How to Answer “How would you value a company with negative free cash flow (cash burn)?” in Investment Banking Interviews
In investment banking interview prep, a common twist on valuation is: “How would you value a company with negative free cash flow (cash burn)?” The key is to show you understand why cash flow is negative (growth investment vs structural issues) and how that changes the choice of valuation techniques for negative cash flow.
A strong analyst-level answer is not “you can’t do a DCF.” It’s a structured approach: diagnose the burn, pick the right valuation methods (often multiple), and explain the assumptions and checks that make the result credible.
What IB Technical Interview Questions Test on Cash Burn Valuation
This question sits in the middle of IB technical interview questions because it tests more than mechanics. Interviewers are checking whether you can separate temporary negative free cash flow (e.g., heavy growth capex, working capital build) from fundamental value destruction (e.g., poor unit economics), and how that affects your model.
They’re also assessing judgment on DCF valuation methods when early-year cash flows are negative. A good candidate explains that a DCF can still work if you can forecast a path to positive cash flow, but you may need a longer explicit forecast, scenario analysis, and careful treatment of terminal value.
Finally, they’re testing communication: can you lay out a clean decision tree, triangulate across valuation methods, and sanity-check the implied performance (margins, reinvestment, growth) rather than relying on a single output.
Valuation Techniques for Negative Cash Flow: Analyst Framework
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Step 1: Diagnose the cash burn and the business model
Start by framing why free cash flow is negative, because that determines which valuation methods are appropriate. Break burn into operating losses vs reinvestment: is the company negative due to low gross margin / weak unit economics (structural), or because it’s funding growth (high sales & marketing, capex, R&D) with an expectation of future scale benefits?
In your cash flow analysis, call out the main drivers: revenue growth, gross margin trajectory, operating leverage, working capital intensity, and capex needs. Clarify whether you’re valuing an early-stage / high-growth business (common for cash burn) or a mature business in distress.
Close the step by stating the practical implication: if there’s a believable path to profitability and steady-state cash generation, you can still use a DCF; if not, you’ll lean more heavily on relative valuation, asset-based methods, or restructuring-style approaches.
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Step 2: Choose valuation techniques for negative cash flow and triangulate
Lay out a clear toolkit and explain when you’d use each method:
- DCF (still viable) if you can model a path to positive free cash flow. You typically extend the explicit forecast period, model the transition to steady-state margins, and ensure reinvestment supports the growth assumptions.
- Comparable company multiples using metrics that make sense pre-FCF: EV/Revenue, EV/Gross Profit, or EV/EBITDA if EBITDA is positive or near break-even. Anchor the multiple to growth, margins, and quality of revenue.
- Precedent transactions for an acquisition context—often more forgiving for loss-making companies if there is strategic value.
- Asset-based / liquidation / sum-of-the-parts if the business is distressed or asset-heavy.
State explicitly that in investment banking interview strategies, you rarely rely on one output here—you triangulate and reconcile, with the DCF (if usable) providing an intrinsic anchor and multiples providing market reality checks.
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Step 3: Build a step-by-step DCF for negative free cash flow
For a step by step DCF for negative cash flow, emphasise forecasting and the transition period. Forecast drivers (volume, pricing, churn/retention where relevant), then margins and reinvestment. Make the path to positive cash flow explicit: when does EBITDA turn positive, when do margins stabilise, and what working capital and capex levels are required to sustain growth?
Key modelling points interviewers like:
- Use a longer explicit period (often 7–10+ years) if the company is far from steady-state.
- Model reinvestment realistically: high growth usually needs higher capex or working capital.
- Be conservative about terminal value: only apply a terminal method once the business is in a mature, steady-state condition; otherwise you risk pushing most value into an unjustified terminal.
Finally, call out risk: higher uncertainty means you’ll rely on scenarios (base/downside/upside) and sensitivity analysis (WACC, terminal assumptions, margin trajectory).
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Step 4: Reconcile outputs and sanity-check the implied story
Once you have a range, interpret it. Compare DCF-implied multiples to comps (e.g., what EV/Revenue does your DCF imply today?) and ask whether the implied long-term margins and growth are plausible for the industry.
Add practical sanity checks: does the valuation require unrealistic market share, margin expansion beyond peers, or perpetual high growth? For cash burn businesses, also check funding needs—while valuation is separate from liquidity, the path to value creation may require interim financing, and your forecast should not ignore that the company must survive to reach steady-state.
Finish with a crisp conclusion: explain which method you’d weight most and why, and tie it back to what you learned in the initial cash flow analysis.
Sample Answer Using DCF Valuation Methods (Analyst Level)
To value a company with negative free cash flow, I’d start by diagnosing why it’s burning cash and then triangulate across methods. Negative FCF doesn’t automatically mean you can’t value it—it usually means the valuation is driven by the expected path to steady-state cash generation and the assumptions need to be very explicit.
First, I’d break the burn into operating losses versus reinvestment: is FCF negative because unit economics are weak, or because the company is deliberately investing in growth through capex, working capital, and opex? That informs whether I’m dealing with a high-growth story or a distressed situation.
If there’s a credible path to positive cash flow, I’d run a DCF using a longer explicit forecast period. I’d forecast revenue drivers and margins, model the transition to operating leverage, and make reinvestment consistent with growth. I’d be careful with terminal value—only applying a perpetuity growth or exit multiple once the business is in a mature, steady-state year—then discount back using a risk-appropriate rate and show sensitivities around WACC, terminal assumptions, and margin ramp.
In parallel, I’d use market-based valuation methods that work pre-FCF, like EV/Revenue or EV/Gross Profit comps, and precedent transactions if it’s an M&A context. Finally, I’d reconcile by checking whether the DCF implies reasonable current multiples and whether the implied long-term margins and growth are realistic versus peers. My final answer would be a range, with weights based on predictability of the cash flow path and quality of comparable sets.
- Open by reframing: negative FCF changes the approach; it doesn’t eliminate valuation.
- Make the “why is FCF negative?” diagnosis your first move (growth investment vs structural losses).
- For DCF, emphasise longer forecast periods, disciplined terminal value timing, and scenario/sensitivity work.
- Triangulate with EV/Revenue or EV/Gross Profit comps and reconcile using implied multiples and realism checks.
Common Pitfalls in Cash Flow Analysis and Valuation Methods
- Saying “you can’t do a DCF” without adding the conditional: you *can* if you can forecast a path to positive cash flow and steady-state assumptions.
- Leaning on EV/Revenue comps with no discussion of growth, margins, and revenue quality, which is where the multiple actually comes from.
- Pushing most of the value into terminal value before the company reaches a mature state, effectively assuming away the hard part of the story.
- Ignoring reinvestment: forecasting rapid growth while keeping capex and working capital unrealistically low.
- Failing to reconcile methods (e.g., not checking what multiple the DCF implies today) and not stress-testing key assumptions with scenarios.
Follow-Ups You’ll Get in Investment Banking Interview Strategies
Which multiples are most appropriate if EBITDA and FCF are negative?
Typically EV/Revenue or EV/Gross Profit, selected based on unit economics and comparability; you then adjust interpretation for growth and margin differences.
How do you treat terminal value when early years are deeply negative?
Use a longer explicit forecast and only apply terminal value once the business is in steady-state; then run sensitivities on terminal assumptions because they can dominate value.
What if you can’t credibly forecast a path to positive cash flow?
You’d weight away from an intrinsic DCF and rely more on comps/transactions, asset-based methods, or a restructuring-style valuation depending on the situation.
How do you sanity-check a DCF for a cash-burn business?
Check implied current multiples versus peers, ensure margins and reinvestment intensity are plausible, and pressure-test the model with downside scenarios on growth and margins.
How to Practise This in Investment Banking Interview Prep
- Practise a 3-minute structure: diagnose burn → pick methods → DCF specifics → reconcile/sanity checks. Time it so you don’t get stuck in modelling detail.
- Build a mini “decision tree” for interviews: growth investment burn (DCF + EV/Revenue) vs structural loss/distress (asset/restructuring angle).
- Prepare 2–3 DCF soundbites that show judgment: longer explicit period, disciplined terminal value, scenarios/sensitivities.
- In AceTheRound, rehearse answering with a follow-up drill: after your initial framework, expect a push on terminal value timing, implied multiples, and what makes comps comparable.
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