How to Answer “How would you diligence a potential acquisition in private equity?” in Private Equity Interviews
In private equity interview prep, few prompts come up more often than: “How would you diligence a potential acquisition in private equity?” This acquisition diligence interview question checks whether you can run investor-led underwriting: start with a thesis, focus on the handful of issues that drive returns, and turn diligence findings into a clear IC recommendation.
A strong answer isn’t a checklist. It’s a structured diligence process in private equity that shows how you would validate the business, quantify risks, and reflect what you learn in the model, valuation, and deal terms.
What Private Equity Technical Questions Reveal About Your Underwriting
Interviewers use this to assess whether you think like an investor rather than a task manager. They want to hear a clear thesis, the “must be true” statements behind it, and how you would design due diligence to confirm or falsify those points.
For an Associate, it also tests process control: can you run parallel workstreams (commercial, financial, legal, operational) with tight deliverables, keep the narrative coherent, and avoid getting lost in the data room.
Finally, it’s a synthesis and communication test common in private equity technical questions. You’re expected to link diligence outputs to investment analysis—what changes your base/downside assumptions, how the LBO sensitivities move, and what you do about residual risk through pricing, structure, and protections.
Acquisition Diligence Interview Question: A 5-Step Framework
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Step 1: Anchor on the thesis and define IC “must be true” questions
Start by stating the investment thesis in one sentence and translate it into 3–5 underwriting questions you’ll answer by the final IC (e.g., Is growth structural or cyclical? Is pricing power real? Are margins sustainable? Is cash conversion clean?). This prevents a generic approach and keeps the work focused on value drivers.
Then set the underwriting frame: target return profile, leverage comfort, hold period, and the value creation plan (price/mix, cost actions, add-ons, geographic or product expansion). These choices determine where diligence effort should concentrate and what downside you must protect.
Output: a diligence plan and tracker that maps each IC question to a workstream, data sources (CIM, data room, management, third parties), owner, timeline, and decision points (IOI/LOI, financing package, final IC).
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Step 2: Run commercial diligence to validate demand, customers, and the moat
Commercial diligence is where you validate the “why this company wins” narrative. Size the market and identify the true growth drivers (end-market growth, share gains, regulatory tailwinds, tech shifts), then pressure-test competitive intensity (switching costs, fragmentation, pricing transparency, barriers to entry).
Go deep on customer quality: concentration, retention/churn by cohort, contract duration/renewal clauses, pricing escalation, and reasons for wins/losses. Triangulate management claims with customer calls, channel checks, usage/volume data, pipeline conversion, and discounting trends.
Tie outputs to acquisition evaluation techniques: what does this imply for sustainable growth, gross margin durability, and the probability-weighted downside (e.g., losing a top customer, competitor pricing, or end-market slowdown).
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Step 3: Do financial diligence (QoE) to get to underwritable earnings and cash
Financial diligence should convert reported results into underwritable EBITDA and free cash flow. Start with a Quality of Earnings bridge: revenue recognition, cut-off, returns/rebates, non-recurring items, run-rate adjustments, and any add-backs that don’t survive scrutiny.
Then focus on cash conversion: working capital seasonality and structural needs (DSO/DPO/DIO), deferred revenue dynamics (if applicable), capex split between maintenance and growth, and any cash leakage (warranties, claims, customer penalties, restructuring costs). Validate that KPIs reconcile to audited statements and that definitions are consistent over time.
Output: clean EBITDA/FCF, a list of “red flag” accounting areas, and the specific model levers you will change (margin normalisation, capex, working capital, one-off costs).
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Step 4: Stress-test execution via operational, legal, and people diligence
Assess whether the business can execute the plan you’re underwriting. Operational diligence covers scalability, supplier concentration, capacity constraints, quality metrics/returns, inventory risk, systems/ERP limitations, and any operational dependencies that can break service levels or margins. Benchmark key operating metrics versus peers to separate “structural advantage” from “temporary tailwind.”
Legal diligence should focus on issues that change risk allocation: change-of-control clauses, assignment restrictions, termination rights, IP ownership, data/privacy exposure, regulatory compliance, employment matters, and pending disputes. Identify what needs specific reps/warranties, indemnities, escrows, or purchase price adjustments.
People diligence: evaluate management depth, incentive alignment, and succession risk—especially if value creation requires a step-change in pricing discipline, operational improvement, or M&A integration capability.
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Step 5: Synthesize findings into the model, valuation, and a decision on terms
Close the loop by turning diligence into underwriting. Update the model drivers (volume/price, margin bridge, opex, working capital, capex), then run sensitivities around the two or three biggest uncertainties. Make sure the downside case is coherent (not just “haircuts everywhere”) and ties to real diligence evidence.
Connect results to valuation and structure: does the entry multiple still make sense given revised growth, margin, and risk? How do leverage capacity and covenant headroom change with the updated FCF profile? This is where you decide whether to re-price, re-trade structure (earn-outs, seller notes), add protections, or walk away.
Deliverable: an IC-ready narrative—thesis, key diligence evidence, base/upside/downside cases, value creation plan, open items, and a crisp recommendation.
Model Answer: Diligence Process in Private Equity (Associate)
I’d diligence a potential acquisition by starting with the investment thesis and designing diligence to prove or disprove the few things that drive returns. The goal of due diligence in private equity is to underwrite durable cash flows and identify deal-breakers early.
First, I’d articulate the thesis in one sentence and translate it into 3–5 IC questions—typically around sustainable growth, pricing power and competitive position, margin durability, and whether cash conversion matches EBITDA. I’d build a diligence tracker that maps those questions to commercial, financial, legal, and operational workstreams with clear deliverables and timing.
Second, on commercial diligence, I’d validate market size and growth drivers, pressure-test competitive dynamics, and go deep on customer quality: concentration, retention/churn, contract terms, pricing escalation, and win/loss drivers. I’d triangulate management’s story with customer calls, cohort trends, and indicators like discounting and pipeline conversion.
Third, on financial diligence, I’d run a QoE-style review to normalise EBITDA, validate revenue recognition and add-backs, and assess working capital, capex, and any hidden liabilities. The key output is underwritable free cash flow and the specific assumptions that should change in the model.
Fourth, I’d confirm execution risk through operational, legal, and people diligence—scalability, supplier dependence, key contracts and change-of-control clauses, and whether the team can deliver the value creation plan.
Finally, I’d synthesise everything into base/upside/downside cases, run sensitivities on the biggest risks, and tie findings to price and terms—re-price, add protections, restructure, or walk away—with a clear IC recommendation.
- Lead with the investor purpose (underwrite cash flows + find deal-breakers), not a category list.
- Use thesis → IC questions → workstreams to show control of the diligence process in private equity.
- Name tangible outputs: QoE bridge, underwritable FCF, model driver updates, key sensitivities, and IC recommendation.
- Explicitly connect diligence results to valuation and deal terms (price, structure, protections).
- Signal prioritisation: focus on the 2–3 issues most likely to change the decision.
Common Errors in the Diligence Process (and How to Avoid Them)
- Turning the answer into a generic checklist without linking each workstream to the investment thesis or IC decision.
- Talking about EBITDA growth but missing cash conversion (working capital, capex, one-offs) and how it affects leverage capacity.
- Saying “we do QoE” without explaining what you would normalise and what would change your model assumptions.
- Not explaining how diligence findings translate into valuation, downside cases, and deal protections.
- Over-indexing on data room review and underweighting customer and competitive diligence.
- Failing to articulate decision points (what would cause you to re-trade or walk away).
Follow-Ups on Acquisition Evaluation Techniques and Deal Risk
What are the first three things you would check after receiving the CIM?
I’d focus on (1) what truly drives growth (repeat vs one-off), (2) what explains margin level/volatility, and (3) whether EBITDA converts to cash over time.
How do you incorporate diligence updates into an LBO model quickly?
I translate findings into a small set of drivers (volume/price, margins, opex, working capital, capex) and update base/downside sensitivities rather than rebuilding the model.
What are typical deal-breakers in acquisition due diligence?
Examples include customer concentration with weak retention, aggressive revenue recognition, structural churn masked by new bookings, unfixable regulatory exposure, or persistent cash leakage from working capital or capex.
How do you decide whether the entry multiple is justified after diligence?
I triangulate comps/precedents, compare the implied growth and margin path to what diligence supports, and stress the downside to see if returns still work with realistic deleveraging and exit assumptions.
If management resists customer reference calls, what do you do?
I’d push for anonymised third-party outreach and triangulate using churn cohorts, discounting and renewal patterns, channel checks, and win/loss data to reduce reliance on management-selected references.
How to Prepare for Private Equity Interview Questions on Diligence
- Practise a 3–4 minute delivery that follows: thesis → commercial → financial (QoE/cash) → ops/legal/people → synthesis into price/terms.
- Build a repeatable “IC questions” template by business model (recurring revenue, project-based services, industrial, consumer) so you can prioritise fast.
- In mock runs, force yourself to state outputs: normalised EBITDA, underwritable FCF, key sensitivities, and specific term protections.
- Use AceTheRound to rehearse under time pressure and get feedback on structure, prioritisation, and whether you connected diligence to valuation and the final recommendation.
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