perpetuity - the philosophy & science of the perpetuity

PERPETUITY: THE SCIENCE OF BUILDING, SELLING & BUYING PERPETUITIES

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Michael Herlache MBADoctor of Business Administration CandidateVP, M&A at AltQuest Group

PerpetuityThe 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 investment banking training program associated with this text, the Investment Banking University (www.InvestmentBankingU.com) course’s syllabus is based upon the content of this book.

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ContentsPERPETUITY SCIENCE:Part I: Perpetuity MethodologyChapter 1: What is Business?Chapter 2: What is a Perpetuity?

FOUNDATIONS OF VALUATION:Part I: Tracking Value (Accounting)Chapter 3: Tracking Value with AccountsPart II: Analyzing Value (Finance)Chapter 4: Analyzing Value with FinancePart III: Modeling ValueChapter 5: Finance with ExcelChapter 6: Financial Statement Modeling

BUILD-SIDE:Part I: How to Build a Perpetuity?Chapter 49: How to Build a Benefit Stream?Chapter 50: How to De-Risk the Benefit Stream?Chapter 51: The Value PerpetuityPart II: Perpetuity AnalysisChapter 52: How to Be a CEO?Chapter 53: How to Be a Consultant?Part III: Perpetuity Modeling & ValuationChapter 58: Valuation MethodologiesChapter 59: Framing ValuationPart IV: Perpetuity EngineeringChapter 54: How to Be an Engineer?Chapter 54: Knowledge EngineeringChapter 55: Content EngineeringChapter 56: Platform EngineeringPart V: Perpetuity ManagementChapter 57: Perpetuity ManagementChapter 61: Index Building & BenchmarkingChapter 62: Financial Data SourcesPart VI: The Market for PerpetuitiesChapter 60: The Market for Perpetuities

SELL-SIDE:Part I: How to Sell a Perpetuity?Chapter 18: Investment BankingChapter 19: How to Become an Investment Banker MethodologyPart II: The Middle MarketChapter 20: Middle Market BreakdownPart III: M&A MultiplesChapter 21: M&A MultiplesPart IV: Investment Banking Coverage MethodologyChapter 22: Investment Banking Coverage MethodologyChapter 23: Index Building & BenchmarkingChapter 24: Financial Data SourcesChapter 25: Industry or Sector NewsletterChapter 26: Industry or Sector ReportChapter 27: Rolodex BuildingPart V: M&A Origination MethodologyChapter 28: M&A Origination MethodologyPart VI: Mandate/Target Matching MethodologyChapter 29: Mandate/Target Matching MethodologyPart VII: Deal StructuringChapter 30: Deal StructuringPart VIII: M&A ProcessChapter 32: M&A ProcessPart IX: Investment Bank ManagementChapter 33: How to Build a Boutique Investment Bank?

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Chapter 34: Running the Boutique Investment BankPart X: Deliverables & CoverageChapter 35: Investment Banking DeliverablesChapter 36: Adjusted EBITDAChapter 37: ValuationChapter 38: TeaserChapter 39: CIM (Confidential Information Memorandum)

BUY-SIDE:Part I: How to Buy a Perpetuity?Chapter 40: The Principle of InvestingChapter 41: How to Be a Warren Buffett?Chapter 42: The Operating ModelChapter 43: The Financial Buyer aka Private Equity (LBO)Chapter 44: The Strategic Buyer aka Corporation (Merger)Chapter 45: Perpetuity Science & Portfolio TheoryChapter 46: How to Start a LMM Search Fund?

CASES:Part XVIII: CasesChapter 47: Cases

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PrefaceThere are many investment banking texts out there that claim that financial modeling and valuation is the core work of the investment banker. This is simply not the truth. The core work of the investment banker is origination, mandate/target matching, and deal structuring. It should follow that a text/course on investment banking should be based upon the same. It is the good fortune that the reader has encountered such a book/course. Investment Banking: M&A Origination, Execution, Financial Modeling & Valuation explains origination, mandate/target matching, and deal structuring (i.e. how investment bankers actually make their money).

For those new to investment banking you are first going to want to clarify whether you would like to work on the sell side for a few years or pursue a career in investment banking. The skills that you will need to get started in investment banking are different than those that you will need to have a long and successful career in investment banking. The role in investment banking transforms from one that is research, financial modeling & valuation based into one focused on origination and facilitating the M&A process. M&A (Mergers & Acquisitions) is the core product of investment banking, and the other products, advisory & capital-raising, simply support this. We founded Investment Banking University (www.InvestmentBankingU.com) to prepare students for both bulge bracket and middle market investment banking career opportunities.

We see a paradigm shift occurring in the field of investment banking. The idea that you need to spend three years of your life as an analyst doing 80+ hour workweeks building financial models to become an investment banker is a faulty paradigm. The real value add of an investment banker is not financial modeling & valuation, but rather origination, mandate/target matching, and deal structuring. You don’t need Goldman Sachs’ permission to be an investment banker just like you don’t need McKinsey’s permission to be a consultant. Investment banking for private companies in the middle market is a great way to build your initial coverage and career as an investment banker without sacrificing a family life or your health.

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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 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.

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 create2. How to advance a perpetuity to the next phase3. Perpetuities that should be exited from4. Perpetuities that should be purchased

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

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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?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:

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.

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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 MethodologyConsistent 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 Business?When thinking about business we have to acknowledge the sources and uses associated with a corporation where sources represent the capital markets and uses represents the asset mix of the corporation. Business can be thought of as a process where the output is a benefit stream with a given level of variability. This benefit stream with a given level of variability is known as a perpetuity. Thus, the model for business is the perpetuity.

Since we know that a perpetuity is the model for business (the integration of industry and the capital markets), we can then build a body of knowledge around the perpetuity which serves as the basis for the science of the perpetuity (Perpetuity Science):

The body of knowledge known as Perpetuity Science can be broken down in the following manner:

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The rest of this text goes into detail regarding the taxonomy of Perpetuity Science and investigates each component.

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Chapter 2: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:

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1. Perpetuity Philosophy

2. Perpetuity Science

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

Standard of Living: Perpetuities

The Goal To increase standard of living without sacrificing quality of life.

How to Get the GoalIn order to increase standard of living without sacrificing quality of life, one is to build, sell or buy perpetuities.

PerpetuityPerpetuities increase standard of living without sacrificing quality of life by possessing recurring revenue and automated work processes to achieve the revenue.

I. Building PerpetuitiesThe building of perpetuities is known as being on the build-side; commonly referred to as entrepreneurship or corporations.

II. Buying PerpetuitiesThe 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 PerpetuitiesThe selling of perpetuities is known as the sell-side. The players here are investment bankers (Wall Street).

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

ExcelIs the scientific computational tool of finance to aid us in the modeling and valuation of perpetuities.

Demand for PerpetuitiesThere is always demand for perpetuities and especially by institutional investors which means that the market for corporate control more closely mirrors the DCF (intrinsic value) of the perpetuity (corporation). Institutional investors can pay higher multiples in order to realize returns over longer periods of time.

Types of PerpetuitiesPerpetuities 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. Durablesb. Non-durables

II. Platforma. Digital

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b. PhysicalIII. Content

a. Educationalb. Entertainment

IV. Servicea. Analysisb. Allocationc. Engineeringd. Logisticse. Managementf. Advocacyg. Relationship

V. Infrastructurea. Private

i. Real estateb. 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:

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Risk (discount rate) on the following page:

Return:

Growth:

Margins (Cash flow):

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Multiples:

Business: The Science of the PerpetuityIntroduction to BusinessBusiness 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 Goal1. 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?

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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?

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 Perpetuityii. MVPiii. Value Perpetuityiv. Financial Perpetuityv. Growing Financial Perpetuityvi. Diversified

b. How to De-Risk the Benefit Stream?i. Customer Concentrationii. Owner Dependenceiii. 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)

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 VALUATIONIn 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 II: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 AccountsValueThe formula for value is:


Accounts and AccountingIn 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 & ExcelExcel is the software used to model the accounts of the enterprise and determine the valuation of the perpetuity (i.e. business).

Account Filings & Public Data10-K annual10-Q quarterly

Account Statements: P&LIncome statement (P&L):RevenuesCOGSGross ProfitOperating ExpensesEBITInterest CostEBTTaxesEarnings

Account Statements: Balance SheetAssets = Liabilities + Shareholder’s EquityTotal Assets = Total Liabilities + Shareholder’s EquityCurrent Assets + Long Term Assets = Current Liabilities + Long Term Liabilities + Value of Shares Previously Issued + Retained Earnings – Treasury Stock

Account Statements: Statement of Cash FlowsCF from OperatingCF from InvestingCF 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)

The following is a 10-K from Berkshire Hathaway:

The following is a 10-Q from Berkshire Hathaway:

The following is the IS from Berkshire Hathaway:

The following is the BS from Berkshire Hathaway:

The following is the SCF from Berkshire Hathaway:

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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 ValueStrategics, 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 ModelsTo 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

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

Analysis of Account StatementsAnalysis 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

The following is the adjusted financials for Berkshire Hathaway:

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Part VII:Modeling ValueContinuing 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 ExcelExpress 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 FinanceWrite down variables (defining the parameters of the decision)Absolute or relative values copying (=A1) (=$A$1) and formulasFunctions (=fx( ))Data tables (“sensitivity tables”)

Express Decisions with ExcelImplement financial analysis with Excel

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Using a Financial Model for Decision Making: The Investment DecisionAbility 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:

Assumptions (value drivers)Existing accounting statements (IS and BS)Projected financial statementsFree cash flow calculation (FCFs)Terminal value calculationValuation calculationSensitivity 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 DecisionAll 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 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.

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Wealth Maximizing DecisionsInvestment decision – What is it worth? NPV of strategic alternativeFinancing decision – What does it cost? IRR of financing alternative

Cash is KingWealth 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 ProfessionalThe 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 MarketsThe capital markets is made up of cash flows and discounts

Capital Markets and InformationInformation 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 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: PortfolioWhen 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 AlternativePut all variables (“value drivers”) at the top of the spreadsheetNever use a number where a formula will also workBlue for hard codes Black for links and outputs

Finance: Exchanging Value Through TimeAssets 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 alternativeVIII. Rate of Return vs. Cost of CapitalWhat 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))

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Cost of CapitalCalculate 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 ModelWhen 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 paymentVIII. Financing Alternatives: Direct ComparisonIRR of differential cash flows tells you the cost of the option

IRR tells you the cost of the financing alternative

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

Analyzing the Strategic Alternative: Sensitivity TableData 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 CostIn 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 AnalysisFor each strategic alternative, compute the NPV and IRR, then have decision rules for investing including:

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

Cost of Capital and Opportunity CostThe returns of similar investments should be used as the cost of capital

The Discount RateAn 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):

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

Value of EquityThe value of equity is the present value of all future dividendsSources & UsesUses SourcesFree Cash Flows WACC

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CAPM to get cost of equity

Accounting Statements: Statement of Cash FlowsThe 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. DCFMarket valuation:

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

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

Accounting Value vs. Finance ValueAccounting 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 DCFFree cash flow (FCF) calculations is DCF

Portfolio Analysis and the Capital Asset Pricing Model (CAPM)Discount rate is a measure of risk associated with:HorizonSafetyLiquidity

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 ReturnsEx Ante is the expected return

Ex Post is the actual returnVIII. 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 FrontierStatistics 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)

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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 PortfolioThe 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 & CAPMThe 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 PerformanceThe 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 PerformanceThe 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 diversifiedVIII. Security Market Line & Investment Performance ContinuedInvestment performance:

Risk adjusted performance; excess returns?

Risk Adjusted PerformanceMarket 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 PerformanceUse 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 ReturnExcess return is the investment’s spread over the one year treasury (i.e. risk free rate)

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

When regressing asset’s returns against the market portfolio, alpha measures excess returns over the market portfolio

Beta & R^2High beta is an aggressive stock

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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 MarketsIn efficient markets, there is no alpha and investments earn their risk-adjusted return

CAPM and the Cost of CapitalCAPM = 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 MarketsMarket efficiency and the role of information in determining asset prices

Publicly available information should be reflected in market price

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 formulasBe consistent with millions and billions (keep conventions the same)Footnote everything in presentationKeep 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 SCFb. Public information for company 10K, 10Qc. If private company, get audited financial statements provided by company

2. Adjust for non-recurrings3. Build cases into the operating model

a. Best caseb. Base casec. Worst cased. Disruption case

4. Build assumptions based upon historical trends in assumptions tab (margins and growth rates)5. Project LIBOR and interest rates

a. Spread over LIBORb. 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

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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 Capitala. 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 SCFb. AP goes up, need positive sign on SCFc. 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)?

The following is a financial statement model for Berkshire Hathaway:

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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/opportunity2. Methodology that answers key question3. Platform architecture consistent with methodology4. MVP (Minimum viable product) of platform5. Value Perpetuity6. Financial Perpetuity7. Growing Financial Perpetuity8. 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:

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1. Syndication:(Getting to PMT)Initial revenue generation

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

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

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. Syndication2. Project/job shop

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2. Perpetuity3. 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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Chapter 31:How to Build a Benefit Stream?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).

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 nature2. Key question associated with challenge/opportunity3. Develop methodology that answers the key question4. Build platform around the methodology5. 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.

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 email2. Methodology adds value for individual (based in reason) and thus the user decides to be a follower3. Followership of brand adds value enough so that when the 'ask' is made, the individual is willing to

experiment with usage4. Usage adds value enough so that the user becomes an active user5. Active usage adds value enough so that individual is willing to recommend others to become users6. 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 social networks including Instagram, Facebook, & Twitter to first advocate the startup's methodology:

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

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Chapter 33:The Value PerpetuityCommodity -> Finite Benefit Job -> Active Benefit Perpetuity -> Passive Benefit Perpetuity

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Part VIII:Perpetuity AnalysisOn 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 create2. How to advance a perpetuity to the next phase3. Perpetuities that should be exited from4. 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 compsII. Benchmark comps into Perpetuity Phases III. Build financial statement models for eachIV. Determine DCF, Comp Companies & Precedent Transactions valuation football fieldV. 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 Analysis can occur at three levels:

1. Vertical (Industry)

At the level of the industry, we can take the public comps as place them on the Market for Perpetuities chart:

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For example, we can take a look at the Oil & Gas vertical and see where the various players at:

2. Sub-Vertical

At the level of the industry, we can take the public comps as place them on the Market for Perpetuities chart:

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For example, we can take a look at the Oil & Gas machine manufacturing sub-vertical and see where the various players at:

3. Corporation

As discussed, a corporation is merely a portfolio of perpetuities. As such, we can map the corporation in terms of its perpetuities and see the stage of each individual perpetuity:

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An example of Perpetuity Analysis at the corporate level would be Berkshire Hathaway, which we have mapped below:

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

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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:

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

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.

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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 AnalysisII. Perpetuity BuildingIII. Perpetuity Management

Perpetuity Exit

Market Analysis

GDP

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

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’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.

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:

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)

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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 Perpetuity2. The Phases of the Perpetuity 3. The Different Sides of the Perpetuity

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:

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, 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:



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:

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3. The Different Sides of the Perpetuity:

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Part IX:Perpetuity ManagementOn 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 CompanyCompanies exist to create value

How Companies Create ValueCompanies 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

Valuation Drivers

The Role of the CEO

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Perpetuity Management

Valuation

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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 (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

Cash Flow

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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 goal3.Determine steps to get to next phase of the perpetuity4.Build Work Breakdown Structure (WBS) to get to next phase working backward from the next phase5.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)

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 transactionsa. Select universe of comp transactionsb. 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 transactionse. Determine implied valuation

Notes:

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20% to 25% control premium paid with the transaction multiple being an implied one based upon the valuation.

Determine whether the market is good or bad based upon whether people are paying good premiums (control premiums).

When a transaction occurs, update client on the latest transaction to show them impact on the control premiums being paid and implied multiple as well.

Point to the transaction comps that have the highest control premium.

4. 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 treasuryMarket risk premium = Rm – Rf. Refer to Ibbotson. Ultimately this is S&P returns over 70, 80, or 90 yearsBeta = 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.

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 valuationDecreasing 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)

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

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%.

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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 rangeIndividual – Desire 30% to 40% IRR, 3x EBITDAFinancial – 4x to 7x EBITDAStrategic – 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 rateSensitize 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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PERPETUITY: THE SCIENCE OF BUILDING, SELLING & BUYING PERPETUITIES 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 as coverage by building an index of public companies and tracking changes in targets relative to the index in terms of:

RevenueEBITDAMultiples

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 LBOEPS change and balance sheet effects for strategic in merger M&A

Run the M&A process

Traditional Investment Bank Responsibilities: Junior Banker:

Industry coverageComps 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 centerPersonal 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. Coveragea) Index buildingb) Vertical reportc) Vertical newsletter

2. Target screen & origination3. Mandate/target matching4. Deal structuring5. Buyer/seller meeting logistics6. Adjusted EBITDA calculation7. Valuation8. Offer analysis9. Purchase agreement drafting/structuring10. Due diligence data room11. 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 cap2. Mid cap3. Small cap4. Middle market5. Lower middle market

Pick an initial vertical and sub-vertical to cover. With AltQuest Group, our initial coverage groups were the following:

1. Manufacturing2. Software3. Business Services4. 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. Manufacturinga. Durable consumerb. Non-durable consumerc. Aerospace & defensed. Building productse. Industrialf. Medical

2. Softwarea. Traditional softwareb. SAASc. Internet

3. Business Servicesa. Education & Trainingb. Business Process Outsourcingc. Facility Services and Industrial Servicesd. Human Resourcese. Information Services

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f. Marketing Servicesg. Real Estate Servicesh. IT Servicesi. Specialty Consulting

4. Healthcarea. Dental Product b. Dental Providers c. Medical Devices & Products d. Medical Product Distributione. 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

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 emails30 sell side pitches (phone and in person)10 sell side engagements won4 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 emails50 sell side pitches (phone and in person)20 (+18 existing = 38 total engagements) sell side engagements won8 IOIs from strategic/financial buyers2 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 scaleMid cap – Lehman scaleSmall cap – Lehman scaleMiddle market – Double Lehman structureLower middle market – 3% to 10%

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Part XI:The Middle MarketThe 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:

Overview of Middle MarketPitchbook 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.

Lower Middle Market: $5 - $50 million of revenue;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.

Middle Market: $50 - $500 million of revenue; andWe define the core middle market as companies with $10 to $75 million of EBITDA.

Upper Middle Market: $500 million - $1 billion of revenue.Upper middle market companies typically have $75 million of EBITDA or more, and are often publicly held or sponsor backed.

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Part XII:M&A MultiplesIt 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 MultiplesSince 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:

These are EBITDA multiples for transactions in the middle market:

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

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Notice how the multiples increase as the size of the perpetuity increases due to the scarcity value of larger perpetuities (increased demand for large perpetuities and less of them).

The following is a chart depicting the average debt to equity breakdown for LBOs. You will notice that equity levels are steadily increasing, indicating a tighter credit market:

In this chart, you will see the average time that is it taking for deals to close. You will notice that the majority of transactions get done in the 5-9 weeks and 10-14 weeks timeframe:

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Next, the following is a chart that depicts the % of deals getting done with some aspect of an earnout, meaning portion of the purchase price contingent on future performance of the business:

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

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Part XII:Investment Banking Coverage MethodologyIt 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:


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 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 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 macroeconomicsa. Industry spendingb. Sub-sector spendingc. Stock market performance of industry

II. Public sub-sector financial and valuation performancea. Sub-sector indexb. Sub-sector index: financial performancec. Sub-sector index: public market multiplesd. Sub-sector index by product categorye. Sub-sector index by product category: financial performancef. Sub-sector index by product category: public market multiples

III. Industry M&A Market Updatea. Industry M&A deal volume and spendingb. Industry M&A exit multiplesc. Sub-sector M&A deal volume and spendingd. Sub-sector M&A exit multiplese. Sub-sector M&A deal volume by product categoryf. Sub-sector M&A exit multiples by product category

IV. Appendixa. Sub-sector index key metricsb. Sub-sector index key metrics by product categoryc. Industry most active buyersd. Sub-sector most active buyerse. Sub-sector most active buyers by product category

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Chapter 30:Index Building & BenchmarkingRegarding the vertical index and sub-vertical index, the investment banker ultimately tracks trends in:

Growth rates

Margins

Multiples

The investment banker takes the index and establishes tiers which turn into peer groups. This is why we pull comps, to build an index and benchmark against the comps.

The indexing and benchmarking that is done for a target company is going to serve as the basis for advising on strategic alternatives.

One should build indexes at the vertical level, then sub-vertical level and finally sub-vertical by product level.

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Chapter 31:Financial Data SourcesIf you are at a larger investment bank, you will have various paid data sources at your disposal. These include:

1.Bloomberg2.CapitalIQ3.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 NewsletterWhen maintaining coverage of an industry or sector, one prepares a newsletter to be send to prospective sell side clients in the industry or sector. Investment bankers use the index information to create this newsletter. The newsletter is about 2 to 6 pages.

For example, our AltQuest software industry coverage has produced the following newsletter which is sent to potential targets:

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Chapter 34:Industry or Sector ReportWhen maintaining coverage of an industry or sector, one prepares a report to be send to prospective sell side clients in the industry or sector. Investment bankers use the index information to create this report. The report goes more in depth than the newsletter. The report can be about 15-20 pages.

For example, our AltQuest software industry coverage has produced the following industry report which is sent to potential targets:

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Chapter 35:Rolodex BuildingAs 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:

Part XIII:

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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-sectors2. Build industry and sub-sector index3. Pull national screens for the coverage area from Salesgenie4. Collect emails for CEOs/owners from Salesgenie and RocketReach.co5. Origination email to identify target considering selling and get price expectations6. Obtain sell side mandate7. 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

Step 1: Database Utilization & Emails CollectedThe following email is used after pulling a county list from infousa.com or screening in Salesgenie and screening for revenue size ($2.5M +) and contact person (owner, CEO, President). Starting from the end of the database (Z), go through each account in the database and determine the business owner’s primary email address either from the database itself or by going to the website and acquiring the email address. Once 30 to 50 emails are obtained in one day, the process of emailing begins with the best practice below. The response rate to the emails should be approximately 3%.

Step 2: Email InquiryJohn,

It's a pleasure. I work with AltQuest Group right here in Fort Lauderdale. Would you be willing to take an offer on your business from a private equity group?

Please let me know.

Best,Michael

Step 3: Offer & Price InquiryAfter receiving initial response, you will then message them that you will email them when you have the offers and ask for the price of the business. The following is the email that should be sent:

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John,

Alright. I'll notify you when I receive the offers. What is your expectation regarding the price of your business?

Best,Michael

Step 4: Phone Call Request (by Sellers) or Meeting RequestAfter requesting price, some sellers will request a phone call and provide their contact information. If the seller provides price information, they reply with the following email:

John,

Alright. Let’s sit down and discuss next steps. Does Monday afternoon at 1pm work for you?

Best,Michael

If the seller accepts a meeting then the engagement is going to be sell side. If the seller does not accept the meeting and instead states that he would like you to represent the buyer then it will be buy side.

Sell side engagements get an RBCA. For buy side engagements, make a buyer list of the largest likely buyers including public companies then contact the head of M&A at these companies and ask:

Brian,

It's a pleasure. Would you care to take a look at a premier business group with a presence in multiple states? $40M revenues and $6M EBITDA.

Please let me know.

Best,Michael

After hearing back from the heads of M&A, let them know that the seller has requested that we represent the buyer and that the buy side fee will be 1.5%. You then ask them to accept in writing to the fee and once they do you can tell them the target name and then proceed to contact the seller and let them know that there is interest and ask what multiple range they are targeting for a sale. From there you send an advisor NDA and request financials. After giving financials to buyer, the company is assessed and a valuation range is determined and an IOI with this valuation range is submitted to the seller.

Step 5: Phone Call or MeetingPhone call:

During the phone call you will introduce yourself and state that you work on behalf of private equity firms in locating quality cash flowing companies and that is how you found their company. From there you will state that you want to get an initial understanding as to the price of the business. After the price of the business is found, ask how the business performed last year (revenue and net income). Finally, request a meeting at the end of the call (in person). The following is your outline for the phone call:

Price:Revenue:Net Income:Meeting:

Meeting:

During the meeting you will introduce yourself and state that you work on behalf of private equity firms in locating quality cash flowing companies and that is how you found their company. From there you will state that you want to get an initial understanding as to the price of the business. After the price of the business is found, ask how the business performed last year (revenue and net income). If this information is already known, you can move straight to giving the seller the signed NDA and explaining that any information that we receive is confidential and will not be shared without the approval of the business owner. Next you discuss the structure of the engagement that you are requesting a non-exclusive relationship whereby you only get paid when your buyers purchase the company. You can hand them the Registered Buyer Commission Agreement and have them sign right there or to

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have them review it. Finally, you ask if they have their financials on hand to view and you view them. You can ask to keep a copy to aid in recasting.

Step 6: Add Backs Calculated and Teaser CreatedAfter the meeting, you now have the financials or financial data needed to do add backs to get to an owner’s benefit or EBITDA number. From here you can input the recasted financials into the teaser and then complete the teaser based upon the general information (usually from the website and meeting conversation) of the business

Step 7: Contact Buyer List & Deal Put on M&A MarketplacesOnce the teaser is finished and financials recasted, you can contact the buyer list of strategic and financial buyers and put the deal on the M&A marketplaces including BizBuySell for smaller deals and Axial for larger deals.

Step 8: NDAs Signed with BuyersOnce inquiries are received from buyers from the M&A marketplaces, you will send NDAs to the buyers which they will then sign and send back to you.

Step 9: Teaser with Name Given to BuyerOnce the NDA is received, you can give the buyer the name of the business on the teaser and request an IOI from the buyer after reviewing the teaser and summary financials. The following is the email to accompany the teaser:

Buyer,

After reviewing the teaser and summary financials, please submit your initial indication of interest (IOI) and we will set up a buyer/seller meeting.

Best,Michael

Step 9: Teaser with Name Given to BuyerOften times a call will be requested by the buyer. On the phone the M&A professional finds out the following, taking notes on the call:

Industry interest:Questions (that the buyer has):Multiples that buyer is seeing or that they typically do:

Step 10: IOI from BuyerAfter reviewing the teaser and summary financials, the buyer will notify you that they are interested in purchasing the company (IOI).

Step 11: Buyer Seller MeetingAfter submitting the IOI, you will arrange an in person meeting with the seller which is called the buyer seller meeting. If the buyer is unavailable due to distance or timing, a phone call can be set up.

Step 12: Purchase Agreement Given to SellerAfter the buyer seller meeting, you prompt the buyer to submit a purchase agreement and then give this purchase agreement to the seller.

Step 13: Signed Purchase Agreement with Different TermsAfter the seller reviews the purchase agreement they will either sign the contract or counter with different terms. They are to sign the contract with the contingencies written into the contract.

Step 14: Enter Due DiligenceAfter receiving the counter, the buyer can sign the agreement with makes for a legally binding purchase agreement contingent to the items that will now be explored during the due diligence period. As items are explored, the buyer signs off that the items are no longer in question one by one.

Step 15: Complete Due DiligenceAfter all the items in the due diligence list are completed, due diligence is now completed and the closing can be scheduled. The documents are sent to the closing agent with instructions as to the M&A fee as well.

Step 16: Closing & Checks CutAfter the both the buyer and seller sign at the closing, the checks are cut and you receive your M&A fee and bring it to your bank.

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Chapter 24:Mandate/Target Matching MethodologyAfter 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 you3. Screen for companies that match the mandate(s) in Salesgenie and obtain CEO/owner emails and phone

numbers4. Begin emailing and calling CEO/owners and soliciting interest in taking an offer on their business from a

financial or strategic buyer5. Structure as a sell-side engagement or a buy-side engagement depending on CEO/owner’s level of interest in

selling6. Collect historical financial data for the last three years7. Introduce the financial and/or strategic buyer to the opportunity with the summary financial information and

have them sign an NDA8. 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 StructuringAfter 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. MinorityII. Cash vs. Stock vs. Cash & StockIII. Seller financingIV. Earn outV. Seller stays on as management vs. consulting agreement for shorter term

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Part XIV: M&A ProcessWhen 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 ExecutionOnce 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 ShortlistThe 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:

StrategicCompetitors - synergiesIndirect Competitor

FinancialHybrid strategic – financial buyer with asset in the sectorPure 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 TeaserThe 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/EBITDAIndicate type of transactionProfessional font (Times New Roman or Arial)Send as PDFDo not capitalize words or use flowery languageNo grammar or spelling errorsIndicate 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 propertyStable management teamsCulture

The NDAThe 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 & FinancialsAfter the NDA is signed, a teaser with the business name is then sent to the buyer along with the financials in PDF form.

The CIMExecutive summaryCompany history

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Sales process and/or manufacturing capabilitiesManagement 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 MeetingFirst conference callIn person meeting & tour the facilitiesIn 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.

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 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

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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 AgreementIncorporates 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 summaryII. Industry specific market update (discuss control premiums and multiples)III. Review of company’s strategic prioritiesIV. Potential strategic targets

a. Vertical Ib. Vertical IIc. Vertical III

Sell side after winning the mandate: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 timingIV. Tax consequencesV. What is going to happen to key management and employees

Confidential Information Memorandum (CIM) Table of Contents:I. Executive summaryII. Key investment considerationsIII. Growth opportunitiesIV. Industry overviewV. Company overview

a. Overviewb. Products and servicesc. Sales and marketingd. Operationse. 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. Valuation3. Recast financials4. Presentation and packaging5. Buyer qualifications6. Marketing7. Management coaching8. Due diligence facilitation (data room)9. Price and contract negotiation

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

Auction Process:100-150 companies initial call4 months; 6-12 months actualInitial call interest, then send teaserIf interested after teaser, sign NDA, send CIM

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Controlled Sale:10-12 companies4 months, 6-8 months actual

Targeted High Level Solicitation:4-5 companies2-4 months

Closed Negotiation:1-2 parties1-3 months

Regarding valuation, the investment banker will form the story which is either:I. Growth storyII. Well operating story

Presentation and PackagingCIM (1st round):Week 1: interviews with CEO, CFO2-3 weeks to create70, 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 CIMWeekly 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 qualsII. Industry overviewIII. Capital market overview (capital markets and products perspective (ex. M&A and IPO))IV. Company and situation overviewV. Valuation (football field)VI. ProcessVII. Buyers/investors

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Part XV: Investment Bank ManagementSince 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.

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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 cover5.Build indices for industry and sub-verticals made up of public co's6.Utilize Coverage & Origination Methodology to advise targets on strategic alternatives7.Utilize Mandate/Target Matching Methodology to match strategic and financial buyers' mandates to targets8.Gather financials, recast & IB deliverables (adjusted EBITDA, valuation, teaser, CIM, management

presentation)9.Offer analysis10. Purchase agreement drafting/structuring11. Due diligence data room12. 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 cap2. Mid cap3. Small cap4. Middle market5. Lower middle market

Pick an initial vertical and sub-vertical to cover. With AltQuest Group, our initial coverage groups were the following:


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:

5. Manufacturinga. Durable consumerb. Non-durable consumerc. Aerospace & defensed. Building productse. Industrialf. Medical

6. Softwarea. Traditional softwareb. SAASc. Internet

7. Business Servicesa. Education & Trainingb. Business Process Outsourcingc. Facility Services and Industrial Servicesd. Human Resources

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e. Information Servicesf. Marketing Servicesg. Real Estate Servicesh. IT Servicesi. Specialty Consulting

8. Healthcarea. Dental Product b. Dental Providers c. Medical Devices & Products d. Medical Product Distributione. 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. Manufacturinga. 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 Indexi. Colgate-Palmolive Co. NYSE:CL 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 Indexi. Honeywell International Inc. NYSE:HON ii. The Boeing Company NYSE:BA iii. General Dynamics Corporation NYSE:GDiv. 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 Indexi. Mohawk Industries Inc. NYSE:MHK ii. USG Corporation NYSE:USG iii. Armstrong World Industries, Inc. NYSE:AWI

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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 xi. Armstrong Flooring, Inc. NYSE:AFI

e. AltQuest Industrial Indexi. United Technologies Corporation NYSE:UTXii. 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:Bxi. 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 Indexi. 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. Softwarea. AltQuest Traditional Software Indexb. AltQuest SAAS Index

i. 2U TWOU NasdaqGSii. Amber Road AMBR NYSEiii. Athenahealth ATHN NasdaqGSiv. Bazaarvoice BV NasdaqGSv. Benefitfocus BNFT NasdaqGSvi. Callidus Software CALD NasdaqGMvii. Castlight Health CSLT NYSEviii. ChannelAdvisors ECOM NYSEix. Cornerstone OnDemand CSOD NasdaqGSx. Covisint COVS NasdaqGSxi. Ebix EBIX NasdaqGSxii. FireEye FEYE NasdaqGSxiii. Fleetmatics FLTX NYSExiv. HortonWorks HDP NasdaqGSxv. HubSpot HUBS NYSExvi. inContact SAAS NasdaqCMxvii. IntraLinks Holdings IL NYSExviii. J2 Global JCOM NasdaqGSxix. Jive Software JIVE Nasdaqxx. Live Person LPSN NasdaqGSxxi. Marin Software MRIN NYSExxii. Medical Transcript MTBC NasdaqCMxxiii. Medidata Solutions MDSO Nasdaqxxiv. Netsuite N NYSExxv. New RelicNEWR NYSExxvi. Paylocity Holding PCTY NasdaqGSxxvii. Q2 Holdings QTWO NYSExxviii. Qualys QLYS NasdaqGSxxix. RealPage RP Nasdaq

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xxx. RingCentral RNG NYSExxxi. Salesforce.com CRM NYSExxxii. Service-now.com NOW NYSExxxiii. SPS Commerce SPSC NasdaqGSxxxiv. Tableau Software DATA NYSExxxv. Tangoe TNGO NasdaqGSxxxvi. The Ultimate Software Group ULTI NasdaqGSxxxvii. TrueCar TRUE NasdaqGSxxxviii. Upland Software UPLD NasdaqGMxxxix. Veeva Systems VEEV NYSE

c. AltQuest Internet Indexi. 1-800-FLOWERS.com FLWS NasdaqGSii. 58.com WUBA NYSEiii. 8x8 EGHT NasdaqGSiv. Akamai Technologies AKAM NasdaqGSv. Alibaba BABA NYSEvi. Amazon.com AMZN NasdaqGSvii. Angie's List ANGI NasdaqGSviii. Baidu.com BIDU NasdaqGSix. Bankrate RATE NYSEx. Bitauto Holdings BITA NYSExi. BlueNile NILE NasdaqGSxii. Brightcove BCOV NasdaqGSxiii. BroadSoft BSFT NasdaqGSxiv. Carbonite CARB NasdaqGSxv. Care.com CRCM NYSExvi. ChangYou.com CYOU NasdaqGSxvii. Chegg CHGG NYSExviii. Cimpress CMPR NasdaqGSxix. Coupons.com QUOT NYSExx. Criteo SA CRTO NasdaqGSxxi. Ctrip CTRP NasdaqGSxxii. DemandMedia DMD NYSExxiii. eBay EBAY NasdaqGSxxiv. eHealthEHTH NasdaqGSxxv. Everyday Health EVDY NYSExxvi. Expedia EXPE NasdaqGSxxvii. Facebook FB NasdaqGSxxviii. GoDaddy GDDY NYSExxix. Google GOOG NasdaqGSxxx. Groupon GRPN NasdaqGSxxxi. GrubHub GRUB NYSExxxii. Harmonic HLIT NasdaqGSxxxiii. Interactive Intelligence ININ NasdaqGSxxxiv. LendingClub LC NYSExxxv. LifeLock LOCK NYSExxxvi. Limelight Networks LLNW NasdaqGSxxxvii. LinkedIn LNKD NYSExxxviii. Liquidity Services LQDT NasdaqGSxxxix. Mail.ru Group 61HE.L LSE

xl. MakeMyTrip MMYT NasdaqGSxli. MaxPoint Interactive MXPT NasdaqGMxlii. Mercadolibre MELI NasdaqGSxliii. Mitel Networks MITL NasdaqGSxliv. Monster Worldwide MWW NYSExlv. NCSoft 036570.KS KSExlvi. Netease NTES NasdaqGSxlvii. Netflix NFLX NasdaqGSxlviii. Overstock.com OSTK NasdaqGSxlix. Pandora P NYSE

l. PetMed ExpressPETS NasdaqGSli. Priceline PCLN NasdaqGSlii. QuinStreet QNST NasdaqGSliii. Renren RENN NYSEliv. Rocket Fuel FUEL NasdaqGSlv. SeaChange International SEAC NasdaqGSlvi. ShoreTel SHOR NasdaqGS

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lvii. Shutterfly SFLY NasdaqGSlviii. Shutterstock SSTK NYSElix. SINA SINA NasdaqGSlx. Sohu.com SOHUlxi. Sonus Networks SONS NasdaqGSlxii. Stamps.com STMP NasdaqGSlxiii. Synacor SYNC NasdaqGSlxiv. Tencent Holdings NNN1.Flxv. The Rubicon Project RUBI NYSElxvi. TheStreet.com TST NasdaqGMlxvii. Travelzoo TZOO NasdaqGSlxviii. Lending Tree TREE NasdaqGSlxix. Tremor TRMR NYSElxx. TripAdvisor TRIP NasdaqGSlxxi. TubeMogul TUBE NasdaqGSlxxii. Tucows TCX NasdaqCMlxxiii. Twitter TWTR NYSElxxiv. VeriSign VRSN NasdaqGSlxxv. WebMD Health WBMD NasdaqGSlxxvi. Wix.com WIX NasdaqGSlxxvii. XO Group XOXO NYSElxxviii. Xunlei XNET NasdaqGSlxxix. Yahoo! YHOO NasdaqGSlxxx. Yandex YNDX NasdaqGSlxxxi. Yelp YELP NYSElxxxii. YuMe YUME NYSElxxxiii. YY YY NasdaqGSlxxxiv. Zillow Z NasdaqGS

3. Business Servicesa. AltQuest Education & Training Index

i. Graham Holdings Company NYSE:GHCii. 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 Indexi. Wipro Ltd. BSE:507685ii. Cognizant Technology Solutions Corporation NasdaqGS:CTSH iii. Sykes Enterprises, Incorporated NasdaqGS: SYKEiv. 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 Indexi. 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 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

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xviii. CECO Environmental Corp. NasdaqGS:CECE xix. Team, Inc. NYSE:TISI

d. AltQuest Human Resources Indexi. 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 Indexi. Thomson Reuters Corporation TSX:TRI ii. Acxiom Corporation NasdaqGS:ACXMiii. 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 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 Indexi. 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 Indexi. 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 Indexi. 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 x. CACI International Inc. NYSE:CACI xi. ManTech International Corporation NasdaqGS:MAN xii. Virtusa Corporation NasdaqGS:VRTU xiii. The Hackett Group, Inc. NasdaqGS:HCKT

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xiv. Unisys Corporation NYSE:UIS xv. ServiceSource International, Inc. NasdaqGS:SREV

i. AltQuest Specialty Consulting Indexi. 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. Healthcarea. 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 Indexi. Birner Dental Management Service OTCPK:BDMS

c. AltQuest Medical Devices & Products Indexi. 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 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 Indexi. 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 Indexi. 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 Indexi. CVS Health Corporation NYSE:CVS ii. Express Scripts Holding Company NASDAQGS:ESRX iii. Perrigo Company plc NYSE:PRGO

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iv. Allscripts Healthcare Solutions, Inc. NasdaqGS:MDRX v. Magellan Health, Inc. NasdaqGS:MGLN

g. AltQuest Practice Management Indexi. WellCare Health Plans, Inc. NYSE:WCG ii. HealthEquity, Inc. NasdaqGS:HQY iii. Team Health Holdings, Inc. NYSE:TMH

h. AltQuest Provider Services Indexi. 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 Indexi. 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.


Growth rates

Margins

Debt to Equity

Multiples


How to Advise on Strategic Alternatives?


Growth ratesMarginsDebt to EquityMultiples

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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.

It is important for the M&A professional to plan for this extended time frame and not to get discouraged when deals blow up, get delayed, or change. All deals associated with an actual perpetuity close, it is just a matter of time.

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Part XVI: Investment Banking DeliverablesInvestment banking requires a certain set of deliverables from coverage, to origination through sell side representation.

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Chapter 28:Investment Banking Deliverables

Investment banking deliverables include the following in order from left to right:

I. Pitchbook (origination)II. Adjusted EBITDAIII. ValuationIV. Teaser & CIM (sell side mandate)V. Purchase Agreement

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Chapter 36:Adjusted EBITDAAfter receiving the financials for the target, the investment banker must calculate adjusted EBITDA. The calculation for EBITDA looks like the following:

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Chapter 37:ValuationAfter 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:

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Chapter 38:TeaserAfter 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 AgreementAfter 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).

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Part XVII:How to Buy a Perpetuity?

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

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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.

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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:



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

Build-side – the building of perpetuities (entrepreneurs, corporations)

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

Buy-side – the buying of perpetuities (private equity, corporate M&A)

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.

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Chapter 42:The Operating Model

We are going to start with the operating model previously built (integrated financial statement model). From here we are going to build on a transaction (ex. LBO, Merger, ECM, DCM).

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Chapter 43:Financial Buyer aka Private Equity (LBO)

There are over 4,000 financial buyers in the world. They command over $2 trillion in capital and are broken down into the following categories:

Leveraged buyoutGrowthMezzanine

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 consolidation2. 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). You can use the following as a general rule of thumb for a private equity group:

15% IRR don’t do the deal25% IRR do the deal30% 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 information2. Build the operating model3. Input transaction structure4. Complete LBO model with new structure5. 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 ModelPurchase price and considerationsSources and usesCap structure alternatives (sources)Integrate proforma BS into operating model (change in debt level and intangibles)IS, BS, and SCF projections integration

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IRR analysis for FS and hybrid debt lender (to find what is EBITDA, how much is cash and how much is debtSensitivity tablesCredit 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 & DCMIB fees – M&ALegal – LawyerOther 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 transactionSponsor upside caseSponsor downside caseEach case underneath line item in Assumptions tabUse 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 deckIndustrySponsor thesis1 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 quicklyCredit officer looks at BS/CF statistics, leverage ratios, and interest coverage statisticsWant to see debt ratios steadily going down; want a few turns of the company being deliveredHow quickly does this company get delivered?

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

PE interview: Interview 1 – ExperienceInterview 2 – You have 2 hrs to build an LBO model and tell me whether or not to invest

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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 information2. Build the standalone operating model for target & acquirer3. Input transaction structure4. Complete merger model with new structure5. Run the merger consequences analysis (accretion/dilution, balance sheet effects, contribution analysis)

Notes:

Merger Modeling2 operating models put together with synergies

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

Accretion (EPS goes up with combined company)/dilution merger model to see impact of acquisition on acquirer’s EPSOffensive 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 stockIf 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 targetB. 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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CASES

For those that have already built perpetuities and their representation, there is another category known as the buy-side. The buy-side is made up of financial (private equity) and strategic buyers (corporate).

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Chapter 40:FameLinked


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In terms of the methodology that is used by FameLinked, we have the FameLinked Methodology as described in the book, FameLinked: The Fame Network & Marketplace:

In terms of messaging on social networks to drive followership, we utilized branded photos to generate brand awareness:

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In terms of building the perpetuity we are building a following first based upon our methodology on various social platforms including Facebook, Twitter and Instagram:

In terms of converting followership into usership, the following are the conversion metrics after we started requesting that our followers become users:

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Chapter 40:Asiansbook


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In terms of the methodology that is used by Asiansbook, we have the Asiansbook Methodology as described in the book, Asiansbook: The Asian Network & Marketplace:


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Chapter 40:DegreeLinked


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In terms of the methodology that is used by DegreeLinked, we have the DegreeLinked Methodology as described in the book, DegreeLinked: The Student Network & Marketplace:


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perpetuity - the philosophy & science of the perpetuity

Economy & Finance