A private equity case asks whether an investor should buy a business at a particular price, improve or develop it during ownership and eventually realise an attractive return. A good company can still be a poor investment if the price or financing leaves too little room for error.
The financial model tells you what the return depends on. Due diligence tests whether those dependencies are credible.
Start by understanding the proposed source of value. Then connect the customer's behaviour, operating plan and cash generation to the investor's entry equity and eventual proceeds.
State the investment thesis in plain language
Suppose a fund is considering a regional industrial-maintenance company. It serves factories through recurring contracts. Management forecasts growth through new branches and better technician utilisation.
A preliminary thesis might be: retain the existing contract base, open profitable branches in adjacent regions and improve scheduling enough to raise margins, while generating cash to repay debt.
That sentence gives the diligence a purpose. You need to investigate contract durability, demand in the expansion regions, technician availability, scheduling economics and cash conversion. “Market, company, financials and risks” would name the same broad territory without explaining what must be proven.
Make the specialist workstreams answer one coherent investment decision. Each finding should change the thesis, operating plan, valuation or conditions for proceeding.
Check the quality of today's earnings
Recurring revenue is useful, but the word “recurring” is not a guarantee. Examine renewal patterns, customer concentration, contract terms, pricing, service quality and the reasons customers might switch.
For the maintenance business, ask whether revenue comes from contracted essential servicing or discretionary projects that customers can defer. A multi-year customer relationship may contain both.
Check whether reported earnings include unusual items or costs that a new owner will have to restore. Deferring maintenance, leaving key roles vacant or excluding recurring “one-off” expenses can make the starting profit look stronger than the operation really is.
The relevant question is what sustainable earnings the fund is buying. That baseline affects both the entry valuation and how much genuine improvement the plan contains.
Translate the operating plan into evidence
Suppose the target earns $10 million of EBITDA today and forecasts $15 million in five years. EBITDA is earnings before interest, tax, depreciation and amortisation. It is an operating measure, not cash available to the investor.
Build a bridge from $10 million to $15 million. How much comes from new branches, higher prices, additional contracts and cost improvement? What investment and management effort does each require?
A branch-growth forecast needs customer demand, technicians, launch spending and time to reach an efficient service density. A scheduling improvement needs evidence that travel time or idle time can actually be reduced without damaging response quality.
If three customers generate half of EBITDA, renewal and relationship diligence become central. If scarce technicians constrain expansion, hiring and retention assumptions deserve more attention than a detailed forecast of office supplies.
Prioritise the facts that could materially change value. This is the same habit used in the M&A framework, applied to the fund's ownership and return plan.
Calculate the equity investment and exit proceeds
Use these simplified assumptions for a five-year hold, with no interim distributions, transaction fees or additional equity contributions:
| Measure | Entry | Exit |
|---|---|---|
| EBITDA | $10m | $15m |
| Enterprise value / EBITDA | 8× | 8× |
| Net debt | $40m | $20m |
Entry enterprise value is $80 million: $10 million multiplied by eight. With $40 million of net debt financing the business, the simplified equity investment is $40 million.
At exit, enterprise value is $120 million. Subtract $20 million of remaining net debt and equity proceeds are $100 million.
The multiple of invested capital, or MOIC, is $100 million divided by $40 million: 2.5 times. With all proceeds received at the end of year five, the annualised return is approximately 20.1%, calculated as 2.5 raised to the power of one-fifth, minus one.
Show the bridge before discussing the return. Multiplying exit EBITDA by the valuation multiple gives enterprise value, not the amount the equity investor receives.
Quick Case Math Drill
A fund is reviewing its five-year ownership of a scaffolding hire business. Assume no fees, interim distributions or additional equity contributions.
| Measure | Entry | Exit |
|---|---|---|
| EBITDA | $8m | $12m |
| Enterprise value / EBITDA | 9× | 8× |
| Net debt | $36m | $15m |
What gross multiple of invested capital did the fund earn on its equity?
Explain where the gain comes from
Equity value rises from $40 million to $100 million, a $60 million gain in this simplified model.
At the unchanged 8× multiple, the $5 million EBITDA increase adds $40 million of enterprise value. Reducing net debt by $20 million adds another $20 million to equity value.
There is no multiple expansion in this base case. That makes the operating improvement and cash generation particularly visible.
Do not add the debt-repayment cash again as a separate distribution. The same cash has already increased exit equity value by reducing debt. If the business makes interim distributions, include their amounts and dates explicitly and use a cash-flow return calculation rather than the simple end-value formula.
Test whether EBITDA turns into usable cash
For one simplified year, suppose EBITDA is $10 million, cash interest is $3 million, cash tax is $1 million, capital expenditure is $2 million and additional working capital absorbs $1 million.
That leaves $3 million before debt principal repayment and any other cash items. A model assuming $8 million of debt repayment in that year needs another funding source or different operating assumptions.
Growth can consume cash through vehicles, equipment, recruitment and unpaid customer invoices. It may still create value, but you cannot simultaneously assume aggressive expansion and ignore the investment required to support it.
Check liquidity through the ownership period as well as at exit. A business can have an attractive year-five valuation and still struggle to meet an earlier obligation. The turnaround framework explains why cash timing matters when the margin for error is small.
Stress-test the assumptions the fund cannot control
If exit EBITDA reaches $15 million but the exit multiple falls to 6×, enterprise value is $90 million. After $20 million net debt, equity proceeds fall to $70 million.
That produces 1.75 times invested capital and approximately 11.8% annualised over five years. A 20% target would not be met.
Now combine a weaker operating outcome with slower debt repayment: $12 million exit EBITDA, a 6× multiple and $30 million net debt. Equity proceeds are $42 million, barely above the initial $40 million. The annualised return is about 1%.
These scenarios reveal the investment's exposure. More debt might improve an optimistic equity return while leaving the business less able to absorb a downturn. It does not repair weak customer demand or an unrealistic operating plan.
Quick Structuring Drill
An analyst has built the base case for buying a specialist food-packaging maker and split the projected equity gain by source for the investment committee.
| Source of equity gain | Gain ($m) |
|---|---|
| EBITDA growth at entry multiple | 18 |
| Debt repayment | 20 |
| Exit multiple rising from 9× to 12× | 66 |
Which point should lead the stress-test section of the investment memo?
Use the return requirement to discipline the price
With $100 million of exit equity proceeds and a 20% annual target over five years, the maximum initial equity investment is roughly $40.2 million before fees under this model: $100 million divided by 1.2 to the fifth power.
The proposed $40 million entry equity therefore leaves very little headroom. A small fee, delay or missed operating target can move the deal below the hurdle.
The recommendation should identify the conditions for proceeding: evidence on customer renewals, a feasible branch plan, credible cash conversion and a price that provides an acceptable return under the investor's chosen assumptions. If those conditions are not met, change the terms or decline the deal.
For practice, use PE Add-On Acquisition. Explain what creates value for this buyer, what must be invested to achieve it and which diligence finding would most change the price you are willing to pay.
Structure drill
Would your case structure convince an MBB interviewer?
PE Add-On Acquisition
If you tried this acquisition drill from the M&A guide, revisit it with an investor’s lens: cash generation, entry equity and exit assumptions. Present your approach to Casey, Case Room’s AI interviewer, then review feedback on your structure and starting point.
Frequently asked questions
Building and testing the thesis
What is a private equity due diligence case really testing?
It tests whether a specific thesis can deliver an attractive return at the proposed price. Start by stating the thesis plainly. For the fictional maintenance company, the plan is to retain contracts, open branches in adjacent regions and improve scheduling to raise margins, while generating cash to repay debt. Your diligence must test each part of that sentence.
Does recurring revenue mean the earnings are safe?
No, 'recurring' is a label rather than a guarantee. Examine renewal patterns, customer concentration, contract terms, pricing, service quality and the reasons customers might switch. Separate contracted essential servicing from discretionary projects that customers can defer, since one multi-year relationship may contain both. Also check whether reported earnings include unusual items.
How do I test whether management's EBITDA forecast is credible?
Build a bridge from today's figure to the forecast and attach evidence to each step. If EBITDA is meant to rise from $10 million to $15 million over five years, split the increase between new branches, higher prices, additional contracts and cost improvement. Then ask what investment and management effort each component needs.
Working through the returns maths
How do I calculate the equity investment and exit proceeds?
Multiply EBITDA by the multiple to get enterprise value, then subtract net debt. Entry enterprise value is $10 million times 8, or $80 million. Less $40 million of net debt, that leaves $40 million of equity. At exit, $15 million times 8 gives $120 million. After $20 million of net debt, the equity is worth $100 million.
What return does the base case actually produce?
The base case produces 2.5 times invested capital, as $40 million grows to $100 million over five years. That is only marginally above a 20% annual target, since the maximum entry equity for that target is roughly $40.2 million. The model also excludes transaction fees, interim distributions and further equity contributions, so real costs would erode this thin margin.
Where does the gain in the base case come from?
The gain comes from two sources: operating improvement and debt reduction. At an unchanged 8× multiple, the $5 million rise in EBITDA adds $40 million of enterprise value. Cutting net debt by $20 million adds another $20 million to equity. With no multiple expansion assumed, the return clearly depends on better performance and cash generation.
Is EBITDA the same as cash available to the investor?
No, EBITDA is an operating measure before interest, tax, depreciation and amortisation. In the simplified year, EBITDA is $10 million. Deduct $3 million of cash interest, $1 million of cash tax, $2 million of capital expenditure and $1 million of extra working capital. That leaves $3 million before any debt principal repayment.
How do I check whether planned debt repayment is realistic?
Compare the repayment schedule with the cash the business generates after its other obligations. Suppose only $3 million remains after interest, tax, capital expenditure and working capital. A model assuming $8 million of repayment that year then needs another funding source or different operating assumptions. Remember that growth itself can absorb cash.
Stress-testing and setting the price
What happens to returns if the exit multiple falls?
Returns can drop sharply even when the operating plan is delivered. If exit EBITDA reaches $15 million but the multiple falls to 6×, enterprise value is $90 million. After $20 million of net debt, equity is worth $70 million. That is 1.75 times invested capital, roughly 11.8% a year over five years, well short of a 20% target.
Which assumptions should I stress-test hardest?
Prioritise the assumptions the fund cannot control, such as the exit multiple. Then combine them with plausible operating shortfalls. The guide pairs a 6× multiple with weaker exit EBITDA of $12 million and slower debt repayment. Testing these together shows whether the deal survives a realistic bad outcome rather than an isolated one.
How do I work out the maximum price the fund should pay?
Work backwards from the exit proceeds and the required return. With $100 million of exit equity and a 20% annual target over five years, divide $100 million by 1.2 to the fifth power. That gives roughly $40.2 million of initial equity before fees. Any higher entry equity fails the hurdle under this model's assumptions.
Can a good company still be a poor investment?
Yes, if the price or financing leaves too little room for error. The maintenance business may be sound, but its $40 million entry equity sits barely below the roughly $40.2 million ceiling for a 20% return. A small fee, a delay or a missed operating target could push the deal below the hurdle.