the billionaire handbook

BILLIONAIRE: THE SCIENCE OF BUILDING, SELLING & BUYING PERPETUITIES

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Michael Herlache MBA

Doctor of Business Administration Candidate

VP, M&A at AltQuest Group

Billionaire The Science of Building, Selling & Buying

Perpetuities


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For my wife, Svitlana, whom is my treasure.


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About the Author: Michael Herlache is the VP of M&A at AltQuest Group, a middle market

boutique investment bank located in Fort Lauderdale, Florida. He lives in his

home in Florida with his wife, Svitlana. Michael has an MBA in Finance from

Texas A&M University and is getting his Doctorate in Business Administration

with a focus on finance. To learn more about AltQuest Group, please go to

www.AltQuest.com.

For those interested in going through a formal billionaire training program

associated with this text, the Billionaire University

(www.UniversityBillionaire.com) course’s syllabus is based upon the content of

this book.

http://www.universitybillionaire.com/


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Contents

PERPETUITY SCIENCE:

Part I: Perpetuity Methodology

Chapter 1: What is a Perpetuity?

FOUNDATIONS OF VALUATION:

Part II: Tracking Value (Accounting)

Chapter 9: Tracking Value with Accounts

Part III: Analyzing Value (Finance)

Chapter 10: Analyzing Value with Finance

Part IV: Modeling Value

Chapter 11: Finance with Excel

Chapter 12: Financial Statement Modeling

BUILD-SIDE:

Part V: How to Build a Perpetuity?

Chapter 13: How to Build a Benefit Stream?

Chapter 14: How to De-Risk the Benefit Stream?

Chapter 14: The Consumption Process & Growth Hacking

Chapter 15; Reasoning to Platform

Part VI: Perpetuity Analysis

Chapter 16: How to Be a CEO?

Chapter 17: How to Be a Consultant?

Part VII: Perpetuity Management

Chapter 19: Perpetuity Management

Chapter 20: Valuation Methodologies

Chapter 21: Framing Valuation

Chapter 22: The Market for Perpetuities

Chapter 23: Index Building & Benchmarking

Chapter 24: Financial Data Sources

SELL-SIDE:

Part VIII: How to Sell a Perpetuity?


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Chapter 25: Investment Banking

Chapter 26: How to Become an Investment Banker Methodology

Part IX: The Middle Market

Chapter 27: Middle Market Breakdown

Part X: M&A Multiples

Chapter 28: M&A Multiples

Part XI: Investment Banking Coverage Methodology

Chapter 29: Investment Banking Coverage Methodology



Chapter 39: Industry or Sector Newsletter

Chapter 40: Industry or Sector Report

Chapter 41: Rolodex Building

Part XI: M&A Origination Methodology

Chapter 29: M&A Origination Methodology

Part XII: Mandate/Target Matching Methodology

Chapter 30: Mandate/Target Matching Methodology

Part XIII: Deal Structuring

Chapter 31: Deal Structuring

Part XIV: M&A Process

Chapter 32: M&A Process

Part XV: Firm Building & Management

Chapter 33: How to Build a Boutique Investment Bank?

Chapter 34: Running the Boutique Investment Bank

Part XVI: Deliverables & Coverage

Chapter 35: Investment Banking Deliverables

Chapter 42: Adjusted EBITDA

Chapter 43: Valuation

Chapter 44: Teaser

Chapter 45: CIM (Confidential Information Memorandum)

BUY-SIDE:

Part XVII: How to Buy a Perpetuity?

Chapter 46: The Principle of Investing

Chapter 47: How to Be a Warren Buffett?

Chapter 48: The Operating Model

Chapter 49: The Financial Buyer aka Private Equity (LBO)

Chapter 50: The Strategic Buyer aka Corporation (Merger)

Chapter 50: Perpetuity Science & Portfolio Theory


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Chapter 48: How to Start a LMM Search Fund?

CASES:

Part XVIII: Cases

Chapter 52: Cases


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Preface

We have all heard about the buy side and the sell side of finance, but who is

actually building the perpetuities. What if there was a third side of finance?

What if there was a build-side, with individuals possessing IB/PE and platform

development talents to use in the building of perpetuities? Shouldn't that be

the logical course of events with individuals taking their knowledge of

valuation and industries and putting them to use in building the next unicorns?

So what would this look like? IB/PE professionals joining startup labs such as

the one I run called Founders Ventures (www.VCFounders.com) to work on

concepts that have a legitimate chance of being a unicorn. Rather than leaving

one's job to join a questionable startup, join a startup lab and be directly

involved in the build-side, even if it part-time. The work of the build-side is

syndication.

Shouldn't we all be working towards getting on the build-side?


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Perpetuity Science

The standard MBA curriculum at most business schools is broken down

along siloed subjects such as accounting, finance, management,

operations, and marketing and attempts to teach students how to be a

mid-level manager at a large corporation for the rest of their lives.

Unfortunately, these jobs are mostly gone, having been shipped

overseas or automated. This MBA curriculum is thus outdated and not

appropriate for the 21st century when most individuals will have multiple

jobs and roles throughout their careers and lives.

The more appropriate field of study which has yet to make it to business

schools is known as Perpetuity Science. Perpetuity Science is the body of

knowledge, methodologies, and optimization models related to the

building, selling, and buying of perpetuities. It explains how perpetuities


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can be built, managed and exited from to create wealth. Perpetuity

science is a paradigm shift in business and finance education in that it

replaces the siloed subjects traditionally taught in undergraduate and

graduate business schools with a holistic methodology that integrates

industry and the capital markets into one framework.

Instead of a disparate business taxonomy along the lines of economics,

finance, accounting, marketing, etc., we have an initial taxonomy 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)

Within each of the three, we have various methodologies and

optimization models that may touch on various subjects such as

accounting, finance, economics. By starting with perpetuity science

however, the student can better synthesize the various moving parts of

industry and the capital markets.

When first learning about industry and the capital markets, one should

first understand the nature of the perpetuity, which is the basis for

industry & the capital markets. 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 perpetuity’s risk of

receiving the benefit stream.


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After understanding the nature of the perpetuity in general, we can then

analyze the nature of the perpetuity within each industry. The nature of

the CF, r, value chain, and value being offered will be different. We

investigate each industry according to these variables by building an

index for each industry and then sub-sector within the industry.

After building the index and sub-sector indices we can then begin

analyzing the value chain and leaders in each part of the value chain. We

then build financial statement models for the leaders in each section of

the value chain and understand the drivers of performance.


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We analyze each leader or target in relation to the phases of perpetuity in

terms of where they are now and the next steps that they can take to move to

the next phase. In doing so, one begins to think in terms of being a CEO. The

CEO’s role is to bring the company/opportunity through the stages of the

perpetuity by building recurring benefit streams (i.e. cash flows) and at the

same time de-risking those benefit streams. In doing so, the valuation of the

perpetuity moves from backward looking towards forward looking and the

valuation is thus maximized (based upon a multiple of future earnings).

The CEO should thus be familiar with Perpetuity Science and the phases of the

perpetuity.

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.


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Phases of the Perpetuity:

I. Syndication (Getting to PMT)

II. Job Shop (From PMT1 to PMT2, PMT3, etc)

III. Perpetuity (From PMTi to CF/r)

IV. Growing Perpetuity (From CF/r to CF/r– g)

V. Diversified (Perpetuity 1 + Perpetuity 2)

The goal of Perpetuity Science is the building, growing, management, exit and

buying of perpetuities, so ultimately, while learning about Perpetuity Science

itself, we are also actively looking for:

1. Perpetuities to create

2. How to advance a perpetuity to the next phase

3. Perpetuities that should be exited from

4. Perpetuities that should be purchased


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Ultimately, Perpetuity Science transforms the individual from a one-

dimensional functional worker into a multi-dimensional value-creator

able to execute on either of the three sides of the perpetuity; build side,

sell side, or buy side.

The Perpetuity Scientist vs. The Functional Specialist

The Perpetuity Scientist builds assets that generate passive benefits whereas

the functional specialist uses labor to generate active benefits. The quality of

life of the perpetuity scientist is thus higher than the functional specialist. It is

the perpetuity scientist that drives the primary value with functional specialists

simply serving a role in the process of building or operating a perpetuity.

The Perpetuity Scientist has the three capabilities associated with the key

question of each side of the perpetuity:

Build-Side:

Key Question: How to Build a Perpetuity?

Capability: The capability to build a perpetuity

Sell-Side:

Key Question: How to Sell a Perpetuity?


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Capability: The capability to sell a perpetuity

Buy-Side:

Key Question: How to Buy a Perpetuity?

Capability: The capability to buy a perpetuity

Capabilities that each business student should have are associated with

the 3 key questions of Perpetuity Science:

Perpetuity Science:


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I. Build side: How to build a perpetuity?

II. Sell side: How to sell a perpetuity?

III. Buy side: How to buy a perpetuity?

The key questions are associated with capabilities to be built learning

perpetuity science.


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From this methodology, Investment Banking University has built a body

of knowledge which turned into the course, How to Become an

Investment Banker. The book, Investment Banking, is meant to

accompany the course which can be taken online, in the weekend

workshop, or in the month-long training.

When asking the key question, “How to Become an Investment Banker?”,

we are really asking four questions simultaneously:

1. How to use finance to model the concept in a perpetuity

format?

2. How to physically build the perpetuity?

3. How to sell/exit the perpetuity?

4. How to buy a perpetuity?

For each question, Investment Banking University has developed

proprietary methodologies which are the basis for building a capability

which is the ultimate answer to the question.

When the individual implements these models and builds the capabilities in

finance, the build side, the sell side and the buy side, one may claim to have

become an investment banker.


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Part I:

Perpetuity Methodology

Consistent with Perpetuity Science, the Perpetuity Methodology is

broken down between the three aspects of the perpetuity and also has

the foundations of valuation to tie it all together:


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Chapter 1:

What is a Perpetuity?

Nature does not provide for man, so he must use reason to obtain value.

Since his task is both survival and pleasure, man must use philosophy

and science to determine what is valuable and then to build something

to obtain said value. That which he builds should not require the same

work continually to operate; this is the basis for the perpetuity. A

perpetuity is an asset that generates a benefit stream continuously into

the future. Perpetuity is the basis for intrinsic value.

All of mans progress is towards the creation of assets that add value on

behalf of the human on a continuous basis into the future without the

human having to replicate previous work to receive benefits. This

phenomena is referred to as the perpetuity. This speaks to the

advancement from the active benefit stream towards the passive benefit

stream (perpetuity). The perpetuity is both a philosophical and scientific

phenomena which embodies mans progress in both philosophy and

science.

Perpetuity can thus be broken down into:

1. Perpetuity Philosophy

2. Perpetuity Science

For the purposes of this book, we will be focusing on Perpetuity Science.


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Standard of Living: Perpetuities

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, sell 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.

I. Building Perpetuities

The building of perpetuities is known as being on the build-side;

commonly referred to as entrepreneurship or corporations.

II. Buying Perpetuities

The buying of perpetuities is known as investment or being on the buy-

side. The players here are Private Equity (PE) or Corporate M&A

Departments for major corporations.

III. Selling Perpetuities

The selling of perpetuities is known as the sell-side. The players here are

investment bankers (Wall Street).

The Lab of Perpetuities

The experimentation and optimization tool of finance is known as Excel.

Excel

Is the scientific computational tool of finance to aid us in the modeling

and valuation of perpetuities.

Demand for Perpetuities

There is always demand for perpetuities and especially by institutional

investors which means that the market for corporate control more closely


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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. Commodity

a. Durables

b. Non-durables

II. Platform

a. Digital

b. Physical

III. Content

a. Educational

b. Entertainment

IV. Service

a. Analysis

b. Allocation

c. Engineering

d. Logistics

e. Management

f. Advocacy

g. Relationship

V. Infrastructure

a. Private

i. Real estate

b. Public

From the types of perpetuities, when applied to the main value themes of

human existence we arrive at industries associated with the perpetuities

(according to Aswath Damodaran at NYU):


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When looking at the different industries in which perpetuities are located, it

becomes helpful to understand the nature of the perpetuities including risk (as

represented by the discount rate in the perpetuity formula), return, growth,

margins, multiples, and cash flow:

Risk (discount rate) on the following page:


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Return:


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Growth:


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Margins (Cash flow):


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Multiples:


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Business: The Science of the Perpetuity

Introduction to Business

Business is the science of the perpetuity

Perpetuity value = CF / Discount rate

As you can see we can increase value by increasing CF (increasing revenues,

decreasing COGS, SG&A) or decreasing the discount rate.

The Corporation’s Goal

1. Become a perpetuity - as characterized by recurring revenue as automated

work processes.

2. Become a growing perpetuity

Value of growing perpetuity = CF / r – g

g decreases the discount rate

One should make the distinction between a perpetuity and a commodity. A

commodity is associated with a single benefit (cash flow) or a finite benefit

stream, whereas the benefit stream of a perpetuity is continuous into the

future.

What is Intrinsic Value?

Something is intrinsically valuable inasmuch as it is a perpetuity.

Perpetuity provides certainty that the benefit stream will be recurring in

the future and is thus, the basis for intrinsic value. Perpetuities allow us

to improve our standard of living while not sacrificing quality of life by

continually dealing with a problem/opportunity in nature and yielding

passive benefits.

How to Become Wealthy?


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The secret that the wealthy know and the middle class is unaware of is

the perpetuity. A perpetuity is an asset that generates a benefit stream

continuously into the future. This yields passive benefits rather than

active benefits of which the middle class works for. The wealthy know

Perpetuity Science which is the science of building, selling & buying

perpetuities. There are three sides to the perpetuity:

1. Build-Side - How to Build a Perpetuity? (entrepreneurs,

corporations)

a. How to Build a Benefit Stream?

i. Case for Value Perpetuity and Financial

Perpetuity

ii. MVP

iii. Value Perpetuity

iv. Financial Perpetuity

v. Growing Financial Perpetuity

vi. Diversified

b. How to De-Risk the Benefit Stream?

i. Customer Concentration

ii. Owner Dependence

iii. Recurring Revenue

2. Sell-Side - How to Sell a Perpetuity? (investment bankers,

wall street)

3. Buy-Side - How to Buy a Perpetuity? (private equity,

corporate M&A)

Ultimately, the wealthy teach their children how to be 21st century

perpetuity scientists rather than 20th century functional specialists that

will remain in the middle class.

In terms of order, the process is usually:

1. Begin on the build-side building a perpetuity which will take 3

to 5 years (initiate coverage and syndicate within a vertical &

sub-vertical)


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2. Enter the sell-side and begin in investment banking after

university/business school (within existing investment bank or

start own boutique investment bank)

3. From the sell-side, take advantage of strong opportunities

and leverage this into a LMM search fund


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FOUNDATIONS OF

VALUATION

In order to understand the role and work of the investment banker, we need to

first have a strong understanding of the foundations of valuation. This helps us

to understand why it is that the investment banking industry exists and where

investment bankers fit into the bigger picture.


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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.


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Chapter 6:

Tracking Value with Accounts

Value

The formula for value is:


Accounts and Accounting

In order to track valuation performance of the perpetuity (i..e business),

companies create accounts for each item of it’s 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

EBIT

Interest Cost

EBT

Taxes


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Earnings

Account Statements: Balance Sheet

Assets = Liabilities + Shareholder’s Equity

Total Assets = Total Liabilities + Shareholder’s 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)


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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.


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Chapter 7: 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:


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

to get to a finance number. We try to get to a finance number to get to a

valuation. We get to a valuation to then take actions in a capitalist economy.

*We want more add backs to get to a higher valuation


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Modeling

After getting valuation, we can then model the different actions we can take in

a capitalist economy to increase the valuation of the strategic, financial or

entrepreneurial firm.

Modeling in Excel

Just like our account statements, our models are built and exist in Excel

Analysis of Account Statements

Analysis of account statements (ratio of analysis) has various uses including

from a liquidity perspective, commercial bank perspective, activity perspective,

profitability perspective, and growth perspective.

Ex. 4x-7x debt multiple for lending purposes


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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.


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Chapter 8: Finance with Excel

Finance with Excel

Express your decisions using Excel. Excel is the premier business computational

tool

Implement financial analysis using the tool for financial analysis, Excel

Valuation process

Heart of finance is time value of money and discounting

Excel Concepts Needed for Finance

Write down variables (defining the parameters of the decision)

Absolute or relative values copying (=A1) (=$A$1) and formulas

Functions (=fx( ))

Data tables (“sensitivity tables”)

Express Decisions with Excel

Implement financial analysis with Excel


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Using a Financial Model for Decision Making: The Investment Decision

Ability to get financing from financial institutions depends on ability to make a

financial model for the new or existing business

The financial model projects future earnings from the organization

Predict the future performance of a firm.

Accounting statements report what happened to the firm in the past. A

financial model predicts what the firm’s accounting statements will look like

in the future. Start by taking the initial accounting statements and inputting

them into Excel

Difference between accounting and financial model is in the current assets and

current liabilities. In financial model we are concerned only with operating

assets and operating liabilities. We exclude financing related

Financial model has three components:

Model parameters (value drivers)

Financing decision assumptions (i.e. Mix between debt and equity, what does

firm do with excess cash? Repay debt, payments to shareholders, or as cash

balance)

Pro forma financial statements

Cash in the financial model is a plug. The plug is so that the balance sheet

balances.

Cash = total liabilities and equity – current assets – net fixed assets

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:


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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 it’s 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

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


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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)

Role of the Finance Professional

The role of the financial professional is to quantify the cash flows and risk of

strategic alternatives available to the individual or organization.

Investment bankers compute the IRR and NPV of strategic alternatives.

Capital Markets

The capital markets is made up of cash flows and discounts

Capital Markets and Information

Information is valuable in determining investment and financing decisions in

the capital markets. Overall, markets are weak form efficient meaning that their

valuations reflect previous stock price performance (i.e. stock price data) and


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are sometimes semistrong meaning that valuations incorporate all public

information. Capital markets are not strong form efficient meaning that

valuations do not reflect private information.

Multiple Investment and Financing Decisions: Portfolio

When there is multiple investment and financing decisions, we have something

called a portfolio. The discount rate can be decreased by diversifying with a

portfolio. When the discount rate is decreased, the valuation of the portfolio

increases as cash flows have maintained more value.

A corporation/organization is simply a portfolio of sources and uses

Modeling a Strategic Alternative

Put all variables (“value drivers”) at the top of the spreadsheet

Never use a number where a formula will also work

Blue for hard codes

Black for links and outputs

Finance: Exchanging Value Through Time

Assets have a time dimension

Future value function =FV( )

Value in the future of a sum of money compounded into the future

Present value =PV( )

Value today of future payments discounted to present

Net present value (NPV) =-First payment + NPV( )

Incremental wealth increase earned by a strategic alternative. NPV tells you

economic value of an investment today. Always use NPV in the investment

decision.

Internal rate of return (IRR) =IRR( )

Compound rate of return earned by a strategic alternative

VIII. Rate of Return vs. Cost of Capital


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What is the asset’s IRR?

Compare to the cost of capital (Effective annual interest rate – which is the

annualized IRR used to compare financing alternatives aka Compound Annual

Growth Rate (CAGR))

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

Finding a Value in a Financial Model

When we want to find a value by setting a particular value to another cell, we

use:

Goal seek – Alt, A, G

Financing Alternatives: Loan Amortization

=PMT( )

To calculate the debt payment per period

=IPMT( )

To calculate the interest portion of the payment of debt

=PPMT( )

To calculate the principal portion of the payment

VIII. Financing Alternatives: Direct Comparison

IRR of differential cash flows tells you the cost of the option

IRR tells you the cost of the financing alternative


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CAGR is Effective Annual Interest Rate (EAIR) to allow for comparison

Analyzing the Strategic Alternative: Sensitivity Table

Data Table is Alt, A, W, T

Tells you how output changes with incremental changes in the inputs (i.e.

variables)

The Financing Alternative: Nominal vs. Real Cost

In determining the true cost of a financing alternative, it is important to use the

real rate of interest which incorporates inflation. The real rate of interest is

determined by using the real cash flows.

Inflation acts as a discount rate

Strategic Alternatives Analysis

For each strategic alternative, compute the NPV and IRR, then have decision

rules for investing including:

Minimum NPV

Hurdle rate (IRR)

You are using NPV and IRR to make investment decisions but you need the

discount rate. The discount rate is associated with the financing decision

Cash Flows and Risk

Are cash flows riskless (i.e. treasury bills) or are they risky (i.e. market portfolio)

Cost of Capital and Opportunity Cost

The returns of similar investments should be used as the cost of capital

The Discount Rate

An organization’s discount rate is the cost of equity and cost of debt. The

cost of the total capital structure is known as the Weighted Average Cost of

Capital (WACC):


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WACC = rE* (E/(E+D)) + rD (1-Tc)*(D/(E+D))

Value of Equity

The value of equity is the present value of all future dividends

Sources & Uses

Uses Sources

Free Cash Flows WACC

CAPM to get cost of equity

Accounting Statements: Statement of Cash Flows

The purpose of the statement of cash flow is to explain the increase in the cash

accounts on the balance sheet as a function of the firm’s operating, investing,

and financing activities.

Valuation Methods: Total Enterprise Value (TEV) vs. DCF

Market valuation:

Total Enterprise Value (TEV) = MVE + MVD + Preferred – Cash

2. DCF Method (intrinsic value) = PV(FCFs) @ WACC + liquid assets

Accounting Value vs. Finance Value

Accounting value of firm is backward looking and thus incorrect to use in

valuation. Finance value is forward looking and consistent with the fact that the

owner of an organization or security has claims on the future cash flows of the

business.

FCF and DCF

Free cash flow (FCF) calculations is DCF

Portfolio Analysis and the Capital Asset Pricing Model (CAPM)

Discount rate is a measure of risk associated with:

Horizon

Safety

Liquidity


50

We get the discount rate by analyzing the distribution of an investment’s

returns. We get the standard deviation which is a measure of variance in

returns. Standard deviation is a component to finding the discount rate:

=STDEVP( )

What does the frequency distribution look like?

Determine risk measure known as beta and plug this into CAPM to get the

discount rate of equity. Derive the cost of debt and then calculate WACC to get

the discount rate of the firm.

Ex Ante vs. Ex Post Returns

Ex Ante is the expected return

Ex Post is the actual return

VIII. Statistics for Portfolios

=Average( )

To get mean return

=Varp( )

To get variance of returns

=Stdevp( )

To get standard deviation of returns

=Covar( )

To get covariance between two sets of returns

=Correl( )

To get correlation between two sets of returns

Trendline (regression) – click on points of XY graph and right click to Add

Trendline with linear regression and display equation and R-squared on chart

Portfolio Returns and The Efficient Frontier


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Statistics are used to determine acceptable and unacceptable portfolios

Diversification lowers standard deviation of the portfolio

Are the returns correlated? If no, then add security to the portfolio (i.e.

diversify)

The efficient frontier is the set of all portfolios that are on the upward-sloping

part of the graph starting with the minimum variance portfolio (i.e. the market

portfolio). Choose the portfolio that is on the efficient frontier.

The Efficient Frontier and the Optimal Portfolio

The best investment portfolio is made up of the risk free asset and a risky asset

representing the market (i.e. the market portfolio)

Determine the market portfolio (the portfolio with the highest attainable

sharpe ratio)

Market portfolio is the best combination of risky assets available to the

investor

Security Market Line & CAPM

The security market line says that the expected return of an asset is a function

of the asset’s 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




Security Market Line & Investment Performance




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VIII. Security Market Line & Investment Performance Continued

Investment performance:

Risk adjusted performance; excess returns?

Risk Adjusted Performance

Market portfolio proxy is S&P 500

Beta is measure of riskiness of security

Alpha measures excess return

Market portfolio proxy is S&P 500

Beta is measure of riskiness of security

Alpha measures excess return

It is about investment performance versus the risk involved in the investment

CAPM & Investment Performance

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 investment’s spread over the one year treasury (i.e. risk

free rate)


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Use regression equation to determine if underperformance (negative alpha) or

overperformance (positive alpha)

When regressing asset’s 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

CAPM = rf + Beta [ E(rm) – rf]

In CAPM, use Beta of asset to calculate cost of equity

WACC is the discount rate based upon the capital structure of the investment

Valuing Securities in Efficient Markets

Market efficiency and the role of information in determining asset prices

Publicly available information should be reflected in market price


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Chapter 9: 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. Spread historical financial statements

a. 3 to 5 years history for IS, BS, and SCF

b. Public information for company 10K, 10Q

c. If private company, get audited financial statements provided by

company

2. Adjust for non-recurrings

3. Build cases into the operating model

a. Best case

b. Base case

c. Worst case

d. Disruption case


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4. Build assumptions based upon historical trends in assumptions tab

(margins and growth rates)

5. Project LIBOR and interest rates

a. Spread over LIBOR

b. LIBOR is the base that banks use to price spread their loans to

make money (called “L”)

c. 3 month LIBOR is the standard reference

6. Project IS and BS & two items on SCF (D&A and CAPEX (before gross PPE

on BS))

a. Maintenance CAPEX vs. Discretionary (growth) CAPEX

7. Separate debt and interest schedule (calculate debt and interest schedule

before calculating BS items for revolver, term loan, and unsecured debt)

8. Project Working Capital

a. Days payable & Days receivable (360 day method)

9. Project rest of SCF (all items pulled from IS or BS)

a. AR goes up, need negative sign on SCF

b. AP goes up, need positive sign on SCF

c. BS cash is ending cash position on SCF

10. Calculate paydown/drawdown for revolver as minimum (Min function) of

CF before revolver and beginning revolver balance

11. Operating model is done when you finish SCF. Operating model check

(zero for Assets – (Liabilities + Owners Equity)

NEXT STEP IS TO USE THE OPERATING MODEL FOR VARIOUS ANALYSES

INCLUDING ORGANIC GROWTH & INORGANIC GROWTH (STRATEGIC

ALTERNATIVES). THE KEY QUESTION TO ASK IS: WHAT IS THE BEST STRATEGIC

ALTERNATIVE FOR THE CORPORATION (I.E. HOW TO BE A GROWING

PERPETUITY OR PARENT COMPANY OF MULTIPLE GROWING PERPETUITIES)?


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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 build-side

include startups, growing businesses, and established corporations.


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Part I:

How to Build a Perpetuity?

The process for building a perpetuity is the following:

1. Challenge/opportunity and case for value perpetuity & financial perpetuity

(total addressable market that exceeds hurdle)

2. Key question associated with challenge/opportunity

2. Methodology that answers key question

3. Platform architecture consistent with methodology

4. MVP (Minimum viable product) of platform

5. Value Perpetuity

6. Financial Perpetuity

7. Growing Financial Perpetuity


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8. Diversified Perpetuity

Perpetuity Science & The Perpetuity Scientist

Within Perpetuity Science, there are definite phases of the perpetuity

corresponding to levels of development of the perpetuity including:

1. Levels of customer concentration where:

a. high levels of customer concentration correspond with a lower EBITDA

multiple and low levels of customer concentration correspond with a high

EBITDA multiple

2. Levels of recurring revenue where:

a. high levels of recurring revenue correspond with a high EBITDA multiple

and low levels of recurring revenue correspond with a low EBITDA multiple

3. Levels of owner dependence where:

a. a high level of owner dependence corresponds with a lower EBITDA

multiple and low levels of owner dependence correspond with a high EBITDA

multiple

The perpetuity scientist (CEO or consultant) is not only responsible for growing

the benefit stream (CF), but also these de-risking factors that determine the

discount rate (r). In doing so, the perpetuity scientist builds a highly sought

after perpetuity for both strategic and financial buyers corresponding with a

premium valuation.

When providing coverage to a target perpetuity and originating an

engagement, the perpetuity scientist should follow these steps:

Stage of the Perpetuity:

1. Syndication:

(Getting to PMT)

Initial revenue generation


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The key here is taking a concept that has a large enough total addressable

market and turning it into a single sale as represented by PMT. 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

syndication’s 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. The syndication is

entirely reliant on the owner’s active involvement. If the owner no longer works

in the syndication, the syndication will cease to operate.

The market here is inefficient.

2. Job Shop:

(From PMT1 to PMT2, PMT3, etc)

The initial efforts create a job shop

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 job

shop’s valuation is based upon a multiple of its EBITDA and is usually in the

range of 3x to 5x. The job shop is not entirely reliant on the owner’s active

involvement and there is thus a larger, albeit still inefficient market for the

prospective perpetuity with likely buyers being individuals and LMM strategic

and financial buyers.

The owner’s 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.

3. Perpetuity:

(From PMTi to CF/r)

Transitioning from a job shop to a recurring revenue stream


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The key here is taking a job shop with disparate projects (PMT1, PMT2, PMT3)

and turning it into a perpetuity with a predictable if not recurring benefit

stream. The perpetuity’s value is based on a larger EBITDA multiple since there

is a semi-strong efficient market for perpetuities with likely buyers being

middle market strategic and financial buyers. The perpetuity is almost entirely

not reliant on the owner’s active involvement.

From here, the owner is to turn the company into a perpetuity as characterized

by predictable, preferably recurring revenue. This can be done by building an

organizational structure with division of labor, automated processes with

technology, and a business model that is recurring by nature. When this is

accomplished, the valuation becomes forward looking.

4. Growing Perpetuity:

(From CF/r to CF/r– g)

Going from recurring revenue stream to a growing perpetuity

The key here is taking a perpetuity with a durable benefit stream (CF) and

reasonable amount or variability in that benefit stream (r) and turning it into a

growing perpetuity with a corresponding growth rate (g). The perpetuity’s

value is based on an even larger EBITDA multiple since there is a weak form

efficient market for growing perpetuities with likely buyers being middle

market strategic and financial buyers and some public strategic and financial

buyers. The growing perpetuity is almost entirely not reliant on the owner’s

active involvement.

This can be accomplished by building a scalable platform as part of the core

business. The valuation of the company now has to incorporate a growth

factor.

5. Diversified:

(Perpetuity 1 + Perpetuity 2)

From one growing perpetuity to growing another perpetuity organically or

purchasing one to grow inorganically


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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. Syndication

2. Project/job shop

2. Perpetuity

3. Growing perpetuity

Since the valuation is forward looking, it has to incorporate the new

product/business’ financial performance. Since the parent company is now

becoming diversified, the discount rate will now decrease which adds value to

the parent company.


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63

Chapter 31: How to Build a Benefit Stream?

The CEO’s role is to bring the company/opportunity through the stages of the





Reasoning to Platform

The ultimate conclusion of reasoning applied to a challenge/opportunity in

nature is the building of a platform which in turn can be turned into a

perpetuity.

1. Opportunity/challenge in nature

2. Key question associated with challenge/opportunity

3. Develop methodology that answers the key question

4. Build platform around the methodology

5. Perpetuity

Existing Platform to New Value Theme

A common way to begin on the build-side is to take an existing platform

and apply the concept to a new value theme. We will discuss this in

great detail in the cases portion of this text.


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Platform vs. Mod

Platform is associated with network and is the core value, the connecting

of individuals in an integrated platform. Platform is ultimately the basis

for becoming a perpetuity.

Mod is associated with a specific functionality.

The Value of Technology & Science

Technology and science have value inasmuch as they are associated with a

perpetuity. Technology and science in isolation has no value.

The Consumption Process & Growth Hacking

It is important to have appropriate expectations regarding growth and returns.

One does not simply build an MVP and turn on users with a switch. Brands are

built one person at a time and consumption follows a definite process which is

the following:

1. Awareness of methodology via being advocated to directly on a social

network or via email

2. Methodology adds value for individual (based in reason) and thus the

user decides to be a follower

3. Followership of brand adds value enough so that when the 'ask' is made,

the individual is willing to experiment with usage

4. Usage adds value enough so that the user becomes an active user

5. Active usage adds value enough so that individual is willing to

recommend others to become users

6. Active users willing to pay for usage

Since there is a definite process to consumption, one's growth hacking

methodology should be consistent with this fact. The Growth Hacking

Methodology means manually connecting with individuals on various


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social networks including Instagram, Facebook, & Twitter to first

advocate the startup's methodology:

1. Develop thought leadership (methodology)

2. Advocate methodology and first contact

3. Acquire followership

4. Convert followership into users

5. Convert users into active users

The key here is to advocate the startup's methodology and then show

traction on the methodology which will be used to gain followership

from influencers and turn them into evangelists for the methodology.

Mechanisms like social proof can be helpful as they accelerate

willingness to participate in followership or experiment with usage, but

they are not a replacement for one by one advocacy of a methodology.

Social proof kicks in incrementally as the startup hits an extra zero at the

end of its followership and user numbers (ex. 100, 1000, 10000, 100000,

1000000).


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69


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Chapter 32: How to De-Risk a Benefit Stream?







71


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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.

The goal of Perpetuity Science is the building, growing, management, exit and

buying of perpetuities, so ultimately, while learning about Perpetuity Science

itself, we are also actively looking for:

1. Perpetuities to create

2. How to advance a perpetuity to the next phase

3. Perpetuities that should be exited from

4. Perpetuities that should be purchased

Perpetuity analysis is performed with an understanding that a perpetuity’s

ideal course of action at any given time is related to one of the three sides of

the perpetuity (Build-side, Sell-side, Buy-side) which depends on the phase

that the perpetuity is in:

I. Industry and sub-industry indices made up of public comps

II. Benchmark comps into Perpetuity Phases

III. Build financial statement models for each

IV. Determine DCF, Comp Companies & Precedent Transactions valuation

football field


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V. Compare peers in Perpetuity Phase to intrinsic value to determine if this

is a Buy-Side, Sell-Side or Build-Side deal (where are peer multiples at in

relation to intrinsic value?)

a. If Build-Side: What needs to be done to get to the next phase of the

perpetuity?

b. If Sell-Side: How to exit the perpetuity?

c. If Buy-Side: How to acquire a target perpetuity?

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 owner’s 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 just 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:


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As you will notice, the owner’s direct involvement in the perpetuity

decreases as the perpetuity moves through the phases of development.

Also, valuation increases as the perpetuity moves through the phases of

development for three reasons; EBITDA increase, EBITDA multiple

expansion, decrease in discount rate.

The key question is: How to build a perpetuity that minimizes the daily

involvement of the owner and at the same time maximizes it’s

valuation.

Though applicable to all industries, the focus industries of perpetuity

science are thus those that do not require significant capital outlays

which could otherwise be used to invest in a diversified portfolio. These

industries include:

1. Technology

2. Media

3. Education

4. Business Services


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As you will notice, these industries have to do with knowledge working

and benefit from information arbitrage and/or network arbitrage. While

it is possible to structure arbitrage in other industries by preselling

various products and services, knowledge working industries offer

genuine information/network arbitrage as well as allowing for recurring

revenue business models rather than being one time commodity or

project-based. You will also notice that margins are much larger in

knowledge working industries which translates into larger EBITDA

multiples. Thus, the owner of the perpetuity is rewarded multiple times

more for the value that their perpetuity creates than they would for

commodity or project-based syndications.

Given that the human has a limited amount of time on earth and

limited resources within which to invest (energy, capital), one should

invest their time in knowledge working industries and build perpetuities

there first. Only after a perpetuity has been built in a knowledge

working industry should the owner explore other non-knowledge

related industries.

One should thoroughly understand these industries overall and their

sub-sectors when syndicating a new perpetuity. We will go into these

industries in detail after explaining the perpetuity building process, the

perpetuity management process, and perpetuity exit process.

The science of the perpetuity can be broken down into three sequential

categories including:

I. Perpetuity Analysis

II. Perpetuity Building

III. Perpetuity Management

Perpetuity Exit

Market Analysis

GDP


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Industry Spend

Sub sector spending

Sub sector spending by product


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Value Chain Analysis

General

Industry

Sub-sector

Sub-sector by product

Gap Analysis

General

Industry

Sub-sector

Sub-sector by product

Product/Platform Analysis

Base

Mods

Perpetuity Science: A methodology that synthesizes industry and the

capital markets in relation to the perpetuity. The science of building,

selling and buying perpetuities.

I. Nature of the Perpetuity

II. Phases of the Perpetuity

III. Sides of the Perpetuity


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IV. Perpetuity Analysis:

Industry and sub-industry indices

Determining where leaders are at in Perpetuity Phases

Build financial statement models for each

Compare Perpetuity Phase to intrinsic value

Determine if this is a Buy Side, Sell Side or Build Side deal (where are

multiples at in relation to intrinsic value?)

What needs to be done to get to the next phase of the perpetuity?


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Chapter 10: How to Be a CEO?






The CEO should thus be familiar with perpetuity science and the phases of the

perpetuity.

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.

Phases of the Perpetuity:

I. Syndication (Getting to PMT)

II. Job Shop (From PMT1 to PMT2, PMT3, etc)

III. Perpetuity (From PMTi to CF/r)

IV. Growing Perpetuity (From CF/r to CF/r– g)

V. Diversified (Perpetuity 1 + Perpetuity 2)


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Chapter 10: How to Be a Consultant?

The consultant’s role is to aid in the building, selling, or buying of a

perpetuity. Since the consultant’s value is in relation to the perpetuity,

the consultant’s core methodology/body of knowledge is Perpetuity

Science. Perpetuity Science is the set of methodologies related to

building, selling, and buying of perpetuities which is referred to as the

build-side, sell-side, and buy-side respectively. The key questions related

to each side of the perpetuity are:

The consultant uses methodologies related to each one of these key

questions which serve as the basis for a consulting engagement:

1. Build-Side: How to move a company/opportunity to the next stage of

the perpetuity building process? The methodology for the phases of a

perpetuity is the following:


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2. Sell-Side: How to obtain a valuation higher than the NPV of the

perpetuity? The methodology for doing so is to get a buyer to price in

the next phase of the perpetuity into the current valuation (ex. if the

perpetuity is at the perpetuity phase, get the buyer to pay for a growing

perpetuity)

3. Buy-Side: How to locate and take ownership of a perpetuity that is being

valued at less than its NPV? The methodology for doing so is to get the

seller to accept a price for the previous phase of the perpetuity (ex. if the

perpetuity is at the growing perpetuity phase, get the seller to sell for at

a perpetuity valuation)

What Should You Learn in Business School?

Since the perpetuity is the basis for both industry and the capital

markets it follows that business school thus focus on educating

individuals on:

1. The Nature of the Perpetuity

2. The Phases of the Perpetuity

3. The Different Sides of the Perpetuity


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The standard MBA curriculum at most business schools is broken down

along siloed subjects such as accounting, finance, management,

operations, and marketing and attempts to teach students how to be a

mid-level manager at a large corporation for the rest of their lives.

Unfortunately, these jobs are mostly gone, having been shipped

overseas or automated. This MBA curriculum is thus outdated and not

appropriate for the 21st century when most individuals will have multiple

jobs and roles throughout their careers and lives.

The more appropriate field of study which has yet to make it to business

schools is known as Perpetuity Science. Perpetuity Science is the body of

knowledge, methodologies, and optimization models related to the

building, selling, and buying of perpetuities. It explains how perpetuities

can be built, managed and exited from to create wealth. Perpetuity

science is a paradigm shift in business and finance education in that it

replaces the siloed subjects traditionally taught in undergraduate and

graduate business schools with a holistic methodology that integrates

industry and the capital markets into one framework.

Instead of a disparate business taxonomy along the lines of economics,

finance, accounting, marketing, etc., we have an initial taxonomy broken

down in relation to the perpetuity, namely:


Sell-side – the selling of perpetuities (investment bankers, wall street)


Within each of the three, we have various methodologies and

optimization models that may touch on various subjects such as

accounting, finance, economics. By starting with perpetuity science, the

student can better synthesize the various moving parts of industry and

the capital markets.

1. The Nature of the Perpetuity: When first learning about industry and

the capital markets, one should first understand the nature of the

perpetuity, which is the basis for industry & the capital markets. The

perpetuity can be modeled with the following formula:


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Where CF represents the benefit stream associated with the

perpetuity and r represents the discount rate associated with the

perpetuity’s risk of receiving the benefit stream.

2. The Phases of the Perpetuity: After understanding the nature of the

perpetuity in general, we can then analyze the perpetuity within

each industry. The nature of the CF, r, value chain, and value being

offered will be different. We investigate each industry according to

these variables by building an index for each industry and then sub-

sectors within the industry:

3. The Different Sides of the Perpetuity:


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Part IX:

Perpetuity 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 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

The Role of the CEO


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Perpetuity Management

Valuation


91

Perpetuity Management with Discounted Cash Flows

Growth or Restructuring

Perpetuity Management Process


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Measuring Value Added: ROIC vs. Market Return

Measure return on invested capital (after-tax operating profits divided by

capital invested in working capital, PP&E) and compare it with stock market

returns

Measuring Value Added: Economic Profit & NPV

Economic profit = ROIC spread % over cost of capital x invested capital

The objective is to maximize economic profit. When the company is larger, one

should use Net Present Value (NPV) which calculates economic profit in a more

robust and flexible fashion.

Valuation in the Public Markets

Valuation in the public markets has investors paying for the performance they

expect the company to achieve in the future; investors ultimately end up

paying more since their valuations are not based upon the past or cost of the

assets.

The CEO should endeavor to have his company in the public markets since the

largest multiples are applied in valuation

Real Markets & Financial Markets

When a public company, the CEO has to both maximize the intrinsic (DCF)

value of the company and manage the expectations of the financial market

Differences between actual performance and market expectations and changes

in these expectations drive share prices. The delivery of surprises produces

higher or lower total shareholder returns

Perpetuity Planning & Control (i.e. Management)

Planning & control system should be put in place to monitor the NPV of every

business unit and summed to get the NPV of the corporation. Economic profit


93

(i.e. NPV) targets set annually for next three years, progress monitored monthly

and managers’ compensation tied to economic profit against these targets

Value Metrics

Metrics are to drive decisions and guide all employees toward value creation.

Perpetuity Planning & Control (i.e. Management) in Practice

Corporate management sets long-term value creation targets in terms of

market value of a company or total returns to shareholders (TRS)

Strategic alternatives valued in DCF (i.e. NPV)

Intrinsic value of chosen strategic alternative translated into short and medium

term financial targets and then targets for operating and strategic value drivers

Performance assessed by comparing results with targets on both financial

indicators and key value drivers. Managerial rewards linked to performance on

financial measures and key value drivers

Value Metrics: Market Value Added & Total Return to Shareholders

Market Value Added is the difference between the market value of a

company’s debt and equity and the amount of capital invested. Measures

financial market’s view of future performance relative to capital invested in

business.

Total Return to Shareholders measure performance against the expectations of

financial markets and changes in these expectations. TRS measures how well a

company betas the target set by market expectations

Value Metrics: DCF vs. Earnings Multiple

DCF is intrinsic value. Earnings multiples are market values.

Earnings alone is inadequate without understanding the investment required

to generate the earnings. Should know ROIC


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Cash Flow

Cash flow equals the operating profits of the company less the net investment

in working capital and fixed assets to support the company’s growth.

Perpetuity Management Capability

1. Analyze where perpetuity is currently at (which phase)

2. Determine which phase is the goal

3. Determine steps to get to next phase of the perpetuity

4. Build Work Breakdown Structure (WBS) to get to next phase working

backward from the next phase

5. Execute the plan

Perpetuity Lifecycle


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Chapter 16: Valuation Methodologies

1. Public Company Valuation

2. Comp Companies – Also known as trading comps. Management team

gives you 1 to 2 years projections or equity research comp reports to get

forward multiples (x Revenue or x EBITDA ) which may be used as the basis

for this valuation. You can get comps from the general overview as it will

discuss the target’s comps in the 10K. Find comps with good multiples to

then tell your story to the marketplace to then get a certain valuation.

a. Select the universe of comparable companies – Choose 7, 8, 10 comps,

need their 10K, 10Q, analyst reports to get TEV for each comp then divide

by line item to get multiple.

b. Locate financial information on comp companies – Information must come

from latest filing (10K or 10Q). Print out 10K, 10Q, analyst reports.

c. Spread key financial information, ratios and multiples – Calculate TEV (in

comp spread tab). To get MVE, use TSM method. TSM = Exercisable

options outstanding x (share price – strike) / share price.

d. Benchmark comp companies – Get the multiple that the company is

trading at for each metric for each comp and get mean and median of

comps for the metrics (ex. TEV/EBITDA)


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e. Determine implied valuation – Multiply mean and median multiple x the

revenue or EBITDA to get the valuation range for your target company.

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. Precedent Transactions – comp transactions

a. Select universe of comp transactions

b. Locate deal-related and financial information – Need press release of the

deal, 8K, 10K, and 10Q. Type of payment: cash, stock, cash & stock.

c. Spread financial information, ratios and multiples – Get transaction TEV

(implied) & transaction MVE (implied)

d. Benchmark precedent transactions

e. Determine implied valuation

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).


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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. Discounted Cash Flow (DCF)

a. Spread historical financial statements (input historicals) and derive

historical ratios, trends and variables (drivers of future performance;

margins and growth rates). Project financial statements (proforma).

Revolver modeling to link IS, BS, and SCF

b. Project free cash flow (FCF)

c. Determine Weighted Average Cost of Capital (WACC) – Discount rate

Cost of equity:

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. With beta, we are

putting capital structure on unlevered beta mean and median of comps to

calculate WACC of own company.

Cost of debt: weighted average of tranches of debt tax effected; found in

10K. Rates from the notes. If private company, get from clients the

tranches and to get rates, go to DCM to get approximation.


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Cost of equity 20% to 25% in private markets. No use of debt is an

inefficient use of capital. Trying to optimize the D/E ratio to minimize cost

of financing.

d. Determine terminal value – EBITDA multiple which is going to be almost

80% of the company value. Terminal value = LTM multiple from comps x

EBITDA. Perpetuity growth rate should be 2.5% to 3% and should not be

larger than the size of the GDP of the country

e. Calculate net present value (NPV) and determine implied valuation

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.

IB interviews test you on DCF. Everything else that you know is a bonus.

Do DCF to find yield to decide whether or not to invest principal.

Creating value:

$ dollars of value increased by…

Changing multiple on valuation

Decreasing the discount rate


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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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For each valuation methodology we are going to do a sensitivity analysis to

determine a valuation range:


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Chapter 18: The Market for Perpetuities

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 EBITDA multiple for the perpetuity increasing 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:

How to Sell a Perpetuity?

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


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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

Sensitize the variables for a range of values to see effect on valuation

(sensitivity table)

Strategics and financials establish their filter criteria (hurdle IRRs for financial

and minimum EPS increase for strategics) and test targets against this filter

Strategics have a range of values with standalone value as the lower end and

valuation with all synergies on the higher end. A deal happens usually in the

middle


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Chapter 19:

Investment Banking

Since M&A (Mergers & Acquisitions) is the core product of investment

banking, discussions around investment banking typically relate to M&A. M&A

is the selling of a perpetuity in the form of a corporation to either a financial or

strategic buyer. Financial and strategic buyers have what is known as

investment/corporate M&A mandates which detail the size and industry of

prospective targets for acquisition. The investment banker takes these

mandates and matches them with targets and takes a fee for doing so.

Investment bankers typically focus on one industry and provide what is known


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as coverage by building an index of public companies and tracking changes in

targets relative to the index in terms of:

Revenue

EBITDA

Multiples

The investment banker monitors trends in these variables and determines the

optimal time to sell (when multiples are strong) or acquire (when multiples are

weak) and advises target management accordingly. When a target agrees to

sell via an investment banker, this relationship is known as a sell-side mandate

and an M&A process will be led by the investment banker. During the M&A

process, there are definite steps and deliverables including a teaser, CIM, and

management presentation. The M&A process can include many prospective

buyers (broad auction) or few prospective buyers (targeted or negotiated sale).

The investment banking core product is M&A. As such, the investment

banker’s role is to aid in the growth of perpetuities via an inorganic strategy

(merger, acquisition).

The real work of M&A is origination, matching and deal-structuring. Financial

modeling and valuation is merely for decision support and deals often get

done simply based upon precedent transactions analysis. Thus, the priority of

the investment bankers is to obtain a base level understanding of financial

modeling & valuation but then to immediately start originating sell side and

buy side mandates.

Investment bankers explore strategic alternatives (value creation opportunities)

with corporation’s CEO’s/owners.

Notes:

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


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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

Run the M&A process

Traditional Investment Bank Responsibilities:

Junior Banker:

Industry coverage

Comps and comp transactions (where are multiples)

Valuation

Mid Banker:

Operating model creation + tailored to transaction client (LBO or

Merger)

Manage M&A process

Senior Banker:

Revenue center

Personal contacts at firms to win engagements


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Chapter 20:

How to Become an Investment

Banker Methodology

The following is the How to Become an Investment Banker Methodology:

1. Coverage

a) Index building

b) Vertical report

c) Vertical newsletter

2. Target screen & origination

3. Mandate/target matching

4. Deal structuring

5. Buyer/seller meeting logistics

6. Adjusted EBITDA calculation

7. Valuation

8. Offer analysis

9. Purchase agreement drafting/structuring

10. Due diligence data room

11. Closing & flow of funds

Decide on the industry/industries that you will cover, read/research the value

themes/players/multiples in the industry on the following levels:

1. Large cap


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2. Mid cap

3. Small cap

4. Middle market

5. Lower middle market

Pick an initial vertical and sub-vertical to cover. With AltQuest Group, our initial

coverage groups were the following:

1. Manufacturing

2. Software


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. Manufacturing

a. Durable consumer

b. Non-durable consumer

c. Aerospace & defense

d. Building products

e. Industrial

f. Medical

2. Software

a. Traditional software

b. SAAS

c. Internet


a. Education & Training

b. Business Process Outsourcing

c. Facility Services and Industrial Services

d. Human Resources

e. Information Services

f. Marketing Services

g. Real Estate Services

h. IT Services


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i. Specialty Consulting

4. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

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

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 sub-

vertical trends in margins, multiples, and M&A.

After establishing one's coverage and then building an index for the vertical

and sub-vertical as well as establishing relationships with strategic and

financial buyers within the vertical and sub-vertical, the investment banker may

begin advising targets on their strategic alternatives using information gleaned

from the vertical and sub-vertical indices. Regarding the vertical index and sub-

vertical index, the investment banker ultimately tracks trends in:

Growth rates

Margins


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Debt to Equity

Multiples

The investment banker takes the index and establishes tiers which turn into

peer groups. This is why we pull public comps; to benchmark a target against

the comps. By comparing a target's level of performance to it's peers and the

industry in general the investment banker can determine when it is ideal to exit

the business (when multiples are strong) and when it is not (when multiples are

weak). This is how investment bankers advise on strategic alternatives.

Getting Started in Investment Banking

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).

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.

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


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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

2 closed M&A deals

$110,000 in M&A fees received

The statistics assume that you will be working full time at 40 hours per week

and not working on the weekends.

Regarding fees, here is a simplified understanding of fee structure for sell side

engagements. The key to remember here is that you do not make your money

when you quote your fee, you make your money when you close the deal. The

point is that I would rather win an engagement and give up 1% to 2% of the

fee than have the seller think that I am not being fair. The Lehman scale

simplifies this a bit but often times the seller will want to know the exact % that

they will be paying you.

Large cap – Lehman scale

Mid cap – Lehman scale

Small cap – Lehman scale

Middle market – Double Lehman structure

Lower middle market – 3% to 10%


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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

write large checks ($100 million or more) also participate in this space, though


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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.

It is important for the investment banker to have a strong understanding of

multiples in the M&A marketplace in general and then in his/her sector and

sub-sector. In general in the middle market, we typically see 7x - 7.5x EBITDA

for companies that are larger than $25M in TEV. For companies that are smaller

than $25M in TEV, we typically see 5x - 5.5x EBITDA. There are adjustments

that need to be made for size and predictability of revenues as well as for

certain sectors (ex. software).


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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 sub-

sector. 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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These are EBITDA multiples for transactions in the middle market:

Finally, we have EBITDA multiples for transactions in the upper middle market:

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).


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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:

Finally, we see a chart depicting activity for the buyers of perpetuities:


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Part XII:

Investment Banking

Coverage Methodology

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 29:

Investment Banking Coverage

Methodology

First, the investment banker is going to choose what size of companies he/she

is going to cover (ex. public co's, middle market, lower middle market). From

there, the investment banker chooses an initial vertical and sub-verticals to

cover. With AltQuest Group, our initial coverage groups were the following:

1. Manufacturing

2. Software


4. Healthcare



index and the changes in the index are going to provide a measuring stick

within which to evaluate targets against.

It is important for the investment banker to have a strong understanding of

multiples in the M&A marketplace in general and then in his/her sector and

sub-sector. In general in the middle market, we typically see 7x - 7.5x EBITDA

for companies that are larger than $25M in TEV. For companies that are smaller

than $25M in TEV, we typically see 5x - 5.5x EBITDA. There are adjustments

that need to be made for size and predictability of revenues as well as for

certain sectors (ex. software).

For those just getting started in investment banking, it is preferable to start

with the lower middle market and middle market building relationships with


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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.

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. Industry macroeconomics

a. Industry spending

b. Sub-sector spending

c. Stock market performance of industry

II. Public sub-sector financial and valuation performance

a. Sub-sector index

b. Sub-sector index: financial performance

c. Sub-sector index: public market multiples

d. Sub-sector index by product category

e. Sub-sector index by product category: financial performance

f. Sub-sector index by product category: public market multiples

III. Industry M&A Market Update

a. Industry M&A deal volume and spending

b. Industry M&A exit multiples

c. Sub-sector M&A deal volume and spending

d. Sub-sector M&A exit multiples

e. Sub-sector M&A deal volume by product category

f. Sub-sector M&A exit multiples by product category

IV. Appendix

a. Sub-sector index key metrics

b. Sub-sector index key metrics by product category

c. Industry most active buyers

d. Sub-sector most active buyers

e. Sub-sector most active buyers by product category


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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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131


132


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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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136


137


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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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140


141


142


143


144


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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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Part XIII:

M&A Origination

Methodology

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:

M&A Origination Methodology

The M&A origination methodology is the following:

1. Determine coverage industries and sub-sectors

2. Build industry and sub-sector index

3. Pull national screens for the coverage area from

Salesgenie

4. Collect emails for CEOs/owners from Salesgenie and

RocketReach.co

5. Origination email to identify target considering selling

and get price expectations

6. Obtain sell side mandate

7. If cannot, develop buyer list and pitch M&A idea to them

in a buy side capacity clarifying that the target is not

running a process and that you do not have the mandate

but that you have been in talks with their CEO/owner. The

target is willing to listen to reasonable offers


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Chapter 24:

Mandate/Target Matching

Methodology

After determining one’s coverage and then initiating coverage in the form of

index-building, it is important for the investment banker to then begin

matching investment mandate’s of strategic and financial buyers to targets

within the investment banker’s coverage. The Mandate/Target Matching

Methodology is the following:

1. Build relationships with strategic and financial buyers in a given industry

sector or subsector

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. Begin emailing and calling CEO/owners and soliciting interest in taking an

offer on their business from a financial or strategic buyer

5. Structure as a sell-side engagement or a buy-side engagement depending

on CEO/owner’s level of interest in selling

6. Collect historical financial data for the last three years

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 buyer’s 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. Majority vs. Minority II. Cash vs. Stock vs. Cash & Stock III. Seller financing IV. Earn out V. Seller stays on as management vs. consulting agreement for shorter

term


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Part XIV: M&A Process

When the owner of a perpetuity has decided to grow inorganically or exit the

perpetuity, the M&A process must be executed/run.


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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.

The CIM

Executive summary

Company history

Sales process and/or manufacturing capabilities


155

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

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.


156

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 buyer’s 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


157

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.)

Pitchbook Table of Contents (exploring strategic alternatives to win a

mandate):

I. Executive summary

II. Industry specific market update (discuss control premiums and

multiples)

III. Review of company’s strategic priorities

IV. Potential strategic targets

a. Vertical I

b. Vertical II

c. Vertical III

Sell side after winning the mandate:


158

I. Discuss and demonstrate knowledge of buyer universe (strategic vs.

financial)

II. Discuss valuation range (“I believe that you can get $_____, providing

that these things hold true”)

III. Process and timing

IV. Tax consequences

V. What is going to happen to key management and employees

Confidential Information Memorandum (CIM) Table of Contents:

I. Executive summary

II. Key investment considerations

III. Growth opportunities

IV. Industry overview

V. Company overview

a. Overview

b. Products and services

c. Sales and marketing

d. Operations

e. Organization

VI. Financial overview

Confidentiality – Discuss in terms of project name, never mention name of

company. “No comment” and refer press to PR department.

M&A Banker’s Role: M&A banker is hired to run a process:

1. Defining exit options and strategies (4 types: auction process, controlled

sale, targeted high level solicitation, closed negotiation)

2. Valuation

3. Recast financials

4. Presentation and packaging

5. Buyer qualifications

6. Marketing

7. Management coaching

8. Due diligence facilitation (data room)

9. Price and contract negotiation

From 100 buyer universe, narrow it down to 20 to 30 target buyers


159

Auction Process:

100-150 companies initial call

4 months; 6-12 months actual

Initial call interest, then send teaser

If interested after teaser, sign NDA, send CIM

Controlled Sale:

10-12 companies

4 months, 6-8 months actual

Targeted High Level Solicitation:

4-5 companies

2-4 months

Closed Negotiation:

1-2 parties

1-3 months

Regarding valuation, the investment banker will form the story which is either:

I. Growth story

II. Well operating story

Presentation and Packaging

CIM (1st round):

Week 1: interviews with CEO, CFO

2-3 weeks to create

70, 80, 90 pages

Teaser (1st round)

Management presentation (2nd round) – all info in CIM

Buyer Qualification:

Finalize to list of 50, bankers begin making phone calls

Marketing:

Sign NDAs, send CIM


160

Weekly calls with client to update (buyer list updates)

Pitching:

To win new business. Pitching can take years. This is ultimately deal sourcing

with MDs calling on clients for 10-15 years.

Bake Off to Win Mandate:

To win sell side mandate there are 9 to 10 banks with 2 to 3 banks in the next

round. They present to management and the board.

The Pitchbook to Win Business:

I. Intros and quals

II. Industry overview

III. Capital market overview (capital markets and products perspective (ex.

M&A and IPO))

IV. Company and situation overview

V. Valuation (football field)

VI. Process

VII. Buyers/investors


161


162


163


164

Part XV: Investment Bank

Management

Since the M&A market is so fragmented in the middle market, it may become

necessary for the investment banker to run his own M&A practice.


165

Chapter 27:

How to Build a Boutique Investment

Bank

At Investment Banking University, we are often asked , "How to build a

boutique investment bank?", so we created a methodology for doing so

consistent with that which built AltQuest Group (www.AltQuest.com), the

middle market boutique investment bank. This methodology is known as the

Boutique Investment Bank Methodology which goes as follows:

1. Decide on IB product (M&A, capital-raising, growth advisory)

2. Decide on size of market to cover (public co's, middle market, lower

middle market)

3. Decide on industry coverage (AltQuest's coverage is broken down

between Healthcare, Manufacturing, Software, and Business Services)

4. Break down industry into sub-verticals to cover

5. Build indices for industry and sub-verticals made up of public co's

6. Utilize Coverage & Origination Methodology to advise targets on

strategic alternatives

7. Utilize Mandate/Target Matching Methodology to match strategic and

financial buyers' mandates to targets

8. Gather financials, recast & IB deliverables (adjusted EBITDA, valuation,

teaser, CIM, management presentation)

9. Offer analysis

10. Purchase agreement drafting/structuring

11. Due diligence data room

12. Closing & flow of funds


166

Decide on the industry/industries that you will cover, read/research the value

themes/players/multiples in the industry on the following levels:

1. Large cap

2. Mid cap

3. Small cap

4. Middle market

5. Lower middle market

Pick an initial vertical and sub-vertical to cover. With AltQuest Group, our initial

coverage groups were the following:

1. Manufacturing

2. Software


4. Healthcare



AltQuest Group coverage is broken down in the following manner:

5. Manufacturing

a. Durable consumer

b. Non-durable consumer

c. Aerospace & defense

d. Building products

e. Industrial

f. Medical

6. Software

a. Traditional software

b. SAAS

c. Internet


a. Education & Training

b. Business Process Outsourcing

c. Facility Services and Industrial Services

d. Human Resources


167

e. Information Services

f. Marketing Services

g. Real Estate Services

h. IT Services

i. Specialty Consulting

8. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

The indices for AltQuest Group look like the following:

1. Manufacturing

a. AltQuest Durable Consumer Index

i. Newell Brands Inc. NYSE:NWL

ii. Whirlpool Corp. NYSE:WHR

iii. Hanesbrands Inc. NYSE:HBI

iv. Gildan Activewear Inc. NYSE:GIL

v. Brunswick Corporation NYSE:BC

vi. Tupperware Brands Corporation NYSE:TUP

vii. G-III Apparel Group, Ltd. NasdaqGS:GIII

viii. La-Z-Boy Incorporated NYSE:LZB

ix. Culp, Inc. NYSE:CFI

x. Flexsteel Industries Inc. NasdaqGS:FLXS

xi. Johnson Outdoors Inc. NasdaqGS:JOUT

xii. CSS Industries Inc. NYSE:CSS

xiii. Delta Apparel Inc. AMEX:DLA

xiv. Escalade Inc. NasdaqGM:ESCA

xv. Black Diamond, Inc. NasdaqGS:BDE

b. AltQuest Non-Durable Consumer Index

i. Colgate-Palmolive Co. NYSE:CL


168

ii. General Mills, Inc. NYSE:GIS

iii. Campbell Soup Company NYSE:CPB

iv. The Clorox Company NYSE:CLX

v. Church & Dwight Co. Inc. NYSE:CHD

vi. Coty Inc. NYSE:COTY

vii. Edgewell Personal Care Company NYSE:EPC

viii. Avon Products Inc. NYSE:AVP

ix. Inter Parfums Inc. NasdaqGS:IPAR

c. AltQuest Aerospace & Defense Index

i. Honeywell International Inc. NYSE:HON

ii. The Boeing Company NYSE:BA

iii. General Dynamics Corporation NYSE:GD

iv. Airbus Group SE ENXTPA:AIR

v. Mohawk Industries Inc. NYSE:MHK

vi. TransDigm Group Incorporated NYSE:TDG

vii. Textron Inc. NYSE:TXT

viii. Spirit AeroSystems Holdings, Inc. NYSE:SPR

ix. B/E Aerospace Inc. NasdaqGS:BEAV

x. Bombardier Inc. TSX:BBD.B

xi. HEICO Corporation NYSE:HEI

xii. Curtiss-Wright Corporation NYSE:CW

xiii. Esterline Technologies Corp. NYSE:ESL

xiv. Triumph Group, Inc. NYSE:TGI

xv. RBC Bearings Inc. NasdaqGS:ROLL

xvi. Aerojet Rocketdyne Holdings, Inc. NYSE:AJRD

xvii. Ducommun Inc. NYSE:DCO

d. AltQuest Building Products Index

i. Mohawk Industries Inc. NYSE:MHK

ii. USG Corporation NYSE:USG

iii. Armstrong World Industries, Inc. NYSE:AWI

iv. Advanced Drainage Systems, Inc. NYSE:WMS

v. Apogee Enterprises, Inc. NasdaqGS:APOG

vi. Builders FirstSource, Inc. NasdaqGS:BLDR

vii. American Woodmark Corp. NasdaqGS:AMWD

viii. Gibraltar Industries, Inc. NasdaqGS:ROCK

ix. Continental Building Products, Inc. NYSE:CBPX

x. Insteel Industries Inc. NasdaqGS:IIIN


169

xi. Armstrong Flooring, Inc. NYSE:AFI

e. AltQuest Industrial Index

i. United Technologies Corporation NYSE:UTX

ii. Illinois Tool Works Inc. NYSE:ITW

iii. Eaton Corporation plc NYSE:ETN

iv. Ingersoll-Rand Plc NYSE:IR

v. Parker-Hannifin Corporation NYSE:PH

vi. Rockwell Automation Inc. NYSE:ROK

vii. Crane Co. NYSE:CR

viii. Hubbell Inc. NYSE:HUBB

ix. Colfax Corporation NYSE:CFX

x. Barnes Group Inc. NYSE:B

xi. Actuant Corporation NYSE:ATU

xii. Albany International Corp. NYSE:AIN

xiii. EnPro Industries, Inc. NYSE:NPO

xiv. Chart Industries Inc. NasdaqGS:GTLS

xv. Columbus McKinnon Corporation NasdaqGS:CMCO

f. AltQuest Medical Index

i. Medtronic plc NYSE:MDT

ii. DENTSPLY SIRONA Inc. NasdaqGS:XRAY

iii. Hologic Inc. NasdaqGS:HOLX

iv. Abaxis, Inc. NasdaqGS:ABAX

v. Analogic Corporation NasdaqGS:ALOG

vi. Integer Holdings Corporation NYSE:ITGR

vii. AngioDynamics Inc. NasdaqGS:ANGO

viii. Misonix, Inc. NasdaqGM:MSON

ix. Amedica Corporation NasdaqCM:AMDA

x. Allied Healthcare Products Inc. NasdaqCM:AHPI

2. Software

a. AltQuest Traditional Software Index

b. AltQuest SAAS Index

i. 2U TWOU NasdaqGS

ii. Amber Road AMBR NYSE

iii. Athenahealth ATHN NasdaqGS

iv. Bazaarvoice BV NasdaqGS

v. Benefitfocus BNFT NasdaqGS

vi. Callidus Software CALD NasdaqGM


170

vii. Castlight Health CSLT NYSE

viii. ChannelAdvisors ECOM NYSE

ix. Cornerstone OnDemand CSOD NasdaqGS

x. Covisint COVS NasdaqGS

xi. Ebix EBIX NasdaqGS

xii. FireEye FEYE NasdaqGS

xiii. Fleetmatics FLTX NYSE

xiv. HortonWorks HDP NasdaqGS

xv. HubSpot HUBS NYSE

xvi. inContact SAAS NasdaqCM

xvii. IntraLinks Holdings IL NYSE

xviii. J2 Global JCOM NasdaqGS

xix. Jive Software JIVE Nasdaq

xx. Live Person LPSN NasdaqGS

xxi. Marin Software MRIN NYSE

xxii. Medical Transcript MTBC NasdaqCM

xxiii. Medidata Solutions MDSO Nasdaq

xxiv. Netsuite N NYSE

xxv. New Relic NEWR NYSE

xxvi. Paylocity Holding PCTY NasdaqGS

xxvii. Q2 Holdings QTWO NYSE

xxviii. Qualys QLYS NasdaqGS

xxix. RealPage RP Nasdaq

xxx. RingCentral RNG NYSE

xxxi. Salesforce.com CRM NYSE

xxxii. Service-now.com NOW NYSE

xxxiii. SPS Commerce SPSC NasdaqGS

xxxiv. Tableau Software DATA NYSE

xxxv. Tangoe TNGO NasdaqGS

xxxvi. The Ultimate Software Group ULTI NasdaqGS

xxxvii. TrueCar TRUE NasdaqGS

xxxviii. Upland Software UPLD NasdaqGM

xxxix. Veeva Systems VEEV NYSE

c. AltQuest Internet Index

i. 1-800-FLOWERS.com FLWS NasdaqGS

ii. 58.com WUBA NYSE

iii. 8x8 EGHT NasdaqGS


171

iv. Akamai Technologies AKAM NasdaqGS

v. Alibaba BABA NYSE

vi. Amazon.com AMZN NasdaqGS

vii. Angie's List ANGI NasdaqGS

viii. Baidu.com BIDU NasdaqGS

ix. Bankrate RATE NYSE

x. Bitauto Holdings BITA NYSE

xi. BlueNile NILE NasdaqGS

xii. Brightcove BCOV NasdaqGS

xiii. BroadSoft BSFT NasdaqGS

xiv. Carbonite CARB NasdaqGS

xv. Care.com CRCM NYSE

xvi. ChangYou.com CYOU NasdaqGS

xvii. Chegg CHGG NYSE

xviii. Cimpress CMPR NasdaqGS

xix. Coupons.com QUOT NYSE

xx. Criteo SA CRTO NasdaqGS

xxi. Ctrip CTRP NasdaqGS

xxii. DemandMedia DMD NYSE

xxiii. eBay EBAY NasdaqGS

xxiv. eHealth EHTH NasdaqGS

xxv. Everyday Health EVDY NYSE

xxvi. Expedia EXPE NasdaqGS

xxvii. Facebook FB NasdaqGS

xxviii. GoDaddy GDDY NYSE

xxix. Google GOOG NasdaqGS

xxx. Groupon GRPN NasdaqGS

xxxi. GrubHub GRUB NYSE

xxxii. Harmonic HLIT NasdaqGS

xxxiii. Interactive Intelligence ININ NasdaqGS

xxxiv. LendingClub LC NYSE

xxxv. LifeLock LOCK NYSE

xxxvi. Limelight Networks LLNW NasdaqGS

xxxvii. LinkedIn LNKD NYSE

xxxviii. Liquidity Services LQDT NasdaqGS

xxxix. Mail.ru Group 61HE.L LSE

xl. MakeMyTrip MMYT NasdaqGS


172

xli. MaxPoint Interactive MXPT NasdaqGM

xlii. Mercadolibre MELI NasdaqGS

xliii. Mitel Networks MITL NasdaqGS

xliv. Monster Worldwide MWW NYSE

xlv. NCSoft 036570.KS KSE

xlvi. Netease NTES NasdaqGS

xlvii. Netflix NFLX NasdaqGS

xlviii. Overstock.com OSTK NasdaqGS

xlix. Pandora P NYSE

l. PetMed Express PETS NasdaqGS

li. Priceline PCLN NasdaqGS

lii. QuinStreet QNST NasdaqGS

liii. Renren RENN NYSE

liv. Rocket Fuel FUEL NasdaqGS

lv. SeaChange International SEAC NasdaqGS

lvi. ShoreTel SHOR NasdaqGS

lvii. Shutterfly SFLY NasdaqGS

lviii. Shutterstock SSTK NYSE

lix. SINA SINA NasdaqGS

lx. Sohu.com SOHU

lxi. Sonus Networks SONS NasdaqGS

lxii. Stamps.com STMP NasdaqGS

lxiii. Synacor SYNC NasdaqGS

lxiv. Tencent Holdings NNN1.F

lxv. The Rubicon Project RUBI NYSE

lxvi. TheStreet.com TST NasdaqGM

lxvii. Travelzoo TZOO NasdaqGS

lxviii. Lending Tree TREE NasdaqGS

lxix. Tremor TRMR NYSE

lxx. TripAdvisor TRIP NasdaqGS

lxxi. TubeMogul TUBE NasdaqGS

lxxii. Tucows TCX NasdaqCM

lxxiii. Twitter TWTR NYSE

lxxiv. VeriSign VRSN NasdaqGS

lxxv. WebMD Health WBMD NasdaqGS

lxxvi. Wix.com WIX NasdaqGS

lxxvii. XO Group XOXO NYSE


173

lxxviii. Xunlei XNET NasdaqGS

lxxix. Yahoo! YHOO NasdaqGS

lxxx. Yandex YNDX NasdaqGS

lxxxi. Yelp YELP NYSE

lxxxii. YuMe YUME NYSE

lxxxiii. YY YY NasdaqGS

lxxxiv. Zillow Z NasdaqGS


a. AltQuest Education & Training Index

i. Graham Holdings Company NYSE:GHC

ii. GP Strategies Corp. NYSE:GPX

iii. Pearson plc LSE:PSON

iv. John Wiley & Sons Inc. NYSE:JW.A

v. Capella Education Co. NasdaqGS:CPLA

vi. Bridgepoint Education, Inc. NYSE:BPI

vii. Strayer Education Inc. NasdaqGS:STRA

viii. K12, Inc. NYSE:LRN

ix. DeVry Education Group Inc. NYSE:DV

x. Career Education Corp. NasdaqGS:CECO

b. AltQuest Business Process Outsourcing Index

i. Wipro Ltd. BSE:507685

ii. Cognizant Technology Solutions Corporation

NasdaqGS:CTSH

iii. Sykes Enterprises, Incorporated NasdaqGS: SYKE

iv. Convergys Corporation NYSE: CVG

v. West Corporation NasdaqGS:WSTC

vi. TeleTech Holdings Inc. NasdaqGS:TTEC

vii. Virtusa Corporation NasdaqGS:VRTU

viii. Unisys Corporation NYSE:UIS

c. AltQuest Facility Services and Industrial Services Index

i. Cintas Corporation NasdaqGS:CTAS

ii. ABM Industries Incorporated NYSE:ABM

iii. SP Plus Corporation NasdaqGS:SP

iv. Aramark NYSE:ARMK

v. Iron Mountain Incorporated NYSE:IRM

vi. UniFirst Corp. NYSE:UNF

vii. FirstService Corporation TSX:FSV


174

viii. Waste Management, Inc. NYSE:WM

ix. Republic Services, Inc. NYSE:RSG

x. Waste Connections US, Inc. NYSE:WCN

xi. Stericycle, Inc. NasdaqGS:SRCL

xii. US Ecology, Inc. NasdaqGS:ECOL

xiii. Casella Waste Systems Inc. NasdaqGS:CWS

xiv. Covanta Holding Corporation NYSE:CVA

xv. Clean Harbors, Inc. NYSE:CLH

xvi. United Rentals, Inc. NYSE:URI

xvii. H&E Equipment Services Inc. NasdaqGS:HEES

xviii. CECO Environmental Corp. NasdaqGS:CECE

xix. Team, Inc. NYSE:TISI

d. AltQuest Human Resources Index

i. Robert Half International Inc. NYSE:RHI

ii. ManpowerGroup Inc. NYSE:MAN

iii. WageWorks, Inc. NYSE:WAGE

iv. On Assignment Inc. NYSE:ASGN

v. 51job Inc. NasdaqGS:JOBS

vi. Insperity, Inc. NYSE:NSP

vii. TriNet Group, Inc. NYSE:TNET

viii. Korn/Ferry International NYSE:KFY

ix. TrueBlue, Inc. NYSE:TBI

x. Kelly Services, Inc. NasdaqGS:KELY.A

xi. Kforce Inc. NasdaqGS:KFRC

xii. Automatic Data Processing, Inc. NasdaqGS:ADP

xiii. Heidrick & Struggles International Inc. NasdaqGS:HSII

e. AltQuest Information Services Index

i. Thomson Reuters Corporation TSX:TRI

ii. Acxiom Corporation NasdaqGS:ACXM

iii. Gartner Inc. NYSE:IT

iv. Alliance Data Systems Corporation NYSE:ADS

v. The Dun & Bradstreet Corporation NYSE:DNB

vi. comScore, Inc. NasdaqGS:SCOR

vii. Fair Isaac Corporation NYSE:FICO

viii. Experian plc LSE:EXPN

ix. Equifax Inc. NYSE:EFX

x. The Advisory Board Company NasdaqGS:ABC


175

xi. Verisk Analytics, Inc. NasdaqGS:VRSK

xii. CoreLogic, Inc. NYSE:CLGX

xiii. CoStar Group Inc. NasdaqGS:CSGP

xiv. FactSet Research Systems Inc. NYSE:FDS

xv. Moody's Corporation NYSE:MCO

xvi. Forrester Research Inc. NasdaqGS:FORR

xvii. IHS Markit Ltd. NasdaqGS:INFO

f. AltQuest Marketing Services Index

i. WPP plc LSE:WPP

ii. Omnicom Group Inc. NYSE:OMC

iii. Publicis Groupe SA ENXTPA:PUB

iv. The Interpublic Group of Companies, Inc. NYSE:IPG

v. MDC Partners Inc. NasdaqGS:MDCA

vi. InnerWorkings Inc. NasdaqGS:INWK

vii. Ipsos SA ENXTPA:IPS

viii. UBM plc LSE:UBM

g. AltQuest Real Estate Services Index

i. CBRE Group, Inc. NYSE:CBG

ii. CoStar Group Inc. NAsdaqGS: CSGP

iii. Jones Lang LaSalle Incorporated NYSE:JLL

iv. Realogy Holdings Corp. NYSE:RLGY

v. SouFun Holdings Ltd. NYSE: SFUN

vi. NM Kennedy-Wilson Holdings, Inc. NYSE:KW

vii. E-House (China) Holdings Limited NYSE:EJ

viii. RE/MAX Holdings, Inc. NYSE:RMAX

ix. Altisource Portfolio Solutions S.A. NasdaqGS:ASPS

h. AltQuest IT Services Index

i. International Business Machines Corporation NYSE:IBM

ii. Accenture plc NYSE:ACN

iii. Cognizant Technology Solutions Corporation

NasdaqGS:CTSH

iv. CGI Group Inc. TSX:GIB.A

v. Booz Allen Hamilton Holding Corporation NYSE:BAH

vi. Leidos Holdings, Inc. NYSE:LDOS

vii. Teradata Corporation NYSE:TDC

viii. EPAM Systems, Inc. NYSE:EPAM

ix. Interxion Holding NV NYSE:INXN


176

x. CACI International Inc. NYSE:CACI

xi. ManTech International Corporation NasdaqGS:MAN

xii. Virtusa Corporation NasdaqGS:VRTU

xiii. The Hackett Group, Inc. NasdaqGS:HCKT

xiv. Unisys Corporation NYSE:UIS

xv. ServiceSource International, Inc. NasdaqGS:SREV

i. AltQuest Specialty Consulting Index

i. CEB Inc. NYSE:CEB

ii. FTI Consulting, Inc. NYSE:FCN

iii. Exponent Inc. NasdaqGS:EXPO

iv. The Advisory Board Company NasdaqGS:ABC

v. Huron Consulting Group Inc. NasdaqGS:HUR

vi. ICF International Inc. NasdaqGS:ICFI

vii. Navigant Consulting Inc. NYSE:NCI

viii. Resources Connection, Inc. NasdaqGS:RECN

ix. CBIZ, Inc. NYSE:CBZ

4. Healthcare

a. AltQuest Dental Product Index

i. Zimmer Biomet Holdings, Inc. NYSE:ZBH

ii. DENTSPLY SIRONA Inc. NasdaqGS:XRAY

iii. Henry Schein, Inc. NasdaqGS:HSIC

iv. Align Technology Inc. NasdaqGS:ALGN

v. Patterson Companies, Inc. NasdaqGS:PDCO

vi. Cantel Medical Corp. NYSE:CMN

vii. BIOLASE, Inc. NasdaqCM:BIOL

viii. Milestone Scientific Inc. AMEX:MLSS

ix. Pro-Dex Inc. NasdaqCM:PDEX

b. AltQuest Dental Providers Index

i. Birner Dental Management Service OTCPK:BDMS

c. AltQuest Medical Devices & Products Index

i. Medtronic plc NYSE:MDT

ii. Abbott Laboratories NYSE:ABT

iii. Stryker Corporation NYSE:SYK

iv. Becton, Dickinson and Company NYSE:BDX

v. Boston Scientific Corporation NYSE:BSX

vi. Baxter International Inc. NYSE:BAX

vii. Intuitive Surgical, Inc. NasdaqGS:ISRG


177

viii. Zimmer Biomet Holdings, Inc. NYSE:ZBH

ix. St. Jude Medical Inc. NYSE:STJ

x. Edwards Lifesciences Corp. NYSE:EW

xi. CR Bard Inc. NYSE:BCR

xii. ABIOMED, Inc. NasdaqGS:ABMD

xiii. Integra LifeSciences Holdings Corporation NasdaqGS:IART

xiv. Wright Medical Group N.V. NasdaqGS:WMGI

xv. Johnson & Johnson NYSE:JNJ

d. AltQuest Medical Product Distribution Index

i. Danaher Corp. NYSE:DHR

ii. Stryker Corporation NYSE:SYK

iii. McKesson Corporation NYSE:MCK

iv. Cardinal Health, Inc. NYSE:CAH

v. AmerisourceBergen Corporation NYSE:ABC

vi. Henry Schein, Inc. NasdaqGS:HSIC

vii. Patterson Companies, Inc. NasdaqGS:PDCO

viii. Owens & Minor Inc. NYSE:OMI

ix. PharMerica Corporation NYSE:PMC

x. Aceto Corp. NASDAQGS:ACET

e. AltQuest Specialty Providers Index

i. Fresenius Medical Care AG & Co… NYSE:FMS

ii. DaVita HealthCare Partners Inc. NYSE:DVA

iii. MEDNAX, Inc. NYSE:MD

iv. AmSurg Corp. NasdaqGS:AMSG

v. HEALTHSOUTH Corp. NYSE:HLS

vi. Surgical Care Affiliates, Inc. NasdaqGS:SCAI

vii. American Renal Associates Holdings, NYSE:ARA

viii. Adeptus Health Inc. NYSE:ADPT

ix. LHC Group, Inc. NasdaqGS:LHCG

x. AAC Holdings, Inc. NYSE:AAC

f. AltQuest Pharma Services Index

i. CVS Health Corporation NYSE:CVS

ii. Express Scripts Holding Company NASDAQGS:ESRX

iii. Perrigo Company plc NYSE:PRGO

iv. Allscripts Healthcare Solutions, Inc. NasdaqGS:MDRX

v. Magellan Health, Inc. NasdaqGS:MGLN

g. AltQuest Practice Management Index


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i. WellCare Health Plans, Inc. NYSE:WCG

ii. HealthEquity, Inc. NasdaqGS:HQY

iii. Team Health Holdings, Inc. NYSE:TMH

h. AltQuest Provider Services Index

i. Cerner Corporation NasdaqGS:CERN

ii. Healthcare Services Group Inc. NasdaqGS:HCSG

iii. HMS Holdings Corp. NasdaqGS:HMSY

iv. The Advisory Board Company NasdaqGS:ABCO

v. Omnicell, Inc. NasdaqGS:OMCL

vi. Evolent Health, Inc. NYSE:EVH

vii. Providence Service Corp. NasdaqGS:PRSC

i. AltQuest Long Term & Behavioral Care Index

i. National HealthCare Corporation AMEX:NHC

ii. The Ensign Group, Inc. NasdaqGS:ENSG

iii. Civitas Solutions, Inc. NYSE:CIVI

iv. Acadia Healthcare Company, Inc. NasdaqGS:ACHC

v. SunLink Health Systems Inc. AMEX:SSY

vi. AAC Holdings, Inc. NYSE:AAC

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

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 sub-

vertical trends in margins, multiples, and M&A.






179



Growth rates

Margins

Debt to Equity

Multiples







How to Advise on Strategic Alternatives?







Growth rates

Margins

Debt to Equity

Multiples






180




181


182

Chapter 27:

Running the Boutique Investment

Bank

In building AltQuest’s 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 banker’s 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.

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.


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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.


184

Part XVI: Investment

Banking Deliverables

Investment banking requires a certain set of deliverables from coverage, to

origination through sell side representation.


185

Chapter 28:

Investment Banking Deliverables

Investment banking deliverables include the following in order from left to

right:

I. Pitchbook (origination)

II. Adjusted EBITDA

III. Valuation

IV. Teaser & CIM (sell side mandate)

V. Purchase Agreement


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Chapter 36: Adjusted EBITDA

After receiving the financials for the target, the investment banker must

calculate adjusted EBITDA. The calculation for EBITDA looks like the

following:


187


188

Chapter 37: Valuation

After arriving at adjusted EBITDA, the investment banker will determine

public comps and extrapolate a multiple for the target company

adjusting for size of the company. From there, precedent transactions

will be spread to determine a mean multiple. Finding the midpoint of the

valuation methodologies can be used for determining valuation but the

range is often communicated to the client or potential buyers:


189

Chapter 38: Teaser

After finding adjusted EBITDA and determining valuation, the investment

banker can build the marketing material for the target company which

includes a teaser and a CIM. The teaser can be broken down in the

following manner:


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Chapter 39: CIM (Confidential Information

Memorandum)

After creating the teaser, the investment banker goes into greater detail

in a marketing document called a CIM. This document is distributed to

buyers after the teaser and is for the serious buyers to do an in depth

analysis of the target.


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Chapter 39: Purchase Agreement

After the strategic or financial buyer decides to draft an LOI and proceed

with an acquisition of a given target, the purchase agreement will need

to be drafted. In the LMM, the investment banker may draft the

agreement himself/herself, but as transactions get larger, M&A attorneys

will be involved and take the lead with the creation of the purchase

agreement. The investment banker will stay actively involved in the

drafting of the agreement.


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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).


193

Part XVII:

How to Buy a Perpetuity?

On the buy-side, we are concerned with the purchasing of perpetuities.


194

Chapter 40:

The Principle of Investing

The principle of investing is to only invest in perpetuities or in risk free

assets. The key is to determine whether the company/opportunity is a

perpetuity or not. We are going to employ financial statement modeling

and valuation to make this determination. Financial statement modeling

begins with the building of the operating model of the company.

After determining whether the company/opportunity is a perpetuity,

strategic and financial buyers attempt to maximize the difference

between NPV (as measured by DCF) of the company/opportunity and

the contributed capital to acquire the opportunity. The difference

between these two is the real wealth transfer from the seller to the buyer

in today’s dollars. For example, if the NPV (i.e. intrinsic value) of a

company is $100M based upon a DCF and the acquirer actually

purchases the asset for $75M, the acquirer has received a transfer of

wealth from the seller to the buyer in the amount of $25M in today’s

dollars. This is the game of buying perpetuities.

Wealth Increase in Today’s Dollars From Opportunity/Company

(Margin of Safety) = DCF NPV – Contributed Capital

One can further maximize their returns by employing leverage in the

form of OPM (other people’s money). Ideally, the financial or strategic

buyer would continue to make such acquisitions using separate entities

(i.e. SPVs) allowing them to use debt financing for each as well as public

equity/LP capital.


195


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Chapter 41:

How to Become the Next Warren

Buffett

In order to become the next Warren Buffett, you should first understand

the nature of the perpetuity, which is the basis for finance and his

approach. Finance is the set of concepts, methodologies, and

optimization models associated with the perpetuity. The perpetuity can

be modeled with the following formula:


Where CF represents the benefit stream associated with the perpetuity

and r represents the discount rate associated with the perpetuity’s risk of

receiving the benefit stream.

All finance content can be broken down in relation to the perpetuity,

namely:



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Sell-side – the selling of perpetuities (investment bankers, Wall Street)


The principle of investing (and Buffett's approach) is to only invest in

perpetuities or in risk free assets. The key is to determine whether the

company/opportunity is a perpetuity or not. We are going to employ

financial statement modeling and valuation to make this determination.

Financial statement modeling begins with the building of the operating

model of the company.

Warren Buffett often speaks of a margin of safety. After determining

whether the company/opportunity is a perpetuity, strategic and financial

buyers attempt to maximize the difference between NPV (as measured

by DCF) of the company/opportunity and the contributed capital to

acquire the opportunity. The difference between these two is the real

wealth transfer from the seller to the buyer in today’s dollars. For

example, if the NPV (i.e. intrinsic value) of a company is $100M based

upon a DCF and the acquirer actually purchases the asset for $75M, the

acquirer has received a transfer of wealth from the seller to the buyer in

the amount of $25M in today’s dollars. This is the game of buying

perpetuities.

Wealth Increase in Today’s Dollars From Opportunity/Company (Margin

of Safety) = DCF NPV – Contributed Capital

So we are either going to purchase perpetuities or not invest (i.e. risk

free assets). The larger the perpetuity the better. Characteristics of a

perpetuity include:


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Low CAPEX as a % of EBITDA

Predictable if not recurring revenue model

Low levels of customer concentration

In terms of capital, you are going to want to have 'evergreen' sources of

capital, which means that there is no required timeline on the return of

capital. This is different than traditional private equity where LPs expect a

return of their original contributions in ~ 7 years. This forces GPs to sell

their portfolio companies in ~5 years from acquisition. Taking the

evergreen or Buffett approach allows one to accumulate the wealth

associated with the cash flows in the terminal value (of a DCF) and to use

the aggregate cash flows to purchase additional perpetuities. This is

what built Berkshire Hathaway.

Ultimately, you are going to want to either build a perpetuity yourself or

start a private equity search fund and acquire a small perpetuity and

then scale up from there to larger perpetuities. Using one perpetuity to

purchase additional perpetuities is what made Warren Buffett what he is

today.


199

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).


200

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. Platform – standalone company that is the basis for a strategy

including consolidation

2. Add on – additional company acquired that is “bolted” onto an

existing platform

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).


201

You can use the following as a general rule of thumb for a private equity

group:

15% IRR don’t 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. Locate financial information

2. Build the operating model

3. Input transaction structure

4. Complete LBO model with new structure

5. Run the LBO analysis

Notes:

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


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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

Proforma is AS IF after the transaction. Adjustments (changes) -> Proforma

(after changes)

Retained earnings: Old RE gets wiped out and new RE starts negative due to

financing fees.

Assumptions for projects:

Operating model start with base case without transaction

Sponsor upside case


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Sponsor downside case

Each case underneath line item in Assumptions tab

Use choose function to choose case

Key question: Is capital structure correct to allow you to pay down amortized

debt and other tranches of debt?

Look at net cash flow being generated and then determine if unsecured needs

to be PIK (if not enough net CF, then need PIK)

Talk to credit officer to get to capital structure that is optimal

Need to do accounting quality of earnings analysis to get to true EBITDA?

Financial sponsors want to see sensitivity table with highlighted options that

make sense. Sensitize entry multiple and exit multiple for IRR.

Reverse LBO: If I have a hurdle rate of x%, what is the max price I can pay for

the asset? Also get an implied entry multiple.

PE transaction rationale: Offense (growth) vs. defense (protecting territory

aka maintain margins)

Credit officer meeting:

25-30 page deck

Industry

Sponsor thesis

1 sheet summary of relevant financial statistics (one for each capital structure)

How quickly do you draw on revolver? Do not want to draw on revolver too

quickly

Credit officer looks at BS/CF statistics, leverage ratios, and interest coverage

statistics

Want to see debt ratios steadily going down; want a few turns of the company

being delivered

How quickly does this company get delivered?

PE work: 10, 20, 30 CIMs (confidential information memorandums) per month.


204

PE interview:

Interview 1 – Experience

Interview 2 – You have 2 hrs to build an LBO model and tell me whether or not

to invest


205

Chapter 44:

Strategic Buyer aka Corporation

(Merger)

There are over 3,000 strategic buyers in the world.

While each of these strategic buyers have different hurdle rates, each perform

a merger analysis to determine whether or not to purchase a perpetuity.

Merger Analysis:

1. Locate financial information

2. Build the standalone operating model for target & acquirer

3. Input transaction structure

4. Complete merger model with new structure

5. Run the merger consequences analysis (accretion/dilution, balance sheet

effects, contribution analysis)

Notes:

Merger Modeling

2 operating models put together with synergies

Don’t want to give away more than 50% of your synergies in your bid


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Accretion (EPS goes up with combined company)/dilution merger model to see

impact of acquisition on acquirer’s EPS

Offensive play vs. defensive play (protecting your market or size)

Dilution is proforma decrease in EPS. What causes dilution?

Buyer with higher PE multiple than target, then accretive as the target is less

expensive. If target has PE that is higher than the acquirer, always dilutive. If

premium paid causes PE of target to be higher, then dilutive.

Accretion/dilution always forward looking as it takes years to get synergies

Proforma ownership structure want to control 50.1% of company

Pretax synergies required to break even: How much synergies does acquirer

need to have for the transaction to be accretive:

((Proforma EPS – Acquirer EPS) x proforma shares outstanding) / (1 – tax rate))

We then take this number as a % of revenue or EBITDA of combined company

Know where your stock’s value is going:

If undervalued, then don’t use stock

If overvalued, then use stock to fund the transaction

Collars: When announce transaction, establish exchange ratio as the stock

price will move so have either:

A. Fixed value collar – favors target

B. Fixed share collar – favors acquirer

Sensitivity tables are used to help structure deals and in negotiations

Surviving entity (acquirer)


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Chapter 45:

Perpetuity Science & Portfolio

Theory

One should not diversify away from perpetuities but rather concentrate wealth

In them. Diversification is not to be among asset classes but among

perpetuities; asset classes that are not perpetuities In nature are commodities

and thus not actually investments.

Perpetuities are investments, commodities are not.


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Chapter 45:

How to Start a LMM Search Fund

For those just getting started in private equity and are looking to buy a

perpetuity, it is advisable to begin in the LMM with TEVs south of $25M. There

are fund sponsors dedicated to working with PE search funds. They partner

with operators that have access to perpetuities being sold by owners. The

typical structure to this process is to meet with the fund sponsor and

demonstrate the capabilities and plan for taking a perpetuity to the next

phase. An example of this would be taking a job shop and turning it into a

perpetuity or taking a perpetuity and turning it into a growing perpetuity. One

should be intimately familiar with Perpetuity Science and have participated on

at least one side of the perpetuity with a track record. The real key is access to

a quality perpetuity where the principle of investing can be applied.

The search fund does not commit capital directly but instead forms an

agreement that capital will be supplied providing that a target meets hurdle

criterion set forth by the fund sponsor. It is the LMM PE search fund’s

responsibility to find the target and negotiate with the owner.

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