How to Answer “How do you run a downside case in a private equity model?” in Private Equity Interviews
In downside case private equity work, interviewers want to see that you can turn “what could go wrong?” into a small set of defensible modelling shocks—and then interpret what those shocks do to cash flow, leverage, and the exit.
When you’re asked “How do you run a downside case in a private equity model?”, a strong associate-level response explains which drivers you stress, how you size them, how you keep the scenario internally consistent, and which outputs (liquidity and covenants, not just IRR) you check before you conclude.
What PE Interviewers Look For in Downside Case Analysis
In private equity technical questions, this prompt tests whether you understand downside risk as a cash flow + leverage + refinancing/exit problem. They’re assessing if you can choose the right value drivers (growth, margins, working capital, capex, financing, exit multiple) and link each change to a credible business story.
It also tests modelling hygiene in a private equity modeling interview: can you implement the downside via a clean scenario switch, avoid circularity, keep the debt schedule and cash flow sweep mechanics consistent, and avoid “double counting” risk (e.g., cutting EBITDA while also layering unrelated capex and working-capital penalties).
Finally, it tests investor judgment: a downside case analysis isn’t just “returns are lower.” It should surface breakpoints (liquidity squeeze, covenant breach, inability to refinance, negative equity value) and lead into what you’d adjust in underwriting (price, leverage, covenants, operational levers).
Downside Case Private Equity: Step-by-Step Modelling Framework
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Step 1: Anchor the base case and define the downside narrative
Start by stating what a downside case is: a coherent scenario where operating performance and/or market conditions deteriorate versus the underwriting case. Make it clear you lock the base case first, then run the downside through a separate scenario column or a simple toggle so the model is auditable.
In your setup, briefly define the type of downside you’re running: an operating miss (demand/price/mix), a cost shock (input inflation), a financing/valuation shock (rates up, multiple down), or a combination that makes business sense. This is where you show you’re not randomly haircutting outputs.
If helpful, mention you often run two versions: (1) operating downside (EBITDA/cash flow miss) and (2) valuation/financing downside (exit multiple compression, higher interest), because they stress the deal in different ways.
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Step 2: Select 3–6 key drivers and size shocks for downside case analysis
For downside case analysis, pick a handful of assumptions that drive most of the variance in an LBO rather than changing everything. A standard set includes: revenue growth (or price/volume), EBITDA margin, working capital (DSO/DIO/DPO), capex (maintenance vs growth), interest rate/spread (and availability under the revolver), and the exit multiple/hold period.
Then explain how you size the downside: use historical down years, cyclicality, peer behaviour in a weaker environment, and what diligence highlights as fragile (customer concentration, pricing power, fixed-cost base, inventory risk). The goal is “defensible, not extreme.”
Call out internal consistency: e.g., if volume drops, you may see operating deleverage and a working-capital inflow from lower inventory; if pricing weakens, margin compression may be worse and cash conversion may deteriorate. Avoid stacking unrelated penalties unless the narrative supports it.
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Step 3: Run the full model and pressure-test liquidity, leverage, and covenants
Run the downside through the full three statements and debt schedule (not just a return sensitivity). In a private equity modeling interview, walk through the mechanics:
- Lower EBITDA reduces CFO and slows debt paydown, keeping leverage higher for longer.
- Higher rates/spreads increase cash interest, which can create a feedback loop into revolver usage.
- Exit multiple compression can reduce equity proceeds even if operations partially recover.
Key outputs to review:
- Liquidity: minimum cash, revolver draws, ability to fund capex and mandatory amortisation.
- Credit metrics / covenants (if relevant): net leverage, interest coverage / FCCR, headroom by period.
- Deleveraging path: net leverage at key dates and at exit.
- Returns: IRR and MoM, plus a quick attribution of what drove the change (EBITDA vs multiple vs debt paydown).
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Step 4: Identify breakpoints and translate results into underwriting actions
Make the downside decision-useful by identifying breakpoints: the first period where the deal “breaks” (covenant breach, revolver maxed, cash shortfall, refinancing infeasible) and the specific driver movement that triggers it (e.g., margin down another 100 bps, or exit multiple down another 0.5x).
Then do quick sanity checks so the interviewer trusts the outputs: working-capital days within plausible ranges, capex not below maintenance reality, interest expense aligning to average debt, and no hidden circularity from cash sweeps.
Close with what you’d do differently if the downside looks unacceptable: reduce entry multiple, increase equity, lower leverage, change amortisation/sweep, add covenant headroom, or underwrite operational levers (pricing, cost takeout, capex timing). This is the bridge from financial modeling to investing judgment in private equity interview prep.
Sample Answer for a Private Equity Modeling Interview
A downside case in a private equity model is a coherent stress scenario where a few key drivers move against the underwriting case to test survivability—liquidity, covenants, and the exit—not just to print a lower IRR.
I start by locking the base case and running the downside through a clear scenario toggle so only a small number of assumptions change. Then I define the narrative first—operating miss, financing/valuation shock, or both—so the shocks are internally consistent.
From there I typically stress 3–6 drivers: revenue growth (or price/volume), EBITDA margin, working capital days, capex (especially maintenance), financing terms like rates/spreads and revolver availability, and the exit multiple/hold period. I size those shocks using historical down-cycle performance, peer comps, and what diligence suggests is most vulnerable, rather than haircutting everything by an arbitrary percentage.
After running the full three statements and debt schedule, I focus on mechanics and credit: lower EBITDA reduces operating cash flow and slows debt paydown; higher cash interest can drive revolver usage; and multiple compression can dominate equity value even if operations stabilise. The first outputs I check are minimum cash and revolver draws, covenant or coverage headroom if applicable, the leverage path over time, and then IRR/MoM with a quick attribution of what drove the change.
Finally, I look for breakpoints—when the model first hits a liquidity or covenant issue and what incremental change causes it—and I translate that into underwriting actions like less leverage, more equity, tighter pricing, or specific operational levers. That’s how I’d run downside scenario analysis in private equity in a way that’s auditable and decision-relevant.
- Define downside as a coherent scenario; emphasise liquidity/covenants, not only returns.
- Mention a scenario toggle and changing only a small set of drivers for auditability.
- Name the core drivers (growth, margin, working capital, capex, financing, exit multiple).
- Explain the mechanics through cash flow and the debt schedule (deleveraging, interest, revolver).
- Finish with breakpoint thinking and underwriting mitigants to show investor mindset.
Common Pitfalls in Private Equity Technical Questions
- Haircutting EBITDA by a flat percentage with no business narrative linking the shocks to how the company actually behaves.
- Changing too many inputs at once so you can’t explain what drove the outcome or defend the scenario in discussion.
- Reporting only IRR/MoM and ignoring liquidity, covenant headroom, leverage path, and refinancing feasibility.
- Double counting risk by layering unrelated penalties (growth down, margin down, working capital worse, capex up) without a consistent story.
- Breaking model integrity (messy scenario tabs, hardcodes, circular cash sweep issues) so the downside can’t be audited quickly.
- Skipping reasonableness checks (e.g., capex below maintenance, working-capital days outside historical ranges), which undermines credibility.
Follow-Ups on Downside Scenario Analysis in Private Equity
What’s the difference between a downside case and a sensitivity table?
A downside case is a linked set of assumption changes run through the full model; a sensitivity table typically varies one input (or two) independently to show dispersion.
Which drivers usually matter most for LBO downside returns?
Exit multiple and EBITDA level/margin typically drive most of the equity value impact, while working capital and capex often drive near-term liquidity stress.
How do you avoid double counting in a downside scenario?
Start with a narrative, change only the assumptions implied by that story, and sanity-check the combined effect against historical/peer ranges.
When the downside looks bad, what do you check first?
Liquidity and credit stats: minimum cash, revolver usage, coverage/leverage (and covenant headroom if applicable), plus the first period where a breakpoint occurs.
Can you give a private equity model downside case example assumption set?
Example: growth -300 bps for two years, margin -150 bps with partial recovery, working-capital days +5, maintenance capex +10%, exit multiple -1.0x, and rates +100 bps—then assess liquidity, leverage at exit, and IRR/MoM.
Private Equity Interview Prep: Practise Drills for Downside Cases
- Build a simple LBO with a single scenario switch and practise explaining exactly which cells change between base and downside.
- Rehearse a 2-minute structure: definition → drivers → mechanics → outputs → breakpoints → mitigants.
- Practise two variants: an operating downside and a valuation/financing downside, so you can answer different interviewer angles.
- After each run, write a one-line conclusion (e.g., “survives but equity value hit is multiple-driven” vs “liquidity breach in Year 2”) to keep your communication crisp.
- Use AceTheRound to drill answering downside case questions in interviews with timed delivery and targeted feedback on structure and technical accuracy.
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