Note: This article is part of a broader series on how to prepare for growth equity interviews
Many assume growth equity interviews aren’t as “technical” as private equity interviews. While it’s true growth equity interviews tend not to dive as deeply into debt and leveraged buyout-related topics, make no mistake: if you are interviewing for growth equity roles, you will still face technical questions.
Given my experience as an at General Atlantic, a top growth equity fund, I pulled together some of the more common technical questions one might face in a growth equity interview. While every firm and interviewer will have their own favorite questions to grill candidates with, these questions should give you a sense of the kinds of topics you should prepare for.
Quick aside before we jump in: this article focuses on technical questions in growth equity interviews, but also don’t miss my other related articles on non-technical growth equity interview questions and the growth equity interview process in general.
Alright, let’s get started!
Growth equity technical interview questions
What are the three ways investors make money, and how do growth investors make money?
I love this interview question. I remember being asked this myself during my own interview process with TPG Growth!
The reason why it’s such a great question – especially for growth equity interviews – is it gets to the core of what growth equity is and why it’s unique among other styles of investing.
Let me explain. When most people think about investing, usually they believe the way to make money is to “buy low, sell high.” Yes, ultimately, it’s always the goal to pay a lower price than you sell something for. But as investing pros, we know there’s much more nuance.
There are fundamentally only 3 ways you can make money as an investor. They are as follows:
- Valuation – If you buy a company for 10x revenue and sell it for 12x revenue – assuming everything else stays the same about the company – you will make a positive return on your investment
- Leverage – If you buy a company for 10x revenue, even if you sell it for the same multiple (10x revenue) and revenue has not changed from when you acquired it, you can still make a positive return as an investor if the company has reduced its net debt from the time you acquired it
- Growth – If you buy and sell a company for 10x revenue, and there’s no change in net debt from the time you acquired it to the time of sale, you can still earn a positive return on your investment if the company has grown its revenue
Mathematically, these are the ONLY ways one can earn a positive return as an investor.
Once you understand this, you can start to understand growth-stage investing (and its risks) with greater sophistication. As the name implies, growth investors typically generate returns through company growth (rather than valuation and leverage).
However, it’s actually very common that growth stage investing returns will be reduced due to the effect of valuation (multiple compression). Since growth investments typically demand high valuation multiples at entry, usually the multiple compresses as growth slows by the time you sell your stake.
This means that growth investing requires that you generate returns from growth that are far in excess of your return hurdle, since you must account for the negative effect of valuation multiple compression. All this is why it’s so important to really underwrite your growth projections before investing – you’ll likely be exposed to negative valuation pressure, so if you are wrong on growth, your investment will really be in trouble!
Note, above is a lot of detail, most of which you may not need to mention in your actual interview. However, it’s a fundamental concept you should grok and be able to speak to if the situation demands it.
What is the biggest risk in growth stage investing?
This is a continuation or follow up to the previous question.
One of the biggest risks of growth stage investing is if a company misses their growth projections. The reason why this is such a big risk is it can lead to a double drag for the investment returns.
As explained in the answer above, if a company’s growth slows down, the valuation multiple you can get at exit will likely also be lower (people won’t pay as much for a company that’s not growing fast). Therefore, if a growth company misses its growth target, it will also have valuation multiple compression, both of which will really impair returns.
Many people think that growth investing is relatively safe, since there’s a sense that you have lots of “margin for error” when you are investing in a company that’s growing 50% per year. The thinking goes: if the company slows down to 20% per year growth, will you really be that bad for your investment?
Well, often the answer is yes, growth slowdowns are VERY bad, assuming you did not forecast this drop in your investment case upfront. In this way, growth investing is quite risky, since there’s so much importance on maintaining high growth, which is fundamentally hard to project.
Finally, there are also other risky aspects of growth investing that you could talk about for this question, such as:
- Limited ownership and operational control – Without majority control, it could be challenging to affect change at the company
- Fast decision-making to invest – Given a hot deal, you may be forced to decide to invest quickly, which could limit your diligence and impair decision making
If I told you the growth rate of a company, what else do you need to know in order to estimate returns?
Here’s a neat trick: you can easily estimate growth returns, if you know the company’s growth rate, by using some assumptions. Let’s say we knew revenue growth of the company was projected to be 20% per year throughout the period of the investment. If we assume that there’s no change in net debt (debt minus cash) over the period, and there’s no change in entry vs. exit revenue multiple, then IRR will equal the compound annual growth rate of revenue (in this case, 20%).
No model needed here!
Furthermore, investor returns are ultimately driven by 3 factors (growth, leverage, and valuation). So, if you knew the growth rate of revenue, you would then need to know valuation (entry and exit revenue multiples), as well as leverage (change in net debt over the investment period) in order to estimate returns.
For in depth explanation or background, see the question above related to the 3 ways investors make money.
A couple quick caveats:
- The company’s valuation multiple be expressed in terms of the same metric as growth (e.g. Enterprise Value / Revenue, and Revenue Growth)
- Often, growth companies see multiple compression during the course of an investment, so just know that the assumption of entry & exit multiple parity is a simplifying one and won’t necessarily become true; in this way, in our example you can say that returns would likely have a “ceiling” of 20%, if you expect some multiple compression
I discuss this and other cool tricks in my guide to growth equity case studies.
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Is it possible for a growth deal to involve a company whose organic growth is single digit percentage?
Yes! As noted in previous questions, there are multiple ways to make money as an investor (e.g. growth, valuation, and leverage). While growth often drives the bulk of returns, it does occur that growth investments generate some portion of their overall return through leverage or multiple expansion.
Besides organic growth, many growth investments generate returns through inorganic growth (e.g. M&A rollups). Therefore, even if the underlying market is only growing at single digits, one could generate greater returns through acquisitions.
What situations might you expect multiple expansion in growth deals?
Multiple expansion is generally rare in growth equity deals, and it is not underwritten in investment cases; however, it can occur. A few possible situations could drive this:
- M&A rollup – A legitimate strategy to drive growth returns can be an M&A rollup. In this case, you might acquire the original target company at a certain valuation multiple; however, after several successful acquisitions, investors may value the overall platform you’ve built more highly, especially if there are advantages to scale or market share leadership in that industry
- Cyclical valuation factors – While a company’s growth trajectory tends to predominate valuation, the degree to which investors favor certain sectors can vary with the timing of the business cycle (e.g. financials)
What are some ways that growth equity investors can protect against downside risk?
Of course, the first tool at any investor’s disposal to reduce risk is to diligence an investment thoroughly. Another way is to pay lower prices for companies, therefore granting yourself more leeway to achieve a given return.
More specific to growth stage investments, firms also commonly reduce risk by adding preferential deal terms, such as anti-dilution provisions, as part of the deal. Finally, low debt levels can also help growth companies survive and even outperform during slowdowns.
What is a liquidation preference?
“Liquidation preference” is a deal term that many growth investors request in investments to limit downside risk. This term gives investors financial protection in the event that the company has a disappointing exit valuation.
To be specific, it lowers risk by guaranteeing that, upon an exit, investors will get paid, at minimum, a certain amount (expressed as a multiple of their original investment) before common shareholders (e.g. employees) are paid any exit proceeds.
Liquidation preference effectively gives investors a “guaranteed” return, assuming the company exits for a valuation that sufficiently clears the preference amount.
- Investor purchases 20% stake for $2 million ($10 million valuation). She also received a 2x liquidation preference.
- A few years later, the company is acquired for $5 million valuation
- Ordinarily, the the investor would receive $1 million at the exit (20% of $5 million), but because of the liquidation preference she receives is $4 million (2x her original investment), she takes $4 million, which leaves only $1 million for the remaining shareholders
Why is liquidation preference significant for investors in “down rounds”?
In the example used to answer the question above, we see a scenario where liquidation massively affected the financial outcome for parties involved when an exit occurs at a lower valuation than the previous round (a so-called “down round”).
In a down round, liquidation preference allows investors to be entitled to much more value than their ownership stake would otherwise allow if they owned common equity shares.
If two companies sell the same product why would one trade at a 15x multiple and the other 10x multiple?
There are several factors that impact the valuation multiple of a company. Ultimately, the multiple is a proxy (or shorthand) for the discounted cash flow value of the company. This means that higher multiples will correlate with anything that investors view as being likely to improve the probability of future cash flow.
Main factors that could drive this discrepancy include: quality and experience of management team, financial profile (e.g. pricing, expenses, margin structure, capital requirements, etc.), and business model considerations (e.g. length of customer contracts, form of payment, supply chain).
More questions for the road
Unfortunately, I need to wrap up this article, so I can’t go into full depth on these, but I’ll leave you with a couple more technical questions to ponder on your own. Like above, I hear about these with regularity in growth interviews.
- Would you rather have $100 extra profit through revenue growth (say, $200 of revenue growth at 50% margin) or margin expansion ($100 increase in profit)?
- Depends on margins, current profit level, competitive dynamics
- Walk me through Depreciation and how it flows through a 3-statement model
- Describe the net working capital cycle of [XYZ business]
If you’d like to go deeper into these growth equity technical questions and more, check out my step-by-step, in-depth growth equity interview course.