Professional Documents
Culture Documents
Investment Banking
M&A Origination, Execution, Financial Modeling
& Valuation
Contents
PERPETUITY SCIENCE:
Part I: Perpetuity Methodology
Chapter 1: Perpetuity Methodology
FOUNDATIONS OF FINANCE:
Part V: Tracking Value (Accounting)
Chapter 5: Tracking Value with Accounts
BUILD-SIDE:
Part VIII: Perpetuity Analysis
Chapter 9: Perpetuity Science
Chapter 10: Perpetuity Analysis
Chapter 11: Market Analysis
Chapter 12: Value Chain Analysis
Chapter 13: Gap Analysis
Chapter 14: Product/Platform Analysis
SELL-SIDE:
Part XI: Perpetuity Exit
Chapter 22: Investment Banking
Chapter 23: How to Become an Investment Banker Methodology
BUY-SIDE:
Part XX: Buying a Perpetuity
Chapter 42: The Principle of Investing
Chapter 43: How to Become the Next Warren Buffett
Chapter 44: The Operating Model
Chapter 45: The Financial Buyer aka Private Equity (LBO)
Chapter 46: The Strategic Buyer aka Corporation (Merger)
Preface
There are many investment banking texts out there that claim that financial
modeling and valuation is the core work of the investment banker. This is
simply not the truth. The core work of the investment banker is origination,
mandate/target matching, and deal structuring. It should follow that a
text/course on investment banking should be based upon the same. It is the
good fortune that the reader has encountered such a book/course. Investment
Banking: M&A Origination, Execution, Financial Modeling & Valuation explains
origination, mandate/target matching, and deal structuring (i.e. how
investment bankers make their money).
First, you are going to want to clarify whether you would like to work on the
sell side for a few years or pursue a career in investment banking. The skills
that you will need to get started in investment banking are different than those
that you will need to have a long and successful career in investment banking.
The role in investment banking transforms from one that is research, financial
modeling & valuation based into one focused on origination and facilitating
the M&A process. M&A (Mergers & Acquisitions) is the core product of
investment banking, and the other products, advisory & capital-raising, simply
support this. We founded Investment Banking University
(www.InvestmentBankingU.com) to answer that very question and prepare
students for both bulge bracket and middle market investment banking career
opportunities. The following is a short free workshop presentation that we give
to our prospective students that will help to answer your question.
As you can see, it helps to understand the bigger picture (perpetuity science)
when trying to comprehend what will make for a successful career in
investment banking and the investment bankers role.
M&A is the core product for any investment bank and is thus the focus of this
text. We however, will begin with an overview of the foundations of finance.
Finally, the idea that you need to spend three years of your life as an analyst
doing 80+ hour workweeks building financial models to become an investment
banker is a faulty paradigm. The real value add of an investment banker is not
financial modeling & valuation, but rather origination, mandate/target
matching, and deal structuring. You dont need Goldman Sachs permission to
be an investment banker just like you dont need McKinseys permission to be
a consultant.
The following is the How to Become an Investment Banker Methodology:
1.
Coverage
a)
Index building
b)
Vertical report
c)
Vertical newsletter
2.
3.
Mandate/target matching
4.
Deal structuring
5.
6.
7.
Valuation
8.
Offer analysis
9.
Large cap
2.
Mid cap
3.
Small cap
4.
Middle market
5.
Pick an initial vertical and sub-vertical to cover. With AltQuest Group, our initial
coverage groups were the following:
1.
Manufacturing
2.
Software
3.
Business Services
4.
Healthcare
After choosing your coverage, the investment banker is then to build an index
for each of the verticals and sub-verticals made up with the public comps. The
AltQuest Group coverage is broken down in the following manner:
1.
2.
3.
Manufacturing
a.
Durable consumer
b.
Non-durable consumer
c.
d.
Building products
e.
Industrial
f.
Medical
Software
a.
Traditional software
b.
SAAS
c.
Internet
Business Services
a.
b.
c.
d.
Human Resources
e.
Information Services
10
4.
f.
Marketing Services
g.
h.
IT Services
i.
Specialty Consulting
Healthcare
a.
Dental Product
b.
Dental Providers
c.
d.
e.
Specialty Providers
f.
Pharma Services
g.
Practice Management
h.
Provider Services
i.
Manufacturing
a.
viii.
xii.
xiii.
11
viii.
viii.
xii.
xiii.
12
viii.
viii.
xii.
xiii.
viii.
13
Software
a.
b.
TWOU NasdaqGS
AMBR NYSE
iii. Athenahealth
ATHN NasdaqGS
iv. Bazaarvoice
BV NasdaqGS
v. Benefitfocus
BNFT NasdaqGS
Castlight Health
CSLT NYSE
viii.
ChannelAdvisors
ECOM NYSE
COVS NasdaqGS
xi.
Ebix
EBIX NasdaqGS
xii.
FireEye
FEYE NasdaqGS
xiii.
Fleetmatics
xiv. HortonWorks
CSOD NasdaqGS
FLTX NYSE
HDP NasdaqGS
IntraLinks Holdings
xviii.
xix.
Jive Software
IL NYSE
JIVE Nasdaq
LPSN NasdaqGS
xxi.
Marin Software
MRIN NYSE
xxii.
MDSO Nasdaq
xxvii.
Q2 Holdings
xxviii.
Qualys
QTWO NYSE
QLYS NasdaqGS
14
xxix.
RealPage RP Nasdaq
xxx. RingCentral
RNG NYSE
xxxi.
Salesforce.com
CRM NYSE
xxxii.
SPSC NasdaqGS
TNGO NasdaqGS
TrueCar
xxxviii.
Upland Software
UPLD NasdaqGM
Veeva Systems
VEEV NYSE
xxxix.
c.
ULTI NasdaqGS
TRUE NasdaqGS
1-800-FLOWERS.com
ii.
iii.
8x8
iv.
Akamai Technologies
FLWS NasdaqGS
EGHT NasdaqGS
AKAM NasdaqGS
v.
vi.
Amazon.com
AMZN NasdaqGS
vii.
Angie's List
ANGI NasdaqGS
viii.
Baidu.com
BIDU NasdaqGS
ix.
Bankrate
RATE NYSE
x.
Bitauto Holdings
xi.
BlueNileNILE NasdaqGS
BITA NYSE
xii.
Brightcove
BCOV NasdaqGS
xiii.
BroadSoft
BSFT NasdaqGS
xiv.
Carbonite
CARB NasdaqGS
CRCM NYSE
xv.
Care.com
xvi.
xvii.
xviii.
Cimpress
CMPR NasdaqGS
xix.
Coupons.com
QUOT NYSE
xx.
Criteo SA
CRTO NasdaqGS
xxi.
Ctrip
CTRP NasdaqGS
15
xxii.
xxiii.
eBay
xxiv.
xxv.
xxvi.
xxvii.
FB NasdaqGS
xxviii.
GoDaddy
GDDY NYSE
EBAY NasdaqGS
xxix.
xxx.
Groupon
GRPN NasdaqGS
xxxi.
GrubHub
GRUB NYSE
xxxii.
Harmonic
HLIT NasdaqGS
xxxiii.
Interactive Intelligence
xxxiv.
LendingClub
xxxv.
xxxvi.
Limelight Networks
xxxvii.
xxxviii.
Liquidity Services
xxxix.
ININ NasdaqGS
LC NYSE
LLNW NasdaqGS
LNKD NYSE
LQDT NasdaqGS
Mail.ru Group
61HE.L LSE
xl.
MakeMyTrip
MMYT NasdaqGS
xli.
MaxPoint Interactive
xlii.
Mercadolibre
MXPT NasdaqGM
xliii.
xliv.
Monster Worldwide
MELI NasdaqGS
MWW NYSE
xlv.
xlvi.
xlvii.
xlviii.
xlix.
PandoraP NYSE
l.
li.
Priceline
PCLN NasdaqGS
QNST NasdaqGS
lii.
QuinStreet
liii.
liv.
Rocket Fuel
FUEL NasdaqGS
16
3.
lv.
lvi.
ShoreTel
SHOR NasdaqGS
lvii.
Shutterfly
SFLY NasdaqGS
lviii.
Shutterstock
SSTK NYSE
lix.
SINA
SINA NasdaqGS
lx.
Sohu.com
lxi.
SOHU
lxii.
Stamps.com
lxiii.
lxiv.
Tencent Holdings
NNN1.F
lxv.
RUBI NYSE
lxvi.
TheStreet.com
TST NasdaqGM
lxvii.
Travelzoo
TZOO NasdaqGS
lxviii.
Lending Tree
TREE NasdaqGS
STMP NasdaqGS
lxix.
lxx.
TripAdvisor
TRIP NasdaqGS
TUBE NasdaqGS
lxxi.
TubeMogul
lxxii.
lxxiii.
lxxiv.
VeriSignVRSN NasdaqGS
lxxv.
lxxvi.
Wix.com
WIX NasdaqGS
lxxvii.
XO Group
XOXO NYSE
lxxviii.
Xunlei
XNET NasdaqGS
lxxix.
lxxx.
lxxxi.
Yelp
YELP NYSE
lxxxii.
YuMe
YUME NYSE
lxxxiii.
YY
YY NasdaqGS
lxxxiv.
Zillow
Z NasdaqGS
Business Services
a.
17
viii.
c.
vii.
viii.
viii.
xii.
xiii.
18
xviii.
xix.
d.
viii.
e.
xi.
xii.
xiii.
viii.
xii.
19
xiii.
g.
vii.
Ipsos SA ENXTPA:IPS
viii.
viii.
20
viii.
xii.
xiii.
viii.
Healthcare
a.
viii.
c.
21
viii.
xii.
xiii.
viii.
22
viii.
g.
h.
i.
The investment banker then spreads each public comp and the financial data
feeds into the median and average for the vertical and sub-vertical which
ultimately ends up in the research (industry report, newsletter), pitchbooks,
and CIMs of the investment bank. For investment banks with an equity
23
research department, financial statement models will be built for each public
comp that is being covered and consensus EPS data taken from research
reports will be used to establish the value of the public comp.
The investment banker ultimately uses the vertical index and sub-vertical index
to perform proprietary research and develop industry reports and newsletters
which will aid in coverage and ultimately origination. The research, which we
will go into greater detail on later in the book focuses on vertical and subvertical trends in margins, multiples, and M&A.
Regarding the vertical index and sub-vertical index, the investment
banker ultimately tracks trends in:
Growth rates
Margins
Multiples
The investment banker takes the index and establishes tiers which turn
into peer groups. This is why we pull comps, to build an index and
benchmark against the comps.
The indexing and benchmarking that is done for a target company is
going to serve as the basis for advising on strategic alternatives.
For those just getting started in investment banking, it is preferable to start
with the lower middle market and middle market building relationships with
financial and strategic buyers as well as potential targets. This means building
your rolodex. Obtain the investment mandates from the strategic and financial
buyers and establish a fee arrangement for buy-side deals. This will end up
being the Lehman scale for the fee on the buy-side. This is how I built the
boutique investment bank, AltQuest Group (www.AltQuest.com).
24
For example, with AltQuest Group, I chose to cover manufacturing. If you are
starting in the lower middle market, the goal is to get 10 sell side engagements
at any given time. It took me one year to get 10 sell side engagements working
40 hours per week and not on weekends. Further, it is going to take you 6
months to one year to close a deal so stay proactive with origination and
mandate/target matching. It took me one year from the time that I won the
mandate to close on my first deal. The M&A fee was $50,000. It took me
another 2 months to close on my next deal. Deals continue to close every 2 to
4 months from then on out.
To give you an idea of the level of productivity that you should target, the
following are the investment banking statistics from year one with AltQuest
Group:
3,000 introduction emails
30 sell side pitches (phone and in person)
10 sell side engagements won
4 IOIs from strategic/financial buyers
2 closed M&A deals
$110,000 in M&A fees received
As you get better and establish a process, your email conversion rates will go
up and you will be pitching more and your ability to win sell side engagements
will go up. I am at the point now that if a seller is interested in selling, I will
either win the sell side mandate or I will structure it as a buy side deal and
receive the fee from the strategic/financial buyer.
Looking forward to year two, here are the projections:
1,000 introduction emails
50 sell side pitches (phone and in person)
20 (+18 existing = 38 total engagements) sell side engagements won
8 IOIs from strategic/financial buyers
25
26
Perpetuity Science
In order to become an investment banker, one must first understand the
nature of the perpetuity. To understand the nature of the perpetuity, we
refer to the field of science related to the perpetuity, namely perpetuity
science. Perpetuity science is the body of knowledge, methodologies,
and optimization models related to the building, selling, and buying of
perpetuities.
27
Part I:
Perpetuity Methodology
This text and Investment Banking University are concerned primarily with
how to become an actual investment banker. Investment Banking
University has created a methodology for doing so. This is the Perpetuity
Methodology:
28
Chapter 1:
Perpetuity Methodology
This text and Investment Banking University are concerned primarily with
how to become an actual investment banker. Investment Banking
University has created a methodology for doing so. This is the Perpetuity
Methodology:
29
30
31
Part II:
Standard of Living
The reason why finance exists is to improve our standard of living. Finance is a
set of concepts, methodologies, and optimization models applied to value
creation.
32
Chapter 2:
Standard of Living: Perpetuities &
Investment
The Goal
To increase standard of living without sacrificing quality of life.
How to Get the Goal
In order to increase standard of living without sacrificing quality of life, one is
to build or buy perpetuities.
Perpetuity
Perpetuities increase standard of living without sacrificing quality of life by
possessing recurring revenue and automated work processes to achieve the
revenue.
Building Perpetuities
The building of perpetuities is known as being on the build-side; commonly
referred to as entrepreneurship.
Buying Perpetuities
The buying of perpetuities is known as investment or being on the buy-side.
Selling Perpetuities
33
34
Part III:
Perpetuities
The main avenue to improve ones standard of living is to build or buy a
perpetuity. Perpetuities generate value on a continual basis for both the owner
and the consumer of the product/service.
35
Chapter 3:
Perpetuities: Build or Buy
The Goal
The goal is to build/buy at least one perpetuity in order to maximize standard
of living while not sacrificing quality of life.
Demand for Perpetuities
There is always demand for perpetuities and especially by institutional
investors which means that the market for corporate control more closely
mirrors the DCF (intrinsic value) of the perpetuity (corporation). Institutional
investors can pay higher multiples in order to realize returns over longer
periods of time.
Types of Perpetuities
Perpetuities can be created from companies that possess some aspect of
recurring revenue and automated work processes associated with product
creation.
At a high level, types of perpetuities include:
I.
II.
III.
Commodity
a.
Durables
b.
Non-durables
Platform
a.
Digital
b.
Physical
Content
a.
Educational
36
b.
IV.
V.
Entertainment
Service
a.
Analysis
b.
Allocation
c.
Engineering
d.
Logistics
e.
Management
f.
Advocacy
g.
Relationship
Infrastructure
a.
Private
i. Real estate
b.
Public
37
38
39
40
Return:
41
Growth:
42
43
Multiples:
44
Part IV:
The Science of the
Perpetuity
In order to build perpetuities, one should follow a methodology and
understand the process associated with its creation. We start out with the
basic formula for a perpetuity and then build up to sources and uses for a
specific perpetuity.
45
Chapter 4:
Business: The Science of the
Perpetuity
Introduction to Business
Business is the science of the perpetuity (buy vs. build)
Perpetuity value = PMT / Discount rate
As you can see we can increase value by increasing PMT (increasing revenues,
decreasing COGS, SG&A) or decreasing the discount rate.
Business as Science
To maximize returns, one either invests in building perpetuities in the form of
positive NPV (net present value) projects or one invests in the market portfolio
when there are no positive NPV projects. If an opportunity is not positive NPV,
one does not invest time, energy or resources into the opportunity.
Business Methodology
When referring to business, we are referring to the science of the perpetuity
and we can break this down further into a methodology:
I.
II.
46
III.
2.
47
FOUNDATIONS OF
FINANCE
In order to understand the role and work of the investment banker, we need to
first have a strong understanding of the foundations of finance. This helps us
to understand why it is that the investment banking industry exists and where
investment bankers fit into the bigger picture.
Finance is the science of the perpetuity is broken down into the following
methodology:
IV.
V.
VI.
48
Part V:
Tracking Value
(Accounting)
As a perpetuity is built, it becomes necessary to track the financial existence of
the perpetuity through time. Accounting is the set of concepts, methodologies,
and models that allows us to do exactly that.
49
Chapter 5:
Tracking Value with Accounts
Value
The formula for value is:
Perpetuity value = PMT / Discount rate
Accounts and Accounting
In order to track valuation performance of the perpetuity (i..e business),
companies create accounts for each item of its financial existence. These
accounts are the basis of valuation. Valuation is the basis of actions taken in a
capitalist economy.
Accounts, Accounting & Excel
Excel is the software used to model the accounts of the enterprise and
determine the valuation of the perpetuity (i.e. business).
Account Filings & Public Data
10-K annual
10-Q quarterly
Account Statements: P&L
Income statement (P&L):
Revenues
COGS
Gross Profit
Operating Expenses
50
EBIT
Interest Cost
EBT
Taxes
Earnings
Account Statements: Balance Sheet
Assets = Liabilities + Shareholders Equity
Total Assets = Total Liabilities + Shareholders Equity
Current Assets + Long Term Assets = Current Liabilities + Long Term Liabilities
+ Value of Shares Previously Issued + Retained Earnings Treasury Stock
Account Statements: Statement of Cash Flows
CF from Operating
CF from Investing
CF from Financing
Statement of Cash Flows is the linkage between the income statement and the
balance sheet.
Get D&A from SCF (CF from Operations) and CAPEX from SCF (CF from
Investing)
51
Part VI:
Analyzing Value with
Models (Finance)
As the economic existence of the perpetuity continues to grow, one becomes
interested in the value of the perpetuity. Enter finance, whose concepts,
methodologies, and models allow us to understand the valuation of the
perpetuity.
52
Chapter 6:
Analyzing Value with Models
Analyzing Value
Strategics, financials, and entrepreneurs undertake investment with the
expectation of NPV & IRR. They accept projects that have positive NPV and IRR
higher than the cost of capital. They actively find and structure positive NPV
projects and then match financial products to them.
The positive NPV project is ideally a perpetuity with the value of the business
being the perpetuity value:
Perpetuity value = PMT / Discount rate
Calculating NPV & IRR is the main analytical work of finance.
*Growth statistic CAGR (Compound Annual Growth Rate) is yearly IRR
From Accounts to Models
To go from accounts (accounting) to a finance number we use models. We
only use Free Cash Flow to determine valuation for major transactions in a
capitalist economy including restructuring, growth, M&A, and capital raising.
To go from account filings to models, we need to clean the numbers, scrub
the financials, normalize the financials. This amounts to recasting accounts
53
54
Part VII:
Modeling Value
Continuing deeper into the field of finance we now discuss the actual work
associated with understanding the value of a perpetuity. The work is done by
modeling the perpetuity in Excel.
55
Chapter 7:
Finance with Excel
))
56
57
The plug is the balance sheet item that guarantees the equality of the future
projected total assets and future projected total liabilities and equity. Every
financial model has a plug and the plug is almost always cash, debt, or stock.
Financial Model and Valuation Process:
Assumptions (value drivers)
Existing accounting statements (IS and BS)
Projected financial statements
Free cash flow calculation (FCFs)
Terminal value calculation
Valuation calculation
Sensitivity table for major value drivers to see range of valuation
Once the financial model is complete (i.e. accounting statements have been
projected), we can use the model to:
Value the firm by projecting free cash flows (FCFs)
Determine ability of firm to pay its debts (i.e. credit analysis)
Using a Financial Model for Decision Making: The Financing Decision
All companies must decide how to finance their activities
Proportion of debt and equity
The discount rate should be appropriate to the riskiness (i.e. variability or beta)
of the cash flows being discounted.
Discount rate is also called interest rate, cost of capital, opportunity cost.
Compute annualized IRR
58
The cost of capital of an investment is related to the risk of the cash flows of
the investment. The relationship of individual asset returns to the risk is called
the security market line (SML). You can use SML to get the discount rate for
individual investments. The SML is used for private companies.
The cost of capital of an organization is related to the risk of the combined
riskiness of the investments in the portfolio. The relationship of portfolio
returns to the risk is called the capital asset pricing model (CAPM). You use
CAPM to get the discount rate (i.e. cost of capital). When the investment is a
public security, you use CAPM since the buyer of the security will have a
portfolio to diversify away risk.
Portfolio risk is associated with statistics.
Wealth Maximizing Decisions
Investment decision What is it worth? NPV of strategic alternative
Financing decision What does it cost? IRR of financing alternative
Cash is King
Wealth maximization has to do with maximizing cash. Cash in the context or
organizations is known as cash flow.
Return is a word for cash flows
Cash Flow Definition (FCF)
Profit after taxes
+ Depreciation (noncash expense)
+ Change in net working capital (- increase in current assets and + increase in
current liabilities)
Capital expenditures (CAPEX)
+ After-tax interest payments
= Free Cash Flow (FCF)
59
60
Cost of Capital
Calculate IRR of financing alternatives to determine cost of capital
Need to get IRR in annual terms to facilitate comparison. May have to start
with monthly IRR then annualize
Annualized IRR = (1 + Monthly IRR)^n-1
61
62
63
Sources
WACC
CAPM to get cost of equity
64
65
66
The security market line says that the expected return of an asset is a function
of the assets beta (i.e. sensitivity to the market).
Only relevant risk is systematic risk since the investors will all be diversified
Security Market Line & Investment Performance
The security market line says that the expected return of an asset is a function
of the assets beta (i.e. sensitivity to the market).
Only relevant risk is systematic risk since the investors will all be diversified
VIII. Security Market Line & Investment Performance Continued
Investment performance:
Risk adjusted performance; excess returns?
67
Use CAPM to get the discount rate of equity and compare to cost of financing
alternatives
Is there risk adjusted overperformance or underperformance?
Is performance commensurate with risk?
Excess Return
Excess return is the investments spread over the one year treasury (i.e. risk
free rate)
Use regression equation to determine if underperformance (negative alpha) or
overperformance (positive alpha)
When regressing assets returns against the market portfolio, alpha measures
excess returns over the market portfolio
Beta & R^2
High beta is an aggressive stock
Low beta is a defensive stock
R^2 is percentage of variability that is market related risk when returns are
regressed on the market portfolio
Diversification increases R^2 of the portfolio and decreases nonsystematic risk
Alpha and Efficient Markets
In efficient markets, there is no alpha and investments earn their risk-adjusted
return
CAPM and the Cost of Capital
68
69
Chapter 8:
Financial Statement Modeling
Financial statement modeling refers to the creation of a standalone operating
model for a company. The operating model is built using historical
performance (i.e. historical financial statements). We use the operating model
to see pro forma performance of a company given certain assumptions. These
pro formas are the basis for decision making within the corporation.
Financial statement modeling best practices:
Blue is hard codes, black is formulas
Be consistent with millions and billions (keep conventions the same)
Footnote everything in presentation
Keep your model simple (1,000 cells is better than 10,000 cells)
Financial Modeling Steps:
1.
b.
c.
2.
3.
Best case
b.
Base case
c.
Worst case
d.
Disruption case
70
4.
5.
b.
LIBOR is the base that banks use to price spread their loans to
make money (called L)
c.
6.
Project IS and BS & two items on SCF (D&A and CAPEX (before gross PPE
on BS))
a.
7.
Separate debt and interest schedule (calculate debt and interest schedule
before calculating BS items for revolver, term loan, and unsecured debt)
8.
9.
b.
c.
71
BUILD-SIDE
Related to the intentional creation of perpetuities following a methodology, we
have what is known as the build-side. The build-side is associated with the
creation and management of perpetuities. Participants on the buy-side include
startups, growing businesses, and established corporations.
72
Part VIII:
Perpetuity Analysis
On the build-side, we are ultimately concerned with the creation and
management of perpetuities. We first explore the perpetuity analysis,
perpetuity building process/timeline (including sources and uses) and then
move towards a methodology for perpetuity management.
73
Chapter 9:
Perpetuity Science
The AltQuest Group (www.AltQuest.com) proprietary methodology is
known as Perpetuity Science, Science of the Perpetuity, or the Build
Side. Perpetuity science explains how perpetuities can be built,
managed and exited from to create wealth. As such, it inherently has an
owner focus rather than simply a capital markets focus which is
manifested by the dual goals of decreasing the owners active
involvement in the day to day of the business and the maximizing of
valuation.
Perpetuity science is where entrepreneurship, strategy & finance come
together. It a field of study complete with a body of knowledge,
methodologies, and optimization models towards improving the
individual's quality of life by the building of a perpetuity that
accomplishes two dual goals:
1. ever decreasing involvement of the perpetuity owner in the
perpetuity
2. ever increasing valuation of the perpetuity
Perpetuity science is ultimately about maximizing quality of life rather
than wealth by building perpetuities with recurring revenue streams
that are not reliant on the daily participation of the owner of the
perpetuity. We can take a look in a visual format of what we are trying
to accomplish:
74
Technology
2.
Media
3.
Education
75
4.
Business Services
Perpetuity Analysis
II.
Perpetuity Building
III.
Perpetuity Management
IV.
Perpetuity Exit
76
Chapter 10:
Market Analysis
GDP
Industry Spend
77
78
Chapter 11:
Value Chain Analysis
General
Industry
Sub-sector
Sub-sector by product
79
Chapter 12:
Gap Analysis
General
Industry
Sub-sector
Sub-sector by product
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Chapter 13:
Product/Platform Analysis
Base
Mods
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Part IX:
Perpetuity Building &
Management
On the build-side, we are ultimately concerned with the creation and
management of perpetuities. We first explore the perpetuity analysis,
perpetuity building process/timeline (including sources and uses) and then
move towards a methodology for perpetuity management.
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Chapter 14:
Perpetuity Building
To begin our study of the perpetuity, we can observe the formula for the
perpetuity:
Perpetuity Value = CF / r
To understand the drivers of value for the perpetuity which include:
Multiple EBITDA (size, % recurring, growth rate) which is represented by CF in
the formula
EBITDA multiple (peer group, level of disruption)
Discount rate (% recurring, diversification) which is represented by r in the
formula
As the perpetuity changes, the formula for valuing the perpetuity changes as
well. There are five phases of perpetuity building. As we move through the
phases, the role of the owner of the perpetuity becomes more passive and the
valuation becomes larger due to size of EBITDA increasing, EBITDA multiple
increasing, and the discount rate decreasing. The perpetuity becomes less
dependent on the owner to exist and run as an organizational structure is
formed coinciding with the division of labor, processes are automated, and
revenue becomes recurring.
Perpetuity Building Process
I. Syndication
A. Perpetuity Concept
B. Perpetuity architecture
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C. Perpetuity engineering
1. In house
2. Outsource
3. White label customization
D. Perpetuity marketing
E. Perpetuity Monetization
F. Value Tracking
G. Value Analysis
II. Job shop
A. Diversification of labor
B. Diversification of clients/users
C. Operations automation
D. Marketing automation
III. Perpetuity
IV. Growing perpetuity
V. Diversified
Phases of Building the Perpetuity:
I.
Syndication
II.
Job Shop
III.
Perpetuity
IV.
Growing Perpetuity
V.
Diversified
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The key here is taking a syndication that has demonstrated product/market fit
and turning it into a job shop with multiple projects as represented by PMT1,
PMT2, PMT3. This demonstrates product market fit between the minimum
viable product/platform and allows the owner to invest additional
time/energy/resources into turning the syndication into a perpetuity. The
syndications value to the owner will be related to the NPV/DCF value,
however, since there is an inefficient market for syndications, the value is going
to be discounted at a high rate, in the 80% to 100% range. This means an
implied beta of 12.2. There is no multiple here since the syndication does not
have a long enough history of operations. The syndication is entirely reliant on
the owners active involvement. If the owner no longer works in the
syndication, the syndication will cease to operate.
The owners primary responsibility is to first turn the company into a project or
job shop (PMT representing a given job). The company is looked at solely as
the sum of the value of its projects/jobs meaning that the valuation of the
company is backward looking. The formula looks like the following:
Project/job shop = PMT1 + PMT2 + PMTi.
EBITDA (size, % recurring, growth rate) Drivers:
Addressable market monetization
product completion
content completion
service completion
platform completion
marketing completion
EBITDA multiple (peer group, level of disruption) Drivers:
Capabilities
Markets
Discount rate (% recurring, diversification) Drivers:
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however, since there is an inefficient market for syndications, the value is going
to be discounted at a high rate, in the 80% to 100% range. This means an
implied beta of 12.2. There is no multiple here since the syndication does not
have a long enough history of operations. The syndication is entirely reliant on
the owners active involvement. If the owner no longer works in the
syndication, the syndication will cease to operate.
Next the owner is to turn the perpetuity into a growing perpetuity. This can be
accomplished by increased levels of paid/unpaid marketing and scalable
technology platform as part of the core business. The valuation of the
company now has to incorporate a growth factor as seem in the formula
below:
Value of growing perpetuity = D1 / Discount rate g
EBITDA (size, % recurring, growth rate) Drivers:
Addressable market penetration
Product differentiation
Content differentiation
Service differentiation
Platform differentiation
Marketing differentiation
EBITDA multiple (peer group, level of disruption) Drivers:
Capability differentiation
Market share
Discount rate (% recurring, diversification) Drivers:
Capital reinvestment
Sales: $150M to $500M & $500M to $1bn
EBITDA:
Discount rate: 15%
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Implied beta: 2
Multiple: 7x-10x
Owner activity: 2/10
PHASE V: DIVERSIFIED (SMALL CAP, MID CAP, LARGE CAP) - from scaling
capabilities to new perpetuity building/acquisition
The key here is taking a syndication that has demonstrated product/market fit
and turning it into a job shop with multiple projects as represented by PMT1,
PMT2, PMT3. This demonstrates product market fit between the minimum
viable product/platform and allows the owner to invest additional
time/energy/resources into turning the syndication into a perpetuity. The
syndications value to the owner will be related to the NPV/DCF value,
however, since there is an inefficient market for syndications, the value is going
to be discounted at a high rate, in the 80% to 100% range. This means an
implied beta of 12.2. There is no multiple here since the syndication does not
have a long enough history of operations. The syndication is entirely reliant on
the owners active involvement. If the owner no longer works in the
syndication, the syndication will cease to operate.
Finally, the owner is to diversify either organically (new product, new business)
or inorganically. If the diversification is organic, the new product/business will
naturally move through the phases of:
1.
Project/job shop
2.
Perpetuity
3.
Growing perpetuity
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Discount rate: 6%
Implied beta: 1
Multiple: 11x-13x EBITDA
Perpetuity reliance on owner: 0/10
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Chapter 15:
Perpetuity Management
The Purpose of the Company
Companies exist to create value
How Companies Create Value
Companies create value by investing capital at rates of return that exceed their
cost of capital. This is the principle of value creation.
The only thing that differs across companies is the implementation (i.e.
different asset and capitalization mix)
Strategy & Finance
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Valuation Drivers
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Perpetuity Management
Valuation
95
Growth or Restructuring
96
97
98
b.
iv.
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2.
b.
2.
3.
3.
b.
Hard areas:
i. Structure (who reports to whom), Decision rights,
people (key jobs), and coordination mechanisms (how
do things get communicated or done)
c.
Soft areas:
i. Beliefs (how much potential people believe exists in
market), values (what people think is important, and
leadership style
d.
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e.
4.
b.
c.
d.
e.
f.
g.
Each business unit should have its own key value drivers and
KPIs
h.
i.
5 to 10 KPIs
j.
5.
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b.
c.
Review performance
i. Structured calendar of performance reviews
ii. Scorecard incorporating value metrics and KPIs from
value driver analysis
iii.
6.
b.
c.
Perpetuity Lifecycle
Product development includes market analysis, product design, invention
and testing
Market introduction initial release of the product and usually followed by
high levels of advertisement
Rapid Growth sales growth accelerates with increasing sales year over year
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Maturity phase the sales growth rate approach the average growth rate of
the economy
Decline demand will slowly decline as newer inventions make it obsolete
Valuation Process: Discounted Cash Flows
1.
iv.
2.
3.
b.
Note historicals
c.
b.
c.
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b.
4.
Calculate results
a.
b.
c.
Interpret results
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105
106
Chapter 16:
Valuation Methodologies
1.
2.
b.
c.
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e.
Notes:
The better the company, the higher the multiple and the better
valuation you get.
In IB/PE/CorpFin, you need to know comp companies and transaction
comps. Here are the comps in your sector
Higher multiple because
Operating in better markets, better operations
The multiple tells you which company is better, margin analysis tells
you why they are better.
Sell side key question:
Which comp would you use to guide potential buyers?
3.
b.
c.
d.
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e.
Notes:
20% to 25% control premium paid with the transaction multiple being
an implied one based upon the valuation.
Determine whether the market is good or bad based upon whether
people are paying good premiums (control premiums).
When a transaction occurs, update client on the latest transaction to
show them impact on the control premiums being paid and implied
multiple as well.
Point to the transaction comps that have the highest control premium.
4.
b.
c.
Rf = 10 year treasury
Market risk premium = Rm Rf. Refer to Ibbotson. Ultimately this
is S&P returns over 70, 80, or 90 years
Beta = Levered beta of comps to unlevered median and mean of
comps (unlevered beta); should be .5 to 2.5; 2 year to 5 year betas
(taking out capital structure and relever to actual capital structure.
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e.
Notes:
Need the valuation date; this determines stub year fraction (i.e. period
left in the year). Stub year fraction investor does not have claim on
revenues before that. DCF value always moving through time
consistent with valuation date.
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Chapter 17:
Framing Valuation
We are not looking at each valuation methodology in isolation but are
ultimately using the methodologies together to frame the valuation in a
valuation summary format. We use a football field (valuation summary) to
frame the valuation which looks like the following:
Regarding the football field, we add control premiums to comp companies and
DCF (% addition that is equal to the control premium average for the
transaction comps) if doing valuation for selling the company.
Footnote everything (assumptions) in the football field. The football field takes
one day to a few days depending on how easy it is to obtain the precedent
transactions data.
Banker should know what valuation the client expects to be at; 10% to 15%
spread of range of valuation (tighten the range if needed by eliminating
comps that skew the range)
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Chapter 18:
The Market for Perpetuities
As finance emerges, so too does the market for the perpetuity. The market for
the perpetuity at its initial stages is inefficient, but as it moves through the
stages of a perpetuity, the market becomes more efficient. You can observe
the coinciding cost of capital move from almost 100% going all the way down
to 3.5%.
You can observe the decreasing discount rate for the perpetuity as the
perpetuity moves through the phases of the perpetuity.
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SELL-SIDE
As perpetuities continue to grow, the builder of the perpetuity seeks to grow
the perpetuity inorganically or exit the perpetuity. This is the primary role of
the sell-side, which is to aid in the buying and selling of perpetuities.
Investment bankers now enter the picture as this is their core work.
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Part X:
Perpetuity Exit
On the sell side, the primary responsibility of the investment banker is to aid
those owning perpetuities in analyzing their strategic alternatives related to
inorganic growth or exit.
Which phase is the perpetuity in? (SMB, LMM, MM, UMM, L)
Which buyers are likely interested in the perpetuity? (Individual, Financial,
Strategic, Special Situation)
Each of these buyers have a different valuation range
Individual Desire 30% to 40% IRR, 3x EBITDA
Financial 4x to 7x EBITDA
Strategic 5x to 10x EBITDA
Valuation is a range
Determine valuation method (DCF, comp companies, precedent transactions)
Calculate benefit stream (synergistic vs. owner benefit)
Determine required rate of return given the phase of the perpetuity and the
buyer (discount rate)
Convert benefit stream into present value at the discount rate
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118
Chapter 19:
Investment Banking
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Valuation Football Field and the Midpoint is the final valuation of the company.
Calculate NPV and IRR to the sponsor in LBO or EPS Change and Balance Sheet
Effects in Merger
Compare NPV and IRR OR compare EPS change and BS effects to other
strategic alternatives and choose the highest return/EPS alternative
Ultimately, as an investment banker, you are to:
Use valuation methodologies to determine valuation ranges of each strategic
alternative and see if capital sources match uses. IBankers should provide the
client with tight ranges on valuation.
Use an operating model of the target (and acquirer if strategic) and then tailor
it to the specific client:
Financial (LBO)
Strategic (Merger)
Determine:
NPV and IRR for financial in LBO
EPS change and balance sheet effects for strategic in merger M&A
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121
Chapter 20:
How to Become an Investment
Banker
Index building
b)
Vertical report
c)
Vertical newsletter
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Part XI:
The Middle Market
The majority of perpetuities are in what is known as the middle market, a
classification for mid-sized perpetuities. This is where the majority of the
transactions occur and where the average investment banker will make his
living.
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Chapter 21:
The Middle Market
Because of the wide range of company sizes within the definition, the middle
market can be further broken down into the following:
Lower Middle Market: $5 - $50 million of revenue;
Middle Market: $50 - $500 million of revenue; and
Upper Middle Market: $500 million - $1 billion of revenue.
Overview of Middle Market
We view the middle market as having three distinct segments, defined by a
company's ownership type, prospects, and access to capital. Companies with
EBITDA below about $10 million (lower middle market) are typically family or
entrepreneur owned and individual customer wins and losses greatly impact
performance. Many of those sales relationships are concentrated in the family,
and senior management ranks are often populated with family members. Such
companies are generally well served by local banking relationships,
government-sponsored entities such as Small Business Investment Companies
(SBICs) in the U.S., or public entities such as Business Development
Corporations (BDCs).
At the other extreme, upper middle market companies typically have $75
million of EBITDA or more, and are often publicly held or sponsor backed.
These companies, given their size, typically ebb and flow with their respective
industries. They have myriad options for accessing capital, notably including
the public high yield market. Some institutional investors who are looking to
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write large checks ($100 million or more) also participate in this space, though
volume is limited. Given the relatively lower yields in this segment, as well as
structural disadvantages such as the lack of maintenance covenants and
limited information rights.
We define the core middle market as companies with $10 to $75 million of
EBITDA and this is the segment where we are most active. Companies are
typically sponsor owned with several opportunities for growth, from taking
share to expanding into related products or new geographies.
Pitchbook defines the middle market as companies with total enterprise value
between $25 million and $1 billion and the core middle market as between
$100 million and $500 million.
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Part XII:
M&A Multiples
It is crucial for investment bankers to understand the M&A marketplace in the
middle market and particularly for the industries that they cover.
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Chapter 22:
M&A Multiples
Since the investment banker will most likely be starting in the lower middle
market or middle market, it is important to have a strong understanding of the
multiples in the M&A marketplace in general and then in your sector and subsector. The following are 2016 M&A multiples from the data provider,
Pitchbook (Morningstar), that you can use initially. Here are the EBITDA
multiples for transactions in the lower middle market:
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Finally, we have EBITDA multiples for transactions in the upper middle market:
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Notice how the multiples increase as the size of the perpetuity increases due to
the scarcity value of larger perpetuities (increased demand for large
perpetuities and less of them).
The following is a chart depicting the average debt to equity breakdown for
LBOs. You will notice that equity levels are steadily increasing, indicating a
tighter credit market:
In this chart, you will see the average time that is it taking for deals to close.
You will notice that the majority of transactions get done in the 5-9 weeks and
10-14 weeks timeframe:
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Next, the following is a chart that depicts the % of deals getting done with
some aspect of an earnout, meaning portion of the purchase price contingent
on future performance of the business:
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Part XIII:
Origination
The following methodology describes the primary work of the investment
banker, origination. The methodology arose through the work of Michael
Herlache in his M&A career and the lack of content about the actual work of
senior M&A professionals. There is plenty of knowledge around the technical
support work of investment bankers including financial modeling and
valuation, but there are no current texts on origination, let alone a
methodology.
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Chapter 23:
Origination Methodology
2.
3.
4.
5.
6.
7.
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After receiving initial response, you will then message them that you will email
them when you have the offers and ask for the price of the business. The
following is the email that should be sent:
John,
Alright. I'll notify you when I receive the offers. What is your expectation
regarding the price of your business?
Best,
Michael
Step 4: Phone Call Request (by Sellers) or Meeting Request
After requesting price, some sellers will request a phone call and provide their
contact information. If the seller provides price information, they reply with the
following email:
John,
Alright. Lets sit down and discuss next steps. Does Monday afternoon at 1pm
work for you?
Best,
Michael
If the seller accepts a meeting then the engagement is going to be sell side. If
the seller does not accept the meeting and instead states that he would like
you to represent the buyer then it will be buy side.
Sell side engagements get an RBCA. For buy side engagements, make a buyer
list of the largest likely buyers including public companies then contact the
head of M&A at these companies and ask:
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Brian,
It's a pleasure. Would you care to take a look at a premier business group with
a presence in multiple states? $40M revenues and $6M EBITDA.
Please let me know.
Best,
Michael
After hearing back from the heads of M&A, let them know that the seller has
requested that we represent the buyer and that the buy side fee will be 1.5%.
You then ask them to accept in writing to the fee and once they do you can tell
them the target name and then proceed to contact the seller and let them
know that there is interest and ask what multiple range they are targeting for a
sale. From there you send an advisor NDA and request financials. After giving
financials to buyer, the company is assessed and a valuation range is
determined and an IOI with this valuation range is submitted to the seller.
Step 5: Phone Call or Meeting
Phone call:
During the phone call you will introduce yourself and state that you work on
behalf of private equity firms in locating quality cash flowing companies and
that is how you found their company. From there you will state that you want
to get an initial understanding as to the price of the business. After the price of
the business is found, ask how the business performed last year (revenue and
net income). Finally, request a meeting at the end of the call (in person). The
following is your outline for the phone call:
Price:
Revenue:
Net Income:
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Meeting:
Meeting:
During the meeting you will introduce yourself and state that you work on
behalf of private equity firms in locating quality cash flowing companies and
that is how you found their company. From there you will state that you want
to get an initial understanding as to the price of the business. After the price of
the business is found, ask how the business performed last year (revenue and
net income). If this information is already known, you can move straight to
giving the seller the signed NDA and explaining that any information that we
receive is confidential and will not be shared without the approval of the
business owner. Next you discuss the structure of the engagement that you are
requesting a non-exclusive relationship whereby you only get paid when your
buyers purchase the company. You can hand them the Registered Buyer
Commission Agreement and have them sign right there or to have them review
it. Finally, you ask if they have their financials on hand to view and you view
them. You can ask to keep a copy to aid in recasting.
Step 6: Add Backs Calculated and Teaser Created
After the meeting, you now have the financials or financial data needed to do
add backs to get to an owners benefit or EBITDA number. From here you can
input the recasted financials into the teaser and then complete the teaser
based upon the general information (usually from the website and meeting
conversation) of the business
Step 7: Contact Buyer List & Deal Put on M&A Marketplaces
Once the teaser is finished and financials recasted, you can contact the buyer
list of strategic and financial buyers and put the deal on the M&A
marketplaces including BizBuySell for smaller deals and Axial for larger deals.
Step 8: NDAs Signed with Buyers
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Once inquiries are received from buyers from the M&A marketplaces, you will
send NDAs to the buyers which they will then sign and send back to you.
Step 9: Teaser with Name Given to Buyer
Once the NDA is received, you can give the buyer the name of the business on
the teaser and request an IOI from the buyer after reviewing the teaser and
summary financials. The following is the email to accompany the teaser:
Buyer,
After reviewing the teaser and summary financials, please submit your initial
indication of interest (IOI) and we will set up a buyer/seller meeting.
Best,
Michael
Step 9: Teaser with Name Given to Buyer
Often times a call will be requested by the buyer. On the phone the M&A
professional finds out the following, taking notes on the call:
Industry interest:
Questions (that the buyer has):
Multiples that buyer is seeing or that they typically do:
Step 10: IOI from Buyer
After reviewing the teaser and summary financials, the buyer will notify you
that they are interested in purchasing the company (IOI).
Step 11: Buyer Seller Meeting
After submitting the IOI, you will arrange an in person meeting with the seller
which is called the buyer seller meeting. If the buyer is unavailable due to
distance or timing, a phone call can be set up.
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Chapter 24:
Mandate/Target Matching
Methodology
1.
2.
Indicate your interest in sourcing deals on their behalf and obtain their
investment mandate. This will usually be detailed in a one-page teaser or
presentation that they will send to you
3.
Screen for companies that match the mandate(s) in Salesgenie and obtain
CEO/owner emails and phone numbers
4.
5.
6.
7.
Introduce the financial and/or strategic buyer to the opportunity with the
summary financial information and have them sign an NDA
8.
Have a call with the financial and/or strategic buyer and then make the
formal introduction to the CEO/owner and have a buyer/seller meeting
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Chapter 25:
Deal Structuring
After matching a financial or strategic buyers mandate with a target, it is up to
the investment banker to work with the buyer and seller to structure a deal.
Deal structures can be along the following lines:
I.
II.
III.
Seller financing
IV.
Earn out
V.
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Chapter 26:
M&A Process
From Origination to M&A Execution
Once the investment banker has originated 8 to 10 multimillion dollar listings,
one should transition from origination to M&A execution process creating a
shortlist for each deal (10 in the shortlist). The investment banker should
concurrently prepare the marketing package which includes the teaser and the
executive summary. Once the teaser is finished, the investment banker should
begin emailing the shortlist with the teaser. From this shortlist, a percentage
will reply seeking additional information on the target. NDAs should be sent
out and after being signed, the executive summary should be sent to the
shortlist member. After the executive summary is sent, a percentage will decide
to request a buyer/seller meeting. After the buyer/seller meeting, a percentage
will decide to make an offer.
Building the Buyer Shortlist
The shortlist should include strategic and financial buyers and the investment
banker should screen each that make it onto the shortlist for financial capacity
to pay. The investment banker should use Salesgenie to pull the geographic
competitors (geography screen with SIC code screen) and have 10 strategics.
The investment banker should use the massinvestor database to determine
which 10 financials to include in shortlist:
Strategic
Competitors - synergies
Indirect Competitor
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Financial
Hybrid strategic financial buyer with asset in the sector
Pure financial
For deals that are $500k earnings and above, BizBuySell.com and
DealNexus.com should be used to find buyers. For deals below $500k in
earnings, only BizBuySell.com should be used.
The Teaser
The teaser will contain an overall financial profile: three years of historical
revenue and EBIT/EBITDA and at least two years of projected revenue and
EBIT/EBITDA
Indicate type of transaction
Professional font (Times New Roman or Arial)
Send as PDF
Do not capitalize words or use flowery language
No grammar or spelling errors
Indicate sustainable growth potential based upon competitive advantage:
Customer entrenchment and high switching costs (ex. Software)
Long term contracts (ex. Equipment service companies)
Brand recognition (ex. Consumer products)
Intellectual property
Stable management teams
Culture
The NDA
The NDA in a sell side engagement is a unilateral NDA meaning that only one
side has to not disclose confidential information
Teaser With Name of Business & Financials
After the NDA is signed, a teaser with the business name is then sent to the
buyer along with the financials in PDF form.
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The CIM
Executive summary
Company history
Sales process and/or manufacturing capabilities
Management team structure
Growth opportunities
Competitive landscape or industry outlook
Intellectual property overview and/or company assets
High-level financials (preferably five years of historical data and projections, if
available)
The IOI (Indication of Interest)
Approximate price range. This can be expressed in a dollar value range (e.g.,
$10-15 million) or stated as a multiple of EBITDA (e.g., 3-5x EBITDA).
Buyer's general availability of funds, including sources of financing
Necessary due diligence items and a rough estimate of the due diligence
timeline
Potential proposed elements of the transaction structure, e.g., asset vs. equity,
leveraged transaction, cash vs. equity, etc.
Management retention plan and role of the equity owner(s) post-transaction
Time frame to close the transaction
The Buyer/Selling Meeting
First conference call
In person meeting & tour the facilities
In person handshake meeting
The LOI (Letter of Intent)
Official deal structure and terms. Acceptance of engagement means that
company cannot receive other offers
Deal Structure. Defines the transaction as a stock or asset purchase. Generally,
the seller prefers a stock transaction from a tax and legal perspective. Asset
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transactions are preferred by the buyer to protect against prior liabilities and
provides a stepped-up tax basis.
Consideration. Outlines the form(s) of payment including cash, stock, seller
notes, earn-outs, rollover equity, and contingent pricing.
Closing Date. The projected date for completing the transaction. This date is an
estimation and often changes based on due diligence or the purchase
agreement.
Closing Conditions. Lists the tasks, approvals, and consents that must be
obtained prior to or on the Closing Date.
Exclusivity Period (Binding). It is common practice for a buyer to request an
exclusive negotiating period to ensure the seller is not shopping their deal to a
higher bidder while appearing to negotiate in good faith. Expect to see
requested periods of 30 to 120 days. The duration may be negotiable, but the
presence of the exclusivity term rarely is.
Break-up Fee (Binding). A fee to be paid to the buyer if the business owner
decides to cancel the deal. Break-up fees are relatively common in larger deals
(above $500 million). The fee can either be a percentage (typically 3%) or a
fixed amount.
Management Compensation. Outlines plan for senior-management post-sale.
This term describes who in the management will be provided employment,
equity plans, and employment agreement. This term is often vaguely worded
to provide the buyer with latitude since they may not be prepared to make
commitments to senior management.
Due Diligence. Describes the buyers due diligence requirements, including
time frame and access.
Confidentiality (Binding). Although both parties have probably signed a
confidentiality agreement at this point, this additional term ensures all
discussions regarding the transaction are confidential.
Approvals. Lists any approvals needed by the buyer (e.g., board of directors) or
seller (e.g., regulatory agencies, customers) to complete the transaction.
Escrow. Provides the summary terms of the buyer's expected escrow terms for
holding back some percentage of the purchase price to cover future payments
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for past liabilities. The escrow is typically highly negotiable and often excluded
from the LOI and presented for the first time in the purchase agreement.
Representations and Warranties. This clause will include indemnifications in the
purchase agreement. It is best practice to include any terms that may be
contentious or non-standard.
Due Diligence
Financial books and records
Incorporation documents
Employee benefits, policies and compliance issues
Internal systems and procedures
Customer contracts
Intellectual property
Condition of assets
Any key area of concern identified while negotiating the letter of intent
Digital deal rooms are now used (ex. Firmex and V-rooms). Due Diligence is
usually 60 to 90 days
The Purchase Agreement
Incorporates all terms of the LOI and is written to address issues discovered in
due diligence. The agreement will lay out a structure to handle this (a hold
back account, deductions from future payments, price adjustment, etc.)
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Executive summary
II.
III.
IV.
Vertical I
b.
Vertical II
c.
Vertical III
II.
Discuss valuation range (I believe that you can get $_____, providing
that these things hold true)
III.
IV.
Tax consequences
V.
Executive summary
II.
III.
Growth opportunities
IV.
Industry overview
V.
Company overview
VI.
a.
Overview
b.
c.
d.
Operations
e.
Organization
Financial overview
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2.
Valuation
3.
Recast financials
4.
5.
Buyer qualifications
6.
Marketing
7.
Management coaching
8.
9.
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1-3 months
Regarding valuation, the investment banker will form the story which is either:
I.
Growth story
II.
II.
Industry overview
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III.
IV.
V.
VI.
Process
VII.
Buyers/investors
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Chapter 27:
Running the Boutique Investment
Bank
In building AltQuests initial book of business, we sent over 2,000 emails to our
initial coverage group, industrials/manufacturers. The response rate was
approximately 2%. Of those that responded approximately 50% were
interested in seller and 50% were interested in taking an offer on their
business. Of those that were interested in selling their business, approximately
50% accepted our fee agreement.
When first starting the M&A firm, majority of time should be spent originating
sell side mandates. Once the investment banker gets to 20 sell side mandates,
one can ease up on origination and transfer those responsibilities to analysts
and associates hired as interns which then turn into full time
analysts/associates.
This means that all of the investment bankers time will now be spent in M&A
execution with sell-side pitches from time to time when the analyst/associate
originates an opportunity.
Good analysts and associates will originate 2 to 3 sell-side pitch opportunities
per week so the investment banker will stay busy on the phone with these
CEOs/Founders/Partners.
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Realistically it will take a year to a year and a half to close your first deal if you
are just starting out in M&A. If you have been in M&A and have a book of
business, the timeframe shortens to the typical time it takes to close a deal
which is shown below.
It is important for the M&A professional to plan for this extended time frame
and not to get discouraged when deals blow up, get delayed, or change. All
deals associated with an actual perpetuity close, it is just a matter of time.
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Chapter 28:
Investment Banking Deliverables
Investment banking deliverables include the following in order from left to
right:
I.
II.
Pitchbook (origination)
III.
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Chapter 29:
Coverage
The investment banker will often focus on a product group (i.e. M&A) and/or
an industry (industrials, healthcare, technology). Proper coverage comes in the
form of maintaining a coverage index for a sector and its sub-sectors which is
broken down in the following manner:
I.
II.
III.
IV.
Industry macroeconomics
a.
Industry spending
b.
Sub-sector spending
c.
Sub-sector index
b.
c.
d.
e.
f.
b.
c.
d.
e.
f.
Appendix
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a.
b.
c.
d.
e.
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Chapter 30:
Index Building & Benchmarking
Regarding the vertical index and sub-vertical index, the investment
banker ultimately tracks trends in:
Growth rates
Margins
Multiples
The investment banker takes the index and establishes tiers which turn
into peer groups. This is why we pull comps, to build an index and
benchmark against the comps.
The indexing and benchmarking that is done for a target company is
going to serve as the basis for advising on strategic alternatives.
One should build indexes at the vertical level, then sub-vertical level
and finally sub-vertical by product level.
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Chapter 31:
Financial Data Sources
If you are at a larger investment bank, you will have various paid data
sources at your disposal. These include:
1.
Bloomberg
2.
CapitalIQ
3.
FactSet
For those that are not at a larger bank, one can use the free sources of
financial data including:
Yahoo Finance
Google Finance
Yahoo Finance and Google Finance get their EBITDA numbers from
CapitalIQ and their analyst EPS consensus estimates from there as well.
Investment banks typically do not want you to use the EBITDA from
CapitalIQ, Bloomberg, FactSet and would prefer that you spread the
comps individually to get to EBITDA.
We are ultimately using the financial data sources to build and maintain
our various indices associated with our coverage group.
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Chapter 32:
Industry or Sector Newsletter
When maintaining coverage of an industry or sector, one prepares a
newsletter to be send to prospective sell side clients in the industry or
sector. Investment bankers use the index information to create this
newsletter. The newsletter is about 2 to 6 pages.
For example, our AltQuest software industry coverage has produced the
following newsletter which is sent to potential targets:
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Chapter 34:
Industry or Sector Report
When maintaining coverage of an industry or sector, one prepares a
report to be send to prospective sell side clients in the industry or sector.
Investment bankers use the index information to create this report. The
report goes more in depth than the newsletter. The report can be about
15-20 pages.
For example, our AltQuest software industry coverage has produced the
following industry report which is sent to potential targets:
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Chapter 35:
Rolodex Building
As an investment banker it is important to establish relationships with
the strategics in your coverage group as well as relationships with
targets and their potential buyers. After building the index containing
relevant strategics, one should go to RocketReach.co and find the email
addresses for each of the CEOs, CFOs, and/or corporate M&A
department head for the potential acquirer.
An example of a vertical specific rolodex would be the following:
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Chapter 36:
Adjusted EBITDA
As an investment banker it is important to establish relationships with
the strategics in your coverage group as well as relationships with
targets and their potential buyers. After building the index containing
relevant strategics, one should go to RocketReach.co and find the email
addresses for each of the CEOs, CFOs, and/or corporate M&A
department head for the potential acquirer.
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Chapter 37:
Valuation
As an investment banker it is important to establish relationships with
the strategics in your coverage group as well as relationships with
targets and their potential buyers. After building the index containing
relevant strategics, one should go to RocketReach.co and find the email
addresses for each of the CEOs, CFOs, and/or corporate M&A
department head for the potential acquirer.
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Chapter 38:
Teaser
As an investment banker it is important to establish relationships with
the strategics in your coverage group as well as relationships with
targets and their potential buyers. After building the index containing
relevant strategics, one should go to RocketReach.co and find the email
addresses for each of the CEOs, CFOs, and/or corporate M&A
department head for the potential acquirer.
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Chapter 39:
CIM (Confidential Information
Memorandum)
As an investment banker it is important to establish relationships with
the strategics in your coverage group as well as relationships with
targets and their potential buyers. After building the index containing
relevant strategics, one should go to RocketReach.co and find the email
addresses for each of the CEOs, CFOs, and/or corporate M&A
department head for the potential acquirer.
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BUY-SIDE
For those that have already built perpetuities and their representation, there is
another category known as the buy-side. The buy-side is made up of financial
(private equity) and strategic buyers (corporate).
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Part XVII:
Buying a Perpetuity
On the buy-side, we are concerned with the purchasing of perpetuities.
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Chapter 40:
The Principle of Investing
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Chapter 41:
How to Become the Next Warren
Buffett
In order to become the next Warren Buffet, you should first understand the
nature of the perpetuity, which is the basis for finance. Finance is the set of
concepts, methodologies, and optimization models associated with the
perpetuity. The perpetuity can be modeled with the following formula:
Perpetuity value = CF / r
Where CF represents the benefit stream associated with the perpetuity and r
represents the discount rate associated with the perpetuitys risk of receiving
the benefit stream.
All finance content can be broken down in relation to the perpetuity, namely:
Build-side the building of perpetuities (entrepreneurs, corporations)
Sell-side the selling of perpetuities (investment bankers, Wall Street)
Buy-side the buying of perpetuities (private equity, corporate M&A)
You are going to then want to master finance:
PART II: FOUNDATIONS OF FINANCE
1.Tracking Value (Accounting)
a.Tracking Value with Accounts
2.Analyzing Value (Finance)
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Chapter 42:
The Operating Model
We are going to start with the operating model previously built (integrated
financial statement model). From here we are going to build on a transaction
(ex. LBO, Merger, ECM, DCM).
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Chapter 43:
Financial Buyer aka Private Equity
(LBO)
There are over 4,000 financial buyers in the world. They command over $2
trillion in capital and are broken down into the following categories:
Leveraged buyout
Growth
Mezzanine
While each of these private equity firms have different hurdle rates, each
perform an LBO analysis to determine whether or not to purchase a perpetuity.
There are two types of private equity plays:
1.
2.
Private equity firms have 7 to 8 years to invest and get returns and be done
with the fund. They have a 2% management fee generally. They are targeting
20% to 25% and think in terms of spread over treasuries. IRR is the name of the
game which the main drivers of returns being; acquisition price, amount of
debt raised, and future operating performance (model projections). There is an
aspect of buy low, sell high regarding multiples (ex. 11x entry and 13x exit).
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You can use the following as a general rule of thumb for a private equity
group:
15% IRR dont do the deal
25% IRR do the deal
30% IRR, you must do the deal
Regarding ideal private equity targets, the private equity firm will specialize in
a few sectors and does not want a lot of discretionary CAPEX. They will
however do maintenance CAPEX. They will look to rework AR and AP contracts.
Furthermore, after an acquisition, the PE group will look to pay debt down as
fast as possible. They ideally want dividend recaps (add additional cash and
then pay self a dividend after paying back additional debt).
The PE firm when considering an investment will run multiple cases to
determine what case to bid on. They will do sensitivity tables as well.
The PE group will work with LevFin, SLF & DCM within a given investment bank
with SLF syndicating the loans and then selling the paper. The IB charges a
financing fee, advisory fee, and syndication fee.
Leveraged Buyout (LBO) Analysis:
1.
2.
3.
4.
5.
Notes:
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Banks want 20% to 30% for financial sponsor. This depends on the industry;
50% necessary for technology company. Bank looks at leverage ratios and
interest coverage to determine which covenants to put in place.
Construction of LBO Model
Purchase price and considerations
Sources and uses
Cap structure alternatives (sources)
Integrate proforma BS into operating model (change in debt level and
intangibles)
IS, BS, and SCF projections integration
IRR analysis for FS and hybrid debt lender (to find what is EBITDA, how much is
cash and how much is debt
Sensitivity tables
Credit ratios
PIK allows you to get more leverage
LBO model is an M&A & DCM transaction in one
EBITDA multiple determined from midpoint of the football field
Transaction fees:
Financing fees SLF & DCM
IB fees M&A
Legal Lawyer
Other fees
Leverage is spoken in terms of x leverage which means x EBITDA
SLF & DCM go through cases of operating model to find optimal tranche of
debt to provide highest leverage to the FS but can still be sold in the
marketplace
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Chapter 44:
Strategic Buyer aka Corporation
(Merger)
2.
3.
4.
5.
Notes:
Merger Modeling
2 operating models put together with synergies
Dont want to give away more than 50% of your synergies in your bid
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