Lee McCabe Warns Against ‘Model Addiction’ in Private Equity Dealmaking

In a recent LinkedIn post, Lee McCabe critically examines the pitfalls of over-reliance on financial models in private equity, a phenomenon he terms ‘model addiction.’ McCabe argues that many deal teams mistake the precision of spreadsheets for genuine business understanding, leading to potentially flawed investment decisions.

The Illusion of Precision

McCabe highlights the common scenario where sophisticated financial models, often with data extending to three decimal places, are built without sufficient grounding in the realities of the business operations they represent. He paints a picture of ubiquitous models within private equity firms, meticulously detailing projections for revenue growth, margin expansion, working capital improvements, synergy capture, and exit multiples. These models, he notes, often come in various ‘cases’—base, downside, and even a ‘fantasy case wearing sensible shoes’—but they frequently fail to account for the unpredictable nature of real businesses.

“The spreadsheet goes to three decimal places. The customer research goes to lunch.”

This stark contrast, according to McCabe, underscores the disconnect between theoretical financial projections and practical business execution. He points out that actual business operations often diverge significantly from model assumptions:

• Sales teams may sandbag projections.
• ERP data can be unreliable or poorly maintained.
• Marketing attribution might be more guesswork than science.
• Management may attribute performance fluctuations to ‘seasonality’ when actual reasons are unknown.
• Obvious pricing opportunities might remain unaddressed for years.

The Reality of Execution

McCabe references findings from S&P, indicating that EBITDA add-backs in 2021 deals represented over 32% of projected EBITDA. This suggests that projected cost savings and synergies, which are crucial for justifying deal valuations, are often doing a substantial amount of ‘heavy lifting’ in the financial narrative. However, the critical question, as Lee McCabe emphasizes, is whether these savings and synergies can actually be delivered.

“Which is fine, provided someone can actually deliver them. That someone is rarely the model.”

He asserts that the responsibility for realizing these projected benefits lies with operational execution, not the model itself. The best investors, in McCabe’s view, do not blindly trust their spreadsheets but actively challenge them.

Interrogating the Model, Not Worshipping It

McCabe advocates for a more rigorous approach to financial modeling, where investors interrogate the underlying assumptions. He poses several key questions that should be asked:

1. Where did the assumption come from?
2. Who owns that assumption?
3. What needs to change operationally to achieve this?
4. What happens if the customer says no?
5. How fast can the company realistically execute without burning out its people?

In essence, McCabe argues that a financial model should serve as a strategic tool—a ‘weapon’ for understanding and driving value. Instead, he observes that many models function merely as ‘comfort blankets with formulas,’ providing a false sense of security rather than actionable insights.

“A model should be a weapon. Most are comfort blankets with formulas.”

Lee McCabe’s analysis serves as a crucial reminder for the private equity industry to balance sophisticated financial analysis with a deep, practical understanding of business operations and the challenges of execution.