Mergers, acquisitions, and due diligence
Should a company or a private-equity fund buy this target: valuing it with multiples, treating synergies with doubt, and checking fund returns.
Key takeaways
- Use the four questions (market, target, valuation, risk) as your structure.
- PE-style cases, common in firms with large PE practices, often push hard on downside risk and on what happens if a key assumption is wrong, because that is how investors think.
- The strong answer values the deal the way acquirers and funds do and treats synergies with healthy doubt.
What this case type is and when it shows up
A mergers and acquisitions (M&A) case asks whether a company should buy a target. A private-equity (PE) version asks whether an investment fund should buy it. Both come down to four questions: is the market good, is the target good, what is it worth, and what could go wrong.
The underlying theory, in plain language
An acquisition is worth doing only if the buyer ends up better off after paying the price. The test: the target's value on its own, plus the value of synergies, minus the one-time cost of integrating, must be more than the price paid.
Synergy is the extra value from combining: cost synergy (removing duplicated costs, such as two warehouses in one city) and revenue synergy (selling more together). Synergies are routinely overestimated, arrive slowly (often only part in year one), and cost money to achieve, often of a similar size to a full year of the synergies. Revenue synergies are the least reliable. Do not pay the synergies away: if the price already includes all the synergy value, the seller keeps the gain and the buyer carries all the risk.
In interviews, value is usually estimated with a multiple. Enterprise value (EV) is the value of the whole business, to both shareholders and lenders. EBITDA (earnings before interest, tax, depreciation, and amortization) is a rough measure of operating cash profit. An EV/EBITDA multiple of 8 means the business is valued at 8 times its yearly EBITDA. You take the multiple from similar companies or recent deals in the same industry. It is a shortcut for the present value of all future cash flows.
Private-equity funds buy companies, usually with a large share of borrowed money, improve them, and sell them after about four to seven years. Their due diligence covers the market, the target's competitive position, customers (often through interviews), whether the management plan is believable, and a value-creation plan. Returns are measured two ways: MOIC (multiple on invested capital: money back divided by money put in) and IRR (internal rate of return, the yearly return rate). A rule of thumb over five years: 2 times the money is about 15 percent a year, 2.5 times is about 20 percent, and 3 times is about 25 percent.
What the prompts sound like, from simple to hard
- Simple: should a US distributor buy a smaller regional rival.
- Medium: a European private-equity fund weighs buying a packaging maker.
- Hard: a Gulf conglomerate's deal that only works if aggressive synergies are real.
Finding and narrowing the real problem
Key idea
Use the four questions (market, target, valuation, risk) as your structure. Value the target on its own first, add synergies you have phased in and reduced for doubt, and compare the total with the price.
Frameworks for this type, each as a thinking tool with its limit
- Market, target, valuation, risk: Four clean buckets that cover a buy decision. Limit: Each needs real evidence; the structure does not value the deal for you.
- Standalone plus synergies versus price: Value the target alone, add net synergies, and compare with the price to find the walk-away price. Limit: The answer is only as good as the multiple and the synergy estimate.
- PE value-creation bridge: Split the gain in equity value into EBITDA growth, a change in the multiple, and debt paid down. Limit: It shows where returns come from, not whether the plan is believable.
Methods for solving this type
- Assess the market and the target on their own
- Value the target with a multiple from similar deals
- Size synergies, phase them in, subtract integration cost, and test a lower case
- Compare value with the asking price and set a walk-away price
- For PE, check MOIC and IRR against the fund's target and find where the return comes from
The math patterns it relies on
- EV = EBITDA x multiple
- Walk-away price = standalone value + synergy value minus integration cost
- Sensitivity to the synergy assumption
- MOIC = equity at exit / equity invested
- IRR from the five-year rule of thumb (2x is about 15 percent, 2.5x about 20 percent, 3x about 25 percent)
Worked cases
Worked case
Buying a regional rival: what is it worth?
The prompt
A US building-products distributor wants to buy a regional rival. The target earns USD 10 million of EBITDA a year and the seller asks USD 90 million. The chart below shows the multiples paid in five recent sales of similar distributors. The buyer expects cost synergies of USD 3 million a year once fully in place (half in year one), and integration will cost USD 4 million one time. Should it pay USD 90 million?
Interviewer-led: the interviewer shows the chart of recent deals and asks, in order, for the standalone value, the synergy value, the walk-away price, and a recommendation.
Clarifying questions, with the interviewer's answers
- Where do the synergies come from?Answer: Closing overlapping warehouses and combining purchasing.
- Why is the owner selling?Answer: The founder is retiring; the business is stable.
- What multiple should we use?Answer: Recent deals for similar distributors were about 8 times EBITDA.
A hypothesis to say out loud: The asking price is above what similar companies sell for, so my hypothesis is that the deal only works if most of the synergies are real. I will value the target alone, add synergies, and find the most we should pay.
The structure
- Standalone value plus net synergies versus price
- Standalone value from the multiple
- Key: Synergy value, phased, minus integration cost
- Walk-away price and the downside case
The exhibit
Bar chart: EV/EBITDA multiples paid for similar US distributors, last three years. Values in times EBITDA. Deal A: 7.5; Deal B: 8; Deal C: 8.5; Deal D: 7.8; Deal E: 8.2.
Working it through
1. The asking multiple
USD 90 million for USD 10 million of EBITDA.
Asking EV/EBITDA:90 ÷ 10 = 92. Read the exhibit
The five recent deals average 8 times EBITDA, and the highest is 8.5 times. The asking price is above all of them.
Average multiple of recent deals:(7.5 + 8 + 8.5 + 7.8 + 8.2) ÷ 5 = 83. Standalone value
At the 8 times paid for similar companies.
Standalone value (USD m):10 × 8 = 804. Synergy value
Value the full USD 3 million a year of synergies at the same multiple, a shortcut for their present value.
Synergy value (USD m):3 × 8 = 245. Phasing
Only half arrives in year one, so year-one profit gets a smaller lift than the run-rate figure suggests.
Year-one synergies (USD m):3 × 0.5 = 1.56. Net of phasing and integration cost
Subtract the USD 1.5 million of synergies missed in year one and the USD 4 million one-time integration cost.
Net synergy value (USD m):24 - 1.5 - 4 = 18.57. Walk-away price
The most the buyer should ever pay, which would hand all synergy value to the seller.
Walk-away price (USD m):80 + 24 - 1.5 - 4 = 98.58. Downside: only half the synergies
If synergies reach USD 1.5 million a year instead of 3 (with half of that missed in year one), the combined value falls below the asking price.
Value with half the synergies (USD m):80 + (1.5 × 8 - 0.75 - 4) = 87.25
What the exhibit shows
Similar companies sold for about 8 times EBITDA on average, and none for more than 8.5 times, so an asking price of 9 times is above every recent deal.
The recommendation
Do not pay USD 90 million; offer about USD 85 million and proceed only with a detailed, costed plan for the warehouse closures. First, the target is worth about USD 80 million on its own, and USD 90 million means paying 9 times EBITDA, above every recent deal in the chart, which average 8 times. Second, with about USD 18.5 million of synergy value after year-one phasing and integration cost, the most we should ever pay is about USD 98.5 million, and at USD 90 million we would give the seller more than half the net synergy value. Third, if only half the synergies arrive, the deal is worth about USD 87 million, less than the price.
Risks: Synergies may arrive late or smaller than planned; Integration may cost more than USD 4 million; Key customers of the target may leave after the deal.
Next steps: Build a site-by-site warehouse closure plan; Interview the target's top ten customers.
A strong candidate
Valued the target alone with a market multiple, phased synergies, subtracted integration cost, set a walk-away price, and tested the downside.
A weak candidate
Added synergies at face value, computed a payback, and called the deal good without comparing the price with similar deals.
Worked case
A private-equity return check
The prompt
A European private-equity fund can buy a packaging maker for EUR 100 million, which is 10 times its EBITDA of EUR 10 million. It would pay with EUR 60 million of debt and EUR 40 million of the fund's own money (equity). The plan: grow EBITDA to EUR 14 million in five years, pay debt down to EUR 40 million, and sell at the same 10 times multiple. The fund targets about 20 percent a year. Does the plan meet it, and what should due diligence focus on?
Candidate-led: you choose what to calculate and where due diligence should look; the interviewer challenges your conclusions.
Clarifying questions, with the interviewer's answers
- Is the exit multiple the same as the entry multiple?Answer: Yes, assume 10 times, with no gain from a higher multiple.
- How does the plan grow EBITDA?Answer: Price increases and a new plant in Poland.
A hypothesis to say out loud: The return will come from growing EBITDA and paying down debt. My hypothesis is that the plan reaches about 2.5 times the money, roughly the 20 percent target, so the real question is whether the EBITDA growth is believable.
The structure
- Equity in, equity out, and where the gain comes from
- Exit value and equity at exit
- MOIC and IRR versus the target
- Key: Value-creation bridge: EBITDA growth and debt paydown
Working it through
1. Exit value
Candidate: "I will work from equity in to equity out. At exit, EUR 14 million of EBITDA at 10 times is:"
Exit EV (EUR m):14 × 10 = 1402. Equity at exit
Exit value minus the remaining debt.
Equity at exit (EUR m):140 - 40 = 1003. MOIC
Money back divided by money put in.
MOIC:100 ÷ 40 = 2.54. IRR check
Candidate: "Growing 20 percent a year for five years multiplies money by about 2.5, so the IRR is about 20 percent, right at the target." Interviewer: "So you would buy it?" Candidate: "Not yet. It meets the target only if the plan holds, so I want to see where the gain comes from."
1.2 to the power of 5:1.2 × 1.2 × 1.2 × 1.2 × 1.2 = 2.495. Where the gain comes from
Equity grows from EUR 40 million to EUR 100 million. EUR 40 million comes from the higher EV (EBITDA growth at the same multiple) and EUR 20 million from debt paid down.
Equity gain (EUR m):(140 - 100) + (60 - 40) = 606. Downside: EBITDA reaches only EUR 12 million
Candidate: "How confident is management in the Poland plant?" Interviewer: "It is not yet approved. Without it, EBITDA may reach only EUR 12 million." Exit value falls to EUR 120 million and equity to EUR 80 million.
MOIC in the downside:(12 × 10 - 40) ÷ 40 = 27. Downside IRR
2 times in five years is about 15 percent a year, well below target.
1.15 to the power of 5:1.15 × 1.15 × 1.15 × 1.15 × 1.15 = 2.01
The recommendation
The plan meets the fund's target but with no room for error, so due diligence should focus on the EBITDA plan. First, it returns about 2.5 times the fund's money, roughly 20 percent a year, which is exactly the target. Second, EUR 40 million of the EUR 60 million gain comes from EBITDA growth and EUR 20 million from paying down debt, so the growth plan carries most of the return. Third, if EBITDA reaches only EUR 12 million, the return falls to about 2 times, or about 15 percent a year. Interview customers about the price increases and test the cost and timing of the Poland plant; proceed only if the plan holds up, or negotiate a lower entry price.
Risks: Customers may resist price increases; The new plant may be late or over budget; Exit multiples may be lower in five years.
Next steps: Run 15 to 20 customer interviews on price; Get an independent estimate of the plant cost and timeline.
A strong candidate
Computed MOIC and IRR, split the gain into EBITDA growth and debt paydown, and pointed due diligence at the assumption that drives the return.
A weak candidate
Said the deal "looks good" because EBITDA grows, without calculating the return or testing a downside.
Prompt: "Should we buy this company?"
Weaker answer
Accepts the projected synergies as given, computes a payback, and concludes the deal is attractive without comparing the price with similar deals.
Stronger answer
Uses market, target, valuation, risk; values the target at a market multiple; phases synergies and subtracts integration cost; sets a walk-away price; and shows the deal fails if synergies halve.
Why the stronger answer wins: The strong answer values the deal the way acquirers and funds do and treats synergies with healthy doubt. The weak one trusts the most fragile number in the deal.
Common mistakes, traps, and curveballs
- Believing synergy numbers without doubt
- Assuming full synergies from the first day
- Forgetting one-time integration cost
- Paying the full synergy value to the seller
- Judging a deal on payback alone, with no comparison to what similar companies sell for
- Forgetting why the seller is selling
PE-style cases, common in firms with large PE practices, often push hard on downside risk and on what happens if a key assumption is wrong, because that is how investors think. Formats differ by office and change over time, so check the current process for your target office.
Practice
A company in the UAE has EBITDA of AED 25 million. Similar companies sell for 7 times EBITDA. What is its enterprise value, in AED millions?
A fund invests EUR 50 million and gets EUR 150 million back after five years. What is the MOIC?
A Saudi food group expects SAR 40 million a year of synergies from a merger once fully in place: 25 percent of that in year one, 75 percent in year two, and all of it in year three. What is the total synergy over the first three years, in SAR millions?
The seller's price already includes the full value of the synergies. What does that mean for the buyer?
Which type of synergy deserves the most doubt?
Most of a private-equity fund's planned return comes from selling at a higher multiple than it paid. What should due diligence ask?
Value the target on its own with a market multiple, add only the synergies you believe after phasing and integration cost, and never pay all of them to the seller.
Sources for this lesson (1)
- Recognized public explanations of case-interview concepts and frameworks
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