV/EBIT, EV/EBITDA and P/E multiples all measure a company’s profitability. What’s the difference between them, and when do you use each one?

P/E depends on the company’s capital structure whereas EV/EBIT and EV/EBITDA are capital structure-neutral. Therefore, you use P/E for banks, financial institutions, and other companies where interest payments/expenses are critical. EV/EBIT includes Depreciation & Amortization whereas EV/EBITDA excludes it – you’re more likely to use EV/EBIT in industries where D&A is large and where capital expenditures and fixed assets are important (e.g. manufacturing), and EV/EBITDA in industries where fixed assets are less important and where D&A is comparatively smaller (e.g. Internet companies).

If you were buying a vending machine business, would you pay a higher multiple for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constant.

You would pay more for the one where you lease the machines. Enterprise Value would be the same for both companies, but with the depreciated situation the charge is not reflected in EBITDA – so EBITDA is higher, and the EV/EBITDA multiple is lower as a result. For the leased situation, the lease would show up in the SG&A so it would be reflected in EBITDA, making EBITDA lower and the EV/EBITDA multiple higher.

How do you value a private company?

You use the same methodologies as with public companies: public comparables, precedent transactions, and DCF. But there are some differences: – You might apply a 10-15% (or more) discount to the public company comparable multiples because the private company you’re valuing is not as "liquid" as the public comps. – You can’t use a premiums analysis or future share price analysis because a private company doesn’t have a share price. – Your valuation shows the Enterprise Value for the company as opposed to the implied per-share price as with public companies. – A DCF gets tricky because a private company doesn’t have a market capitalization or Beta – you would probably just estimate WACC based on the public comps’ WACC rather than trying to calculate it.

Let’s say we’re valuing a private company. Why might we discount the public company comparable multiples but not the precedent transaction multiples?

There’s no discount because with the precedent transactions, you’re acquiring the entire company – and once it’s acquired, the shares immediately become illiquid. But shares – the ability to buy individual "pieces" of a company rather than the whole thing – can be either liquid (if it’s public) or illiquid (if it’s private). Since shares of public companies are always more liquid, you would discount public company comparable multiples to account for this.

Can you use private companies as part of your valuation?

Only in the context of precedent transactions – it would make no sense to include them for public company comparables or as part of the Cost of Equity/WACC calculation in a DCF because they are not public and therefore have no values for market cap or Beta.

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