Private Special Situations: formula sheet

Key formulas

Distressed investment return logic

Return ≈ (Recovery value ÷ Purchase price) − 1, plus any interim cash flows

Recovery value is uncertain and depends on the restructuring outcome and the claim's rank in the capital structure.

Priority of claims rule

Senior secured → senior unsecured → subordinated → equity

Recovery is usually higher higher up the ranking. Check where the instrument sits before judging a discount.

Strategy classification rule

Distressed = financial stress; Turnaround = operational fix; Event-driven = corporate catalyst

Use the main source of value to classify. A deal can mix more than one.

Priority of claims

Secured → Senior unsecured → Subordinated → Equity

Recovery is paid in this order. Absolute priority is the general rule, though negotiated plans can deviate.

Fulcrum security

Fulcrum = the most senior class not fully covered by the reorganized firm's value

Add claims from the top down until cumulative claims exceed value. The class where this happens is the fulcrum.

Recovery rate for a class

Recovery % = value allocated to class ÷ claim of class

For the fulcrum class, value allocated = remaining value after more senior claims are paid.

Return on a distressed purchase

Return = (recovery value − purchase price) ÷ purchase price

Use per unit of face value. Ignore time value unless the question asks for annualised return.

Enterprise value to equity value

Equity value = Enterprise value − Net debt (debt − cash) − other senior claims

Use after valuing the recovered business. Claims are paid by priority, so junior claims may get little or nothing.

Recovered EV by multiple

Recovered EV = Normalised (post-turnaround) EBITDA × target multiple

Use the EBITDA expected after the plan works, not current depressed EBITDA. Use a multiple from healthy peers.

Expected value with scenarios

Expected value = Σ (probability × value in scenario)

Probabilities must sum to 1. Include a failure scenario with low recovery.

Money multiple

MOIC = Total proceeds ÷ Capital invested

Does not reflect timing, so pair with IRR when the holding period is long.

Recovery by priority (waterfall)

Each class receives min(its claim, value remaining after more senior classes)

Pay secured creditors first, then unsecured, then equity.

Event-driven return logic

Expected return = Σ (probability of outcome × payoff in that outcome)

Use for scenarios such as deal completes, deal delayed or deal fails. Probabilities must sum to 100%.

Annualised return on a short-dated event

Annualised return ≈ (Holding period return) × (365 ÷ days held)

A simple scaling for comparison only. Compounding gives a higher figure, so state which method you use.

Litigation finance payoff

Net gain = (Probability of success × Investor share of award) − Funding provided

Ignore time value in a rough screen. Discount for time if the question gives a rate or duration.

Distributable value (going concern)

Enterprise value = Σ PV of expected free cash flows, or EBITDA × multiple

Use when the business is expected to keep operating after restructuring.

Distributable value (liquidation)

Net liquidation proceeds = Σ (asset value × expected recovery %) − liquidation costs

Apply haircuts to each asset class. Costs and administrative claims are paid before creditors.

Recovery for a class

Recovery % = MIN(100%, value available to class ÷ claim of class)

Work down the priority ladder. Remaining value after each class is passed to the next.

Expected recovery value

E(value) = Σ (probability of scenario × recovery in scenario)

Probabilities must sum to 100%.

Present value of recovery

PV = expected recovery ÷ (1 + r)^t

Use a high required return r and a realistic time t to resolution.

Net return to investor

Net return = gross return − management fee − performance fee

Performance fee usually applies only above any hurdle rate, as set by fund terms.

Quick revision

• Special situations earn returns from a specific event or stress, not from the broad market.
• Distressed investors look at the capital structure first: priority of claims drives recovery.
• Buying senior debt favours safety; buying junior or equity-like claims favours upside and control.
• Loan-to-own style approaches aim to convert debt into ownership during restructuring.
• Turnarounds need both a financial fix and an operating fix to create value.
• Restructuring outcomes depend on negotiation, legal process and timing, so outcomes are uncertain.
• Event-driven ideas depend on the event actually happening, so deal or event failure is a key risk.
• Illiquidity and long, uncertain timelines are central risks in these strategies.
• Valuation should use scenarios and probabilities rather than a single point estimate.
• Always answer with the exact command word and show calculation steps.
• Match every recommendation to the client's objectives and constraints.
• Attempt every question; wrong answers carry no penalty.

Common mistakes

• Treating distressed and special situations as the same thing. Fix: Remember that special situations is the broad category. Distressed is one part, alongside turnaround and event-driven.
• Calling a turnaround a distressed investment just because the firm is losing money. Fix: Ask what creates the value. If it is operational fixes under investor control, it is a turnaround. If it is buying claims at a discount and restructuring them, it is distressed.
• Naming the most junior class that gets something as the fulcrum when value falls exactly at a class boundary. Fix: Use running totals. In most questions the fulcrum is the first class not fully covered. If value exactly equals cumulative claims, the convention is ambiguous: the last class paid in full is where value is exhausted, while the next class is the first not covered. Follow the definition the question gives, and state your reading if it does not.
• Treating passive and active approaches as the same. Fix: Passive means no role in the process. Active means large position, negotiation, creditor committee and often influence on management.
• Valuing the firm on current depressed earnings Fix: Use normalised earnings after the plan, then discount for execution risk and time.
• Applying a financial fix to an operating problem Fix: Diagnose the cause first. If margins are weak, cost and management changes come before refinancing.
• Treating spin-offs and carve-outs as the same thing. Fix: Spin-off: shares distributed to existing shareholders. Carve-out: part of the subsidiary is sold, bringing cash to the parent.
• Saying DIP financing removes credit risk. Fix: Say it lowers risk through seniority but the business can still fail and collateral may be worth less than expected.
• Paying junior classes before senior classes are full. Fix: Apply absolute priority: fill each class completely before moving down. Pro rata applies only within the same class.
• Forgetting to deduct liquidation or administrative costs. Fix: Subtract costs first to get net distributable value.

Exam tips

• Read the vignette for the trigger word: default, restructuring, underperformance, spin-off or merger. It tells you the strategy.
• Under a command word like justify, give the catalyst, the return source and one key risk, then stop.
• When recommending, always tie the answer to the client's liquidity, horizon and risk tolerance.
• Know the difference between control-oriented strategies (turnaround) and claim-based strategies (distressed debt).
• Draw the capital structure with running totals every time. It is quick and earns method credit.
• On a justify question, give the reason tied to the client, not a generic benefit of the strategy.
• Show recovery and return as separate numbers with their own denominators. A correct number alone earns calculation credit.
• Learn one clear line for each approach: passive waits, active negotiates, loan-to-own aims for ownership.