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INVESTMENT BANKING: M&A ORIGIINATION, EXECUTION, FINANCIAL MODELING & VALUATION 1

Investment Banking - How to Become an Investment Banker - Investment Banking University

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Page 1: Investment Banking - How to Become an Investment Banker - Investment Banking University

INVESTMENT BANKING: M&A ORIGIINATION, EXECUTION, FINANCIAL MODELING & VALUATION

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Page 2: Investment Banking - How to Become an Investment Banker - Investment Banking University

INVESTMENT BANKING: M&A ORIGIINATION, EXECUTION, FINANCIAL MODELING & VALUATION

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Michael Herlache MBA

Doctor of Business Administration Candidate

VP, M&A at AltQuest Group

Investment Banking M&A Origination, Execution, Financial Modeling & Valuation

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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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Contents

PERPETUITY SCIENCE:

Part I: Perpetuity Methodology

Chapter 1: What is Business?

Chapter 2: What is a Perpetuity?

Chapter 3: What You Learn in Business School vs. What You Should Learn in Business School

FOUNDATIONS OF VALUATION:

Part I: Tracking Value (Accounting)

Chapter 3: Tracking Value with Accounts

Part II: Analyzing Value (Finance)

Chapter 4: Analyzing Value with Finance

Part III: Modeling Value

Chapter 5: Finance with Excel

Chapter 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 Perpetuity

Part II: Perpetuity Analysis

Chapter 52: How to Be a CEO?

Chapter 53: How to Be a Consultant?

Part III: Perpetuity Modeling & Valuation

Chapter 58: Valuation Methodologies

Chapter 59: Framing Valuation

Part IV: Perpetuity Engineering

Chapter 54: How to Be an Engineer?

Chapter 54: Knowledge Engineering

Chapter 55: Content Engineering

Chapter 56: Platform Engineering

Part V: Perpetuity Management

Chapter 57: Perpetuity Management

Chapter 61: Index Building & Benchmarking

Chapter 62: Financial Data Sources

Part VI: The Market for Perpetuities

Chapter 60: The Market for Perpetuities

SELL-SIDE:

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Part I: How to Sell a Perpetuity?

Chapter 18: Investment Banking

Chapter 19: How to Become an Investment Banker Methodology

Part II: The Middle Market

Chapter 20: Middle Market Breakdown

Part III: M&A Multiples

Chapter 21: M&A Multiples

Part IV: Investment Banking Coverage Methodology

Chapter 22: Investment Banking Coverage Methodology

Chapter 23: Index Building & Benchmarking

Chapter 24: Financial Data Sources

Chapter 25: Industry or Sector Newsletter

Chapter 26: Industry or Sector Report

Chapter 27: Rolodex Building

Part V: M&A Origination Methodology

Chapter 28: M&A Origination Methodology

Part VI: Mandate/Target Matching Methodology

Chapter 29: Mandate/Target Matching Methodology

Part VII: Deal Structuring

Chapter 30: Deal Structuring

Part VIII: M&A Process

Chapter 32: M&A Process

Part IX: Investment Bank Management

Chapter 33: How to Build a Boutique Investment Bank?

Chapter 34: Running the Boutique Investment Bank

Part X: Deliverables & Coverage

Chapter 35: Investment Banking Deliverables

Chapter 36: Adjusted EBITDA

Chapter 37: Valuation

Chapter 38: Teaser

Chapter 39: CIM (Confidential Information Memorandum)

BUY-SIDE:

Part I: How to Buy a Perpetuity?

Chapter 40: The Principle of Investing

Chapter 41: How to Be a Warren Buffett?

Chapter 42: The Operating Model

Chapter 43: The Financial Buyer aka Private Equity (LBO)

Chapter 44: The Strategic Buyer aka Corporation (Merger)

Chapter 45: Perpetuity Science & Portfolio Theory

Chapter 46: How to Start a LMM Search Fund?

CASES:

Part XVIII: Cases

Chapter 47: Cases

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Preface

There are many investment banking texts out there that claim that financial modeling and valuation is the core work of

the investment banker. This is simply not the truth. The core work of the investment banker is origination,

mandate/target matching, and deal structuring. It should follow that a text/course on investment banking should be

based upon the same. It is the good fortune that the reader has encountered such a book/course. Investment Banking:

M&A Origination, Execution, Financial Modeling & Valuation explains origination, mandate/target matching, and deal

structuring (i.e. how investment bankers 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.

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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.

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

within each industry. The nature of the CF, r, value chain, and value being offered will be different. We investigate

each industry according to these variables by building an index for each industry and then sub-sector within the

industry.

After building the index and sub-sector indices we can then begin analyzing the value chain and leaders in each

part of the value chain. We then build financial statement models for the leaders in each section of the value chain

and understand the drivers of performance.

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We analyze each leader or target in relation to the phases of perpetuity in terms of where they are now and the next

steps that they can take to move to the next phase. In doing so, one begins to think in terms of being a CEO. The CEO’s

role is to bring the company/opportunity through the stages of the perpetuity by building recurring benefit streams (i.e.

cash flows) and at the same time de-risking those benefit streams. In doing so, the valuation of the perpetuity moves

from backward looking towards forward looking and the valuation is thus maximized (based upon a multiple of future

earnings).

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

As the perpetuity changes, the formula for valuing the perpetuity changes as well. There are five phases of perpetuity

building. As we move through the phases, the role of the owner of the perpetuity becomes more passive and the

valuation becomes larger due to size of EBITDA increasing, EBITDA multiple increasing, and the discount rate decreasing.

The perpetuity becomes less dependent on the owner to exist and run as an organizational structure is formed

coinciding with the division of labor, processes are automated, and revenue becomes recurring.

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Phases of the Perpetuity:

I. Syndication (Getting to PMT)

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

III. Perpetuity (From PMTi to CF/r)

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

V. Diversified (Perpetuity 1 + Perpetuity 2)

The goal of Perpetuity Science is the building, growing, management, exit and buying of perpetuities, so ultimately,

while learning about Perpetuity Science itself, we are also actively looking for:

1. Perpetuities to create

2. How to advance a perpetuity to the next phase

3. Perpetuities that should be exited from

4. Perpetuities that should be purchased

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Ultimately, Perpetuity Science transforms the individual from a one-dimensional functional worker into a multi-

dimensional value-creator able to execute on either of the three sides of the perpetuity; build side, sell side, or buy

side.

The Perpetuity Scientist vs. The Functional Specialist

The Perpetuity Scientist builds assets that generate passive benefits whereas the functional specialist uses labor to

generate active benefits. The quality of life of the perpetuity scientist is thus higher than the functional specialist. It is the

perpetuity scientist that drives the primary value with functional specialists simply serving a role in the process of

building or operating a perpetuity.

The Perpetuity Scientist has the three capabilities associated with the key question of each side of the perpetuity:

Build-Side:

Key Question: How to Build a Perpetuity?

Capability: The capability to build a perpetuity

Sell-Side:

Key Question: How to Sell a Perpetuity?

Capability: The capability to sell a perpetuity

Buy-Side:

Key Question: How to Buy a Perpetuity?

Capability: The capability to buy a perpetuity

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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 Methodology

Consistent with Perpetuity Science, the Perpetuity Methodology is broken down between the three aspects of the

perpetuity and also has the foundations of valuation to tie it all together:

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Chapter 1:

What is 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):

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

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.

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Perpetuity can thus be broken down into:

1. Perpetuity Philosophy

2. Perpetuity Science

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

Standard of Living: Perpetuities

The Goal

To increase standard of living without sacrificing quality of life.

How to Get the Goal

In order to increase standard of living without sacrificing quality of life, one is to build, sell or buy perpetuities.

Perpetuity

Perpetuities increase standard of living without sacrificing quality of life by possessing recurring revenue and

automated work processes to achieve the revenue.

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I. Building Perpetuities

The building of perpetuities is known as being on the build-side; commonly referred to as entrepreneurship or

corporations.

II. Buying Perpetuities

The buying of perpetuities is known as investment or being on the buy-side. The players here are Private Equity

(PE) or Corporate M&A Departments for major corporations.

III. Selling Perpetuities

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

The Lab of Perpetuities

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

Excel

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

Demand for Perpetuities

There is always demand for perpetuities and especially by institutional investors which means that the market for

corporate control more closely mirrors the DCF (intrinsic value) of the perpetuity (corporation). Institutional investors can

pay higher multiples in order to realize returns over longer periods of time.

Types of Perpetuities

Perpetuities can be created from companies that possess some aspect of recurring revenue and automated work

processes associated with product creation.

At a high level, types of perpetuities include:

I. Commodity

a. Durables

b. Non-durables

II. Platform

a. Digital

b. Physical

III. Content

a. Educational

b. Entertainment

IV. Service

a. Analysis

b. Allocation

c. Engineering

d. Logistics

e. Management

f. Advocacy

g. Relationship

V. Infrastructure

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a. Private

i. Real estate

b. Public

From the types of perpetuities, when applied to the main value themes of human existence we arrive at industries

associated with the perpetuities (according to Aswath Damodaran at NYU):

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:

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Margins (Cash flow):

Multiples:

Business: The Science of the Perpetuity

Introduction to Business

Business is the science of the perpetuity

Perpetuity value = CF / Discount rate

As you can see we can increase value by increasing CF (increasing revenues, decreasing COGS, SG&A) or decreasing the

discount rate.

The Corporation’s Goal

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

2. Become a growing perpetuity

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Value of growing perpetuity = CF / r – g

g decreases the discount rate

One should make the distinction between a perpetuity and a commodity. A commodity is associated with a single

benefit (cash flow) or a finite benefit stream, whereas the benefit stream of a perpetuity is continuous into the future.

What is Intrinsic Value?

Something is intrinsically valuable inasmuch as it is a perpetuity. Perpetuity provides certainty that the benefit

stream will be recurring in the future and is thus, the basis for intrinsic value. Perpetuities allow us to improve our

standard of living while not sacrificing quality of life by continually dealing with a problem/opportunity in nature

and yielding passive benefits.

How to Become Wealthy?

The secret that the wealthy know and the middle class is unaware of is the perpetuity. A perpetuity is an asset that

generates a benefit stream continuously into the future. This yields passive benefits rather than active benefits of

which the middle class works for. The wealthy know Perpetuity Science which is the science of building, selling &

buying perpetuities. There are three sides to the perpetuity:

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

a. How to Build a Benefit Stream?

i. Case for Value Perpetuity and Financial Perpetuity

ii. MVP

iii. Value Perpetuity

iv. Financial Perpetuity

v. Growing Financial Perpetuity

vi. Diversified

b. How to De-Risk the Benefit Stream?

i. Customer Concentration

ii. Owner Dependence

iii. Recurring Revenue

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

3. Buy-Side - How to Buy a Perpetuity? (private equity, corporate M&A)

Ultimately, the wealthy teach their children how to be 21st century perpetuity scientists rather than 20th century

functional specialists that will remain in the middle class.

In terms of order, the process is usually:

1. Begin on the build-side building a perpetuity which will take 3 to 5 years (initiate coverage and

syndicate within a vertical & sub-vertical)

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2. Enter the sell-side and begin in investment banking after university/business school (within existing

investment bank or start own boutique investment bank)

3. From the sell-side, take advantage of strong opportunities and leverage this into a LMM search fund

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Chapter 3:

What You Learn in Business School vs.

What You Should Learn in Business

School

Currently, in business school you learn in a siloed manner about the various

support functions in business, namely; accounting, finance, management,

marketing etc. without an integrated framework for industry and the capital

markets.

What you should learn in business school is the Perpetuity Body of Knowledge

including Perpetuity Philosophy and Perpetuity Science:

Perpetuity Philosophy:

1. Reason

2. Morality

3. Human Progress

4. Perpetuity: The Model for Human Progress

Perpetuity Science:

1. Nature of the Perpetuity

2. Sides of the Perpetuity

3. Phases of the Perpetuity

4. Perpetuity Analysis

5. The Market for Perpetuities

6. Perpetuity Modeling & Valuation

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FOUNDATIONS OF VALUATION

In order to understand the role and work of the investment banker, we need to first have a strong understanding of the

foundations of valuation. This helps us to understand why it is that the investment banking industry exists and where

investment bankers fit into the bigger picture.

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Part 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 Accounts

Value

The formula for value is:

Perpetuity value = CF / Discount rate

Accounts and Accounting

In order to track valuation performance of the perpetuity (i..e business), companies create accounts for each item of it’s

financial existence. These accounts are the basis of valuation. Valuation is the basis of actions taken in a capitalist

economy.

Accounts, Accounting & Excel

Excel is the software used to model the accounts of the enterprise and determine the valuation of the perpetuity (i.e.

business).

Account Filings & Public Data

10-K annual

10-Q quarterly

Account Statements: P&L

Income statement (P&L):

Revenues

COGS

Gross Profit

Operating Expenses

EBIT

Interest Cost

EBT

Taxes

Earnings

Account Statements: Balance Sheet

Assets = Liabilities + Shareholder’s Equity

Total Assets = Total Liabilities + Shareholder’s Equity

Current Assets + Long Term Assets = Current Liabilities + Long Term Liabilities + Value of Shares Previously Issued +

Retained Earnings – Treasury Stock

Account Statements: Statement of Cash Flows

CF from Operating

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CF from Investing

CF from Financing

Statement of Cash Flows is the linkage between the income statement and the balance sheet.

Get D&A from SCF (CF from Operations) and CAPEX from SCF (CF from Investing)

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 Value

Strategics, financials, and entrepreneurs undertake investment with the expectation of NPV & IRR. They accept projects

that have positive NPV and IRR higher than the cost of capital. They actively find and structure positive NPV projects and

then match financial products to them.

The positive NPV project is ideally a perpetuity with the value of the business being the perpetuity value:

Perpetuity value = CF / Discount rate

Calculating NPV & IRR is the main analytical work of finance.

*Growth statistic CAGR (Compound Annual Growth Rate) is yearly IRR

From Accounts to Models

To go from accounts (accounting) to a finance number we use models. We only use Free Cash Flow to determine

valuation for major transactions in a capitalist economy including restructuring, growth, M&A, and capital raising.

To go from account filings to models, we need to “clean the numbers”, “scrub the financials”, “normalize the financials”.

This amounts to recasting accounts 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

Modeling

After getting valuation, we can then model the different actions we can take in a capitalist economy to increase the

valuation of the strategic, financial or entrepreneurial firm.

Modeling in Excel

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

Analysis of Account Statements

Analysis of account statements (ratio of analysis) has various uses including from a liquidity perspective, commercial

bank perspective, activity perspective, profitability perspective, and growth perspective.

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

The following is the adjusted financials for Berkshire Hathaway:

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Part VII:

Modeling Value

Continuing deeper into the field of finance we now discuss the actual work associated with understanding the value of a

perpetuity. The work is done by modeling the perpetuity in Excel.

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Chapter 8: Finance with Excel

Finance with Excel

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

Implement financial analysis using the tool for financial analysis, Excel

Valuation process

Heart of finance is time value of money and discounting

Excel Concepts Needed for Finance

Write down variables (defining the parameters of the decision)

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

Functions (=fx( ))

Data tables (“sensitivity tables”)

Express Decisions with Excel

Implement financial analysis with Excel

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Using a Financial Model for Decision Making: The Investment Decision

Ability to get financing from financial institutions depends on ability to make a financial model for the new or existing

business

The financial model projects future earnings from the organization

Predict the future performance of a firm.

Accounting statements report what happened to the firm in the past. A financial model predicts what the firm’s

accounting statements will look like in the future. Start by taking the initial accounting statements and inputting them

into Excel

Difference between accounting and financial model is in the current assets and current liabilities. In financial model we

are concerned only with operating assets and operating liabilities. We exclude financing related

Financial model has three components:

Model parameters (value drivers)

Financing decision assumptions (i.e. Mix between debt and equity, what does firm do with excess cash? Repay debt,

payments to shareholders, or as cash balance)

Pro forma financial statements

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

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

The plug is the balance sheet item that guarantees the equality of the future projected total assets and future projected

total liabilities and equity. Every financial model has a plug and the plug is almost always cash, debt, or stock.

Financial Model and Valuation Process:

Assumptions (value drivers)

Existing accounting statements (IS and BS)

Projected financial statements

Free cash flow calculation (FCFs)

Terminal value calculation

Valuation calculation

Sensitivity table for major value drivers to see range of valuation

Once the financial model is complete (i.e. accounting statements have been projected), we can use the model to:

Value the firm by projecting free cash flows (FCFs)

Determine ability of firm to pay it’s debts (i.e. credit analysis)

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Using a Financial Model for Decision Making: The Financing Decision

All companies must decide how to finance their activities

Proportion of debt and equity

The discount rate should be appropriate to the riskiness (i.e. variability or beta) of the cash flows being discounted.

Discount rate is also called interest rate, cost of capital, opportunity cost.

Compute annualized IRR

The cost of capital of an investment is related to the risk of the cash flows of the investment. The relationship of

individual asset returns to the risk is called the security market line (SML). You can use SML to get the discount rate for

individual investments. The SML is used for private companies.

The cost of capital of an organization is related to the risk of the combined riskiness of the investments in the portfolio.

The relationship of portfolio returns to the risk is called the capital asset pricing model (CAPM). You use CAPM to get the

discount rate (i.e. cost of capital). When the investment is a public security, you use CAPM since the buyer of the security

will have a portfolio to diversify away risk.

Portfolio risk is associated with statistics.

Wealth Maximizing Decisions

Investment decision – What is it worth? NPV of strategic alternative

Financing decision – What does it cost? IRR of financing alternative

Cash is King

Wealth maximization has to do with maximizing cash. Cash in the context or organizations is known as cash flow.

Return is a word for cash flows

Cash Flow Definition (FCF)

Profit after taxes

+ Depreciation (noncash expense)

+ Change in net working capital (- increase in current assets and + increase in current liabilities)

Capital expenditures (CAPEX)

+ After-tax interest payments

= Free Cash Flow (FCF)

Role of the Finance Professional

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

individual or organization.

Investment bankers compute the IRR and NPV of strategic alternatives.

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Capital Markets

The capital markets is made up of cash flows and discounts

Capital Markets and Information

Information is valuable in determining investment and financing decisions in the capital markets. Overall, markets are

weak form efficient meaning that their valuations reflect previous stock price performance (i.e. stock price data) and are

sometimes semistrong meaning that valuations incorporate all public information. Capital markets are not strong form

efficient meaning that valuations do not reflect private information.

Multiple Investment and Financing Decisions: Portfolio

When there is multiple investment and financing decisions, we have something called a portfolio. The discount rate can

be decreased by diversifying with a portfolio. When the discount rate is decreased, the valuation of the portfolio

increases as cash flows have maintained more value.

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

Modeling a Strategic Alternative

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

Never use a number where a formula will also work

Blue for hard codes

Black for links and outputs

Finance: Exchanging Value Through Time

Assets have a time dimension

Future value function =FV( )

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

Present value =PV( )

Value today of future payments discounted to present

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

Incremental wealth increase earned by a strategic alternative. NPV tells you economic value of an investment today.

Always use NPV in the investment decision.

Internal rate of return (IRR) =IRR( )

Compound rate of return earned by a strategic alternative

VIII. Rate of Return vs. Cost of Capital

What is the asset’s IRR?

Compare to the cost of capital (Effective annual interest rate – which is the annualized IRR used to compare financing

alternatives aka Compound Annual Growth Rate (CAGR))

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Cost of Capital

Calculate IRR of financing alternatives to determine cost of capital

Need to get IRR in annual terms to facilitate comparison. May have to start with monthly IRR then annualize

Annualized IRR = (1 + Monthly IRR)^n-1

Finding a Value in a Financial Model

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

Goal seek – Alt, A, G

Financing Alternatives: Loan Amortization

=PMT( )

To calculate the debt payment per period

=IPMT( )

To calculate the interest portion of the payment of debt

=PPMT( )

To calculate the principal portion of the payment

VIII. Financing Alternatives: Direct Comparison

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

IRR tells you the cost of the financing alternative

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

Analyzing the Strategic Alternative: Sensitivity Table

Data Table is Alt, A, W, T

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

The Financing Alternative: Nominal vs. Real Cost

In determining the true cost of a financing alternative, it is important to use the real rate of interest which incorporates

inflation. The real rate of interest is determined by using the real cash flows.

Inflation acts as a discount rate

Strategic Alternatives Analysis

For each strategic alternative, compute the NPV and IRR, then have decision rules for investing including:

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Minimum NPV

Hurdle rate (IRR)

You are using NPV and IRR to make investment decisions but you need the discount rate. The discount rate is associated

with the financing decision

Cash Flows and Risk

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

Cost of Capital and Opportunity Cost

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

The Discount Rate

An organization’s discount rate is the cost of equity and cost of debt. The cost of the total capital structure is known as

the Weighted Average Cost of Capital (WACC):

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

Value of Equity

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

Sources & Uses

Uses Sources

Free Cash Flows WACC

CAPM to get cost of equity

Accounting Statements: Statement of Cash Flows

The purpose of the statement of cash flow is to explain the increase in the cash accounts on the balance sheet as a

function of the firm’s operating, investing, and financing activities.

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

Market valuation:

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

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

Accounting Value vs. Finance Value

Accounting value of firm is backward looking and thus incorrect to use in valuation. Finance value is forward looking and

consistent with the fact that the owner of an organization or security has claims on the future cash flows of the business.

FCF and DCF

Free cash flow (FCF) calculations is DCF

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Portfolio Analysis and the Capital Asset Pricing Model (CAPM)

Discount rate is a measure of risk associated with:

Horizon

Safety

Liquidity

We get the discount rate by analyzing the distribution of an investment’s returns. We get the standard deviation which

is a measure of variance in returns. Standard deviation is a component to finding the discount rate:

=STDEVP( )

What does the frequency distribution look like?

Determine risk measure known as beta and plug this into CAPM to get the discount rate of equity. Derive the cost of

debt and then calculate WACC to get the discount rate of the firm.

Ex Ante vs. Ex Post Returns

Ex Ante is the expected return

Ex Post is the actual return

VIII. Statistics for Portfolios

=Average( )

To get mean return

=Varp( )

To get variance of returns

=Stdevp( )

To get standard deviation of returns

=Covar( )

To get covariance between two sets of returns

=Correl( )

To get correlation between two sets of returns

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

equation and R-squared on chart

Portfolio Returns and The Efficient Frontier

Statistics are used to determine acceptable and unacceptable portfolios

Diversification lowers standard deviation of the portfolio

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

The efficient frontier is the set of all portfolios that are on the upward-sloping part of the graph starting with the

minimum variance portfolio (i.e. the market portfolio). Choose the portfolio that is on the efficient frontier.

The Efficient Frontier and the Optimal Portfolio

The best investment portfolio is made up of the risk free asset and a risky asset representing the market (i.e. the market

portfolio)

Determine the market portfolio (the portfolio with the highest attainable sharpe ratio)

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

Security Market Line & CAPM

The security market line says that the expected return of an asset is a function of the asset’s beta (i.e. sensitivity to the

market).

Only relevant risk is systematic risk since the investors will all be diversified

Security Market Line & Investment Performance

The security market line says that the expected return of an asset is a function of the asset’s beta (i.e. sensitivity to the

market).

Only relevant risk is systematic risk since the investors will all be diversified

Security Market Line & Investment Performance

The security market line says that the expected return of an asset is a function of the asset’s beta (i.e. sensitivity to the

market).

Only relevant risk is systematic risk since the investors will all be diversified

VIII. Security Market Line & Investment Performance Continued

Investment performance:

Risk adjusted performance; excess returns?

Risk Adjusted Performance

Market portfolio proxy is S&P 500

Beta is measure of riskiness of security

Alpha measures excess return

Market portfolio proxy is S&P 500

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Beta is measure of riskiness of security

Alpha measures excess return

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

CAPM & Investment Performance

Use CAPM to get the discount rate of equity and compare to cost of financing alternatives

Is there risk adjusted overperformance or underperformance?

Is performance commensurate with risk?

Excess Return

Excess return is the investment’s spread over the one year treasury (i.e. risk free rate)

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

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

Beta & R^2

High beta is an aggressive stock

Low beta is a defensive stock

R^2 is percentage of variability that is market related risk when returns are regressed on the market portfolio

Diversification increases R^2 of the portfolio and decreases nonsystematic risk

Alpha and Efficient Markets

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

CAPM and the Cost of Capital

CAPM = rf + Beta [ E(rm) – rf]

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

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

Valuing Securities in Efficient Markets

Market efficiency and the role of information in determining asset prices

Publicly available information should be reflected in market price

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Chapter 9: Financial Statement Modeling

Financial statement modeling refers to the creation of a standalone operating model for a company. The operating

model is built using historical performance (i.e. historical financial statements). We use the operating model to see pro

forma performance of a company given certain assumptions. These pro-formas are the basis for decision making within

the corporation.

Financial statement modeling best practices:

Blue is hard codes, black is formulas

Be consistent with millions and billions (keep conventions the same)

Footnote everything in presentation

Keep your model simple (1,000 cells is better than 10,000 cells)

Financial Modeling Steps:

1. Spread historical financial statements

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

b. Public information for company 10K, 10Q

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

2. Adjust for non-recurrings

3. Build cases into the operating model

a. Best case

b. Base case

c. Worst case

d. Disruption case

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

5. Project LIBOR and interest rates

a. Spread over LIBOR

b. LIBOR is the base that banks use to price spread their loans to make money (called “L”)

c. 3 month LIBOR is the standard reference

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

a. Maintenance CAPEX vs. Discretionary (growth) CAPEX

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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 Capital

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

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

a. AR goes up, need negative sign on SCF

b. AP goes up, need positive sign on SCF

c. BS cash is ending cash position on SCF

10. Calculate paydown/drawdown for revolver as minimum (Min function) of CF before revolver and beginning revolver

balance

11. Operating model is done when you finish SCF. Operating model check (zero for Assets – (Liabilities + Owners Equity)

NEXT STEP IS TO USE THE OPERATING MODEL FOR VARIOUS ANALYSES INCLUDING ORGANIC GROWTH & INORGANIC

GROWTH (STRATEGIC ALTERNATIVES). THE KEY QUESTION TO ASK IS: WHAT IS THE BEST STRATEGIC ALTERNATIVE FOR

THE CORPORATION (I.E. HOW TO BE A GROWING PERPETUITY OR PARENT COMPANY OF MULTIPLE GROWING

PERPETUITIES)?

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/opportunity

2. Methodology that answers key question

3. Platform architecture consistent with methodology

4. MVP (Minimum viable product) of platform

5. Value Perpetuity

6. Financial Perpetuity

7. Growing Financial Perpetuity

8. Diversified Perpetuity

Perpetuity Science & The Perpetuity Scientist

Within Perpetuity Science, there are definite phases of the perpetuity corresponding to levels of development of the

perpetuity including:

1. Levels of customer concentration where:

a. high levels of customer concentration correspond with a lower EBITDA multiple and low levels of customer

concentration correspond with a high EBITDA multiple

2. Levels of recurring revenue where:

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

correspond with a low EBITDA multiple

3. Levels of owner dependence where:

a. a high level of owner dependence corresponds with a lower EBITDA multiple and low levels of owner dependence

correspond with a high EBITDA multiple

The perpetuity scientist (CEO or consultant) is not only responsible for growing the benefit stream (CF), but also these

de-risking factors that determine the discount rate (r). In doing so, the perpetuity scientist builds a highly sought after

perpetuity for both strategic and financial buyers corresponding with a premium valuation.

When providing coverage to a target perpetuity and originating an engagement, the perpetuity scientist should follow

these steps:

Stage of the Perpetuity:

1. Syndication:

(Getting to PMT)

Initial revenue generation

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)

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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. Syndication

2. Project/job shop

2. Perpetuity

3. Growing perpetuity

Since the valuation is forward looking, it has to incorporate the new product/business’ financial performance. Since the

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

company.

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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 nature

2. Key question associated with challenge/opportunity

3. Develop methodology that answers the key question

4. Build platform around the methodology

5. Perpetuity

Existing Platform to New Value Theme

A common way to begin on the build-side is to take an existing platform and apply the concept to a new value

theme. We will discuss this in great detail in the cases portion of this text.

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.

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The Consumption Process & Growth Hacking

It is important to have appropriate expectations regarding growth and returns. One does not simply build an MVP and

turn on users with a switch. Brands are built one person at a time and consumption follows a definite process which is

the following:

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

2. Methodology adds value for individual (based in reason) and thus the user decides to be a follower

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

with usage

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

5. Active usage adds value enough so that individual is willing to recommend others to become users

6. Active users willing to pay for usage

Since there is a definite process to consumption, one's growth hacking methodology should be consistent with

this fact. The Growth Hacking Methodology means manually connecting with individuals on various social

networks including Instagram, Facebook, & Twitter to first advocate the startup's methodology:

1. Develop thought leadership (methodology)

2. Advocate methodology and first contact

3. Acquire followership

4. Convert followership into users

5. Convert users into active users

The key here is to advocate the startup's methodology and then show traction on the methodology which will be

used to gain followership from influencers and turn them into evangelists for the methodology.

Mechanisms like social proof can be helpful as they accelerate willingness to participate in followership or

experiment with usage, but they are not a replacement for one by one advocacy of a methodology. Social proof

kicks in incrementally as the startup hits an extra zero at the end of its followership and user numbers (ex. 100,

1000, 10000, 100000, 1000000).

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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 Perpetuity

Commodity -> Finite Benefit Job -> Active Benefit Perpetuity -> Passive Benefit Perpetuity

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Part VIII:

Perpetuity Analysis

On the build-side, we are ultimately concerned with the creation and management of perpetuities. We first explore the

perpetuity analysis, perpetuity building process/timeline (including sources and uses) and then move towards a

methodology for perpetuity management.

The goal of Perpetuity Science is the building, growing, management, exit and buying of perpetuities, so ultimately,

while learning about Perpetuity Science itself, we are also actively looking for:

1. Perpetuities to create

2. How to advance a perpetuity to the next phase

3. Perpetuities that should be exited from

4. Perpetuities that should be purchased

Perpetuity analysis is performed with an understanding that a perpetuity’s ideal course of action at any given time is

related to one of the three sides of the perpetuity (Build-side, Sell-side, Buy-side) which depends on the phase that the

perpetuity is in:

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

II. Benchmark comps into Perpetuity Phases

III. Build financial statement models for each

IV. Determine DCF, Comp Companies & Precedent Transactions valuation football field

V. Compare peers in Perpetuity Phase to intrinsic value to determine if this is a Buy-Side, Sell-Side or Build-Side deal

(where are peer multiples at in relation to intrinsic value?)

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

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

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

Perpetuity science explains how perpetuities can be built, managed and exited from to create wealth. As such, it

inherently has an owner focus rather than simply a capital markets focus which is manifested by the dual goals of

decreasing the owner’s active involvement in the day to day of the business and the maximizing of valuation.

Perpetuity 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

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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:

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

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Perpetuity science is where entrepreneurship, strategy & finance come together. It a field of study complete with

a body of knowledge, methodologies, and optimization models towards improving the individual's quality of life

by the building of a perpetuity that accomplishes two dual goals:

1. ever decreasing involvement of the perpetuity owner in the perpetuity

2. ever increasing valuation of the perpetuity

Perpetuity science is ultimately about maximizing quality of life rather than just wealth by building perpetuities

with recurring revenue streams that are not reliant on the daily participation of the owner of the perpetuity. We

can take a look in a visual format of what we are trying to accomplish:

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

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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.

One should thoroughly understand these industries overall and their sub-sectors when syndicating a new

perpetuity. We will go into these industries in detail after explaining the perpetuity building process, the

perpetuity management process, and perpetuity exit process.

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

I. Perpetuity Analysis

II. Perpetuity Building

III. Perpetuity Management

Perpetuity Exit

Market Analysis

GDP

Industry Spend

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Sub sector spending

Sub sector spending by product

Value Chain Analysis

General

Industry

Sub-sector

Sub-sector by product

Gap Analysis

General

Industry

Sub-sector

Sub-sector by product

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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:

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2. Sell-Side: How to obtain a valuation higher than the NPV of the perpetuity? The methodology for doing so is to

get a buyer to price in the next phase of the perpetuity into the current valuation (ex. if the perpetuity is at the

perpetuity phase, get the buyer to pay for a growing perpetuity)

3. Buy-Side: How to locate and take ownership of a perpetuity that is being valued at less than its NPV? The

methodology for doing so is to get the seller to accept a price for the previous phase of the perpetuity (ex. if the

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

What Should You Learn in Business School?

Since the perpetuity is the basis for both industry and the capital markets it follows that business school thus focus

on educating individuals on:

1. The Nature of the Perpetuity

2. The Phases of the Perpetuity

3. The Different Sides of the Perpetuity

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.

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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:

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.

2. The Phases of the Perpetuity: After understanding the nature of the perpetuity in general, we can then analyze

the perpetuity within each industry. The nature of the CF, r, value chain, and value being offered will be

different. We investigate each industry according to these variables by building an index for each industry and

then sub-sectors within the industry:

3. The Different Sides of the Perpetuity:

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Part IX:

Perpetuity Management

On the build-side, we are ultimately concerned with the creation and management of perpetuities. We first explore the

perpetuity analysis, perpetuity building process/timeline (including sources and uses) and then move towards a

methodology for perpetuity management.

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Chapter 15: Perpetuity Management

The Purpose of the Company

Companies exist to create value

How Companies Create Value

Companies create value by investing capital at rates of return that exceed their cost of capital. This is the principle of

value creation.

The only thing that differs across companies is the implementation (i.e. different asset and capitalization mix)

Strategy & Finance

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

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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

Cash flow equals the operating profits of the company less the net investment in working capital and fixed assets to

support the company’s growth.

Perpetuity Management Capability

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

2. Determine which phase is the goal

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

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

5. Execute the plan

Perpetuity Lifecycle:

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Chapter 16: Valuation Methodologies

1. Public Company Valuation

2. Comp Companies – Also known as trading comps. Management team gives you 1 to 2 years projections or equity

research comp reports to get forward multiples (x Revenue or x EBITDA ) which may be used as the basis for this

valuation. You can get comps from the general overview as it will discuss the target’s comps in the 10K. Find comps

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

a. Select the universe of comparable companies – Choose 7, 8, 10 comps, need their 10K, 10Q, analyst reports to get

TEV for each comp then divide by line item to get multiple.

b. Locate financial information on comp companies – Information must come from latest filing (10K or 10Q). Print out

10K, 10Q, analyst reports.

c. Spread key financial information, ratios and multiples – Calculate TEV (in comp spread tab). To get MVE, use TSM

method. TSM = Exercisable options outstanding x (share price – strike) / share price.

d. Benchmark comp companies – Get the multiple that the company is trading at for each metric for each comp and

get mean and median of comps for the metrics (ex. TEV/EBITDA)

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

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The multiple tells you which company is better, margin analysis tells you why they are better.

Sell side key question:

“Which comp would you use to guide potential buyers?”

3. Precedent Transactions – comp transactions

a. Select universe of comp transactions

b. Locate deal-related and financial information – Need press release of the deal, 8K, 10K, and 10Q. Type of payment:

cash, stock, cash & stock.

c. Spread financial information, ratios and multiples – Get transaction TEV (implied) & transaction MVE (implied)

d. Benchmark precedent transactions

e. Determine implied valuation

Notes:

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

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

premiums).

When a transaction occurs, update client on the latest transaction to show them impact on the control premiums

being paid and implied multiple as well.

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

4. Discounted Cash Flow (DCF)

a. Spread historical financial statements (input historicals) and derive historical ratios, trends and variables (drivers of

future performance; margins and growth rates). Project financial statements (proforma). Revolver modeling to link IS,

BS, and SCF

b. Project free cash flow (FCF)

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

Cost of equity:

Rf = 10 year treasury

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

Beta = Levered beta of comps to unlevered median and mean of comps (unlevered beta); should be .5 to 2.5; 2 year

to 5 year betas (taking out capital structure and relever to actual capital structure. With beta, we are putting capital

structure on unlevered beta mean and median of comps to calculate WACC of own company.

Cost of debt: weighted average of tranches of debt tax effected; found in 10K. Rates from the notes. If private

company, get from clients the tranches and to get rates, go to DCM to get approximation.

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Cost of equity 20% to 25% in private markets. No use of debt is an inefficient use of capital. Trying to optimize the

D/E ratio to minimize cost of financing.

d. Determine terminal value – EBITDA multiple which is going to be almost 80% of the company value. Terminal value

= LTM multiple from comps x EBITDA. Perpetuity growth rate should be 2.5% to 3% and should not be larger than

the size of the GDP of the country

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

Notes:

Need the valuation date; this determines stub year fraction (i.e. period left in the year). Stub year fraction – investor

does not have claim on revenues before that. DCF value always moving through time consistent with valuation date.

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

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

Creating value:

$ dollars of value increased by…

Changing multiple on valuation

Decreasing the discount rate

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Chapter 17: Framing Valuation

We are not looking at each valuation methodology in isolation but are ultimately using the methodologies together to

frame the valuation in a valuation summary format. We use a “football field” (valuation summary) to frame the valuation

which looks like the following:

Regarding the football field, we add control premiums to comp companies and DCF (% addition that is equal to the

control premium average for the transaction comps) if doing valuation for selling the company.

Footnote everything (assumptions) in the football field. The football field takes one day to a few days depending on how

easy it is to obtain the precedent transactions data.

Banker should know what valuation the client expects to be at; 10% to 15% spread of range of valuation (“tighten” the

range if needed by eliminating comps that skew the range)

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

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Chapter 18: The Market for Perpetuities

The market for the perpetuity at its initial stages is inefficient, but as it moves through the stages of a perpetuity, the

market becomes more efficient. You can observe the coinciding cost of capital move from almost 100% going all the way

down to 3.5%.

You can observe the EBITDA multiple for the perpetuity increasing as the perpetuity moves through the phases of the

perpetuity.

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SELL-SIDE

As perpetuities continue to grow, the builder of the perpetuity seeks to grow the perpetuity inorganically or exit the

perpetuity. This is the primary role of the sell-side, which is to aid in the buying and selling of perpetuities. Investment

bankers now enter the picture as this is their core work.

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Part X:

How to Sell a Perpetuity?

On the sell side, the primary responsibility of the investment banker is to aid those owning perpetuities in analyzing their

strategic alternatives related to inorganic growth or exit.

Which phase is the perpetuity in? (SMB, LMM, MM, UMM, L)

Which buyers are likely interested in the perpetuity? (Individual, Financial, Strategic, Special Situation)

Each of these buyers have a different valuation range

Individual – Desire 30% to 40% IRR, 3x EBITDA

Financial – 4x to 7x EBITDA

Strategic – 5x to 10x EBITDA

Valuation is a range

Determine valuation method (DCF, comp companies, precedent transactions)

Calculate benefit stream (synergistic vs. owner benefit)

Determine required rate of return given the phase of the perpetuity and the buyer (discount rate)

Convert benefit stream into present value at the discount rate

Sensitize the variables for a range of values to see effect on valuation (sensitivity table)

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Strategics and financials establish their filter criteria (hurdle IRRs for financial and minimum EPS increase for strategics)

and test targets against this filter

Strategics have a range of values with standalone value as the lower end and valuation with all synergies on the higher

end. A deal happens usually in the middle

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Chapter 19:

Investment Banking

Since M&A (Mergers & Acquisitions) is the core product of investment banking, discussions around investment banking

typically relate to M&A. M&A is the selling of a perpetuity in the form of a corporation to either a financial or strategic

buyer. Financial and strategic buyers have what is known as investment/corporate M&A mandates which detail the size

and industry of prospective targets for acquisition. The investment banker takes these mandates and matches them with

targets and takes a fee for doing so. Investment bankers typically focus on one industry and provide what is known as

coverage by building an index of public companies and tracking changes in targets relative to the index in terms of:

Revenue

EBITDA

Multiples

The investment banker monitors trends in these variables and determines the optimal time to sell (when multiples are

strong) or acquire (when multiples are weak) and advises target management accordingly. When a target agrees to sell

via an investment banker, this relationship is known as a sell-side mandate and an M&A process will be led by the

investment banker. During the M&A process, there are definite steps and deliverables including a teaser, CIM, and

management presentation. The M&A process can include many prospective buyers (broad auction) or few prospective

buyers (targeted or negotiated sale).

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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

Compare NPV and IRR OR compare EPS change and BS effects to other strategic alternatives and choose the highest

return/EPS alternative

Ultimately, as an investment banker, you are to:

Use valuation methodologies to determine valuation ranges of each strategic alternative and see if capital sources match

uses. IBankers should provide the client with tight ranges on valuation.

Use an operating model of the target (and acquirer if strategic) and then tailor it to the specific client:

Financial (LBO)

Strategic (Merger)

Determine:

NPV and IRR for financial in LBO

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

Run the M&A process

Traditional Investment Bank Responsibilities:

Junior Banker:

Industry coverage

Comps and comp transactions (where are multiples)

Valuation

Mid Banker:

Operating model creation + tailored to transaction client (LBO or Merger)

Manage M&A process

Senior Banker:

Revenue center

Personal contacts at firms to win engagements

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Chapter 20:

How to Become an Investment Banker

Methodology

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

1. Coverage

a) Index building

b) Vertical report

c) Vertical newsletter

2. Target screen & origination

3. Mandate/target matching

4. Deal structuring

5. Buyer/seller meeting logistics

6. Adjusted EBITDA calculation

7. Valuation

8. Offer analysis

9. Purchase agreement drafting/structuring

10. Due diligence data room

11. Closing & flow of funds

Decide on the industry/industries that you will cover, read/research the value themes/players/multiples in the industry

on the following levels:

1. Large cap

2. Mid cap

3. Small cap

4. Middle market

5. Lower middle market

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

1. Manufacturing

2. Software

3. Business Services

4. Healthcare

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After choosing your coverage, the investment banker is then to build an index for each of the verticals and sub-verticals

made up with the public comps. The AltQuest Group coverage is broken down in the following manner:

1. Manufacturing

a. Durable consumer

b. Non-durable consumer

c. Aerospace & defense

d. Building products

e. Industrial

f. Medical

2. Software

a. Traditional software

b. SAAS

c. Internet

3. Business Services

a. Education & Training

b. Business Process Outsourcing

c. Facility Services and Industrial Services

d. Human Resources

e. Information Services

f. Marketing Services

g. Real Estate Services

h. IT Services

i. Specialty Consulting

4. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

The investment banker then spreads each public comp and the financial data feeds into the median and average for the

vertical and sub-vertical which ultimately ends up in the research (industry report, newsletter), pitchbooks, and CIMs of

the investment bank. For investment banks with an equity research department, financial statement models will be built

for each public comp that is being covered and consensus EPS data taken from research reports will be used to establish

the value of the public comp.

The investment banker ultimately uses the vertical index and sub-vertical index to perform proprietary research and

develop industry reports and newsletters which will aid in coverage and ultimately origination. The research, which we

will go into greater detail on later in the book focuses on vertical and sub-vertical trends in margins, multiples, and

M&A.

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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 emails

30 sell side pitches (phone and in person)

10 sell side engagements won

4 IOIs from strategic/financial buyers

As you get better and establish a process, your email conversion rates will go up and you will be pitching more and your

ability to win sell side engagements will go up. I am at the point now that if a seller is interested in selling, I will either

win the sell side mandate or I will structure it as a buy side deal and receive the fee from the strategic/financial buyer.

Looking forward to year two, here are the projections:

1,000 introduction emails

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50 sell side pitches (phone and in person)

20 (+18 existing = 38 total engagements) sell side engagements won

8 IOIs from strategic/financial buyers

2 closed M&A deals

$110,000 in M&A fees received

The statistics assume that you will be working full time at 40 hours per week and not working on the weekends.

Regarding fees, here is a simplified understanding of fee structure for sell side engagements. The key to remember here

is that you do not make your money when you quote your fee, you make your money when you close the deal. The

point is that I would rather win an engagement and give up 1% to 2% of the fee than have the seller think that I am not

being fair. The Lehman scale simplifies this a bit but often times the seller will want to know the exact % that they will be

paying you.

Large cap – Lehman scale

Mid cap – Lehman scale

Small cap – Lehman scale

Middle market – Double Lehman structure

Lower middle market – 3% to 10%

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Part XI:

The Middle Market

The majority of perpetuities are in what is known as the middle market, a classification for mid-sized perpetuities. This is

where the majority of the transactions occur and where the average investment banker will make his living.

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Chapter 21:

The Middle Market

Because of the wide range of company sizes within the definition, the middle market can be further broken down into

the following:

Overview of Middle Market

Pitchbook defines the middle market as companies with total enterprise value between $25 million and $1 billion and

the “core middle market” as between $100 million and $500 million.

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; and

We 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 Multiples

It is crucial for investment bankers to understand the M&A marketplace in the middle market and particularly for the

industries that they cover.

It is important for the investment banker to have a strong understanding of multiples in the M&A marketplace in general

and then in his/her sector and sub-sector. In general in the middle market, we typically see 7x - 7.5x EBITDA for

companies that are larger than $25M in TEV. For companies that are smaller than $25M in TEV, we typically see 5x - 5.5x

EBITDA. There are adjustments that need to be made for size and predictability of revenues as well as for certain sectors

(ex. software).

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Chapter 22:

M&A Multiples

Since the investment banker will most likely be starting in the lower middle market or middle market, it is important to

have a strong understanding of the multiples in the M&A marketplace in general and then in your sector and sub-sector.

The following are 2016 M&A multiples from the data provider, Pitchbook (Morningstar), that you can use initially. Here

are the EBITDA multiples for transactions in the lower middle market:

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

Methodology

It is crucial for investment bankers to understand the M&A marketplace in the middle market and particularly for the

industries that they cover.

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Chapter 29:

Investment Banking Coverage Methodology

First, the investment banker is going to choose what size of companies he/she is going to cover (ex. public co's, middle

market, lower middle market). From there, the investment banker chooses an initial vertical and sub-verticals to cover.

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

1. Manufacturing

2. Software

3. Business Services

4. Healthcare

After choosing your coverage, the investment banker is then to build an index for each of the verticals and sub-verticals

made up with the public comps. The 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 macroeconomics

a. Industry spending

b. Sub-sector spending

c. Stock market performance of industry

II. Public sub-sector financial and valuation performance

a. Sub-sector index

b. Sub-sector index: financial performance

c. Sub-sector index: public market multiples

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d. Sub-sector index by product category

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

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

III. Industry M&A Market Update

a. Industry M&A deal volume and spending

b. Industry M&A exit multiples

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

d. Sub-sector M&A exit multiples

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

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

IV. Appendix

a. Sub-sector index key metrics

b. Sub-sector index key metrics by product category

c. Industry most active buyers

d. Sub-sector most active buyers

e. Sub-sector most active buyers by product category

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Chapter 30: Index Building & Benchmarking

Regarding the vertical index and sub-vertical index, the investment banker ultimately tracks trends in:

Growth rates

Margins

Multiples

The investment banker takes the index and establishes tiers which turn into peer groups. This is why we pull

comps, to build an index and benchmark against the comps.

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

strategic alternatives.

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

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Chapter 31: Financial Data Sources

If you are at a larger investment bank, you will have various paid data sources at your disposal. These include:

1. Bloomberg

2. CapitalIQ

3. FactSet

For those that are not at a larger bank, one can use the free sources of financial data including:

Yahoo Finance

Google Finance

Yahoo Finance and Google Finance get their EBITDA numbers from CapitalIQ and their analyst EPS consensus

estimates from there as well.

Investment banks typically do not want you to use the EBITDA from CapitalIQ, Bloomberg, FactSet and would

prefer that you spread the comps individually to get to EBITDA.

We are ultimately using the financial data sources to build and maintain our various indices associated with our

coverage group.

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Chapter 32: Industry or Sector Newsletter

When maintaining coverage of an industry or sector, one prepares a newsletter to be send to prospective sell side

clients in the industry or sector. Investment bankers use the index information to create this newsletter. The

newsletter is about 2 to 6 pages.

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

potential targets:

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Chapter 34: Industry or Sector Report

When maintaining coverage of an industry or sector, one prepares a report to be send to prospective sell side

clients in the industry or sector. Investment bankers use the index information to create this report. The report

goes more in depth than the newsletter. The report can be about 15-20 pages.

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

potential targets:

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Chapter 35: Rolodex Building

As an investment banker it is important to establish relationships with the strategics in your coverage group as

well as relationships with targets and their potential buyers. After building the index containing relevant strategics,

one should go to RocketReach.co and find the email addresses for each of the CEOs, CFOs, and/or corporate M&A

department head for the potential acquirer.

An example of a vertical specific rolodex would be the following:

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Part XIII:

M&A Origination Methodology

The following methodology describes the primary work of the investment banker, origination. The methodology arose

through the work of Michael Herlache in his M&A career and the lack of content about the actual work of senior M&A

professionals. There is plenty of knowledge around the technical support work of investment bankers including financial

modeling and valuation, but there are no current texts on origination, let alone a methodology.

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Chapter 23:

M&A Origination Methodology

The M&A origination methodology is the following:

1. Determine coverage industries and sub-sectors

2. Build industry and sub-sector index

3. Pull national screens for the coverage area from Salesgenie

4. Collect emails for CEOs/owners from Salesgenie and RocketReach.co

5. Origination email to identify target considering selling and get price expectations

6. Obtain sell side mandate

7. If cannot, develop buyer list and pitch M&A idea to them in a buy side capacity clarifying that the

target is not running a process and that you do not have the mandate but that you have been in

talks with their CEO/owner. The target is willing to listen to reasonable offers

Step 1: Database Utilization & Emails Collected

The 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

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day, the process of emailing begins with the best practice below. The response rate to the emails should be

approximately 3%.

Step 2: Email Inquiry

John,

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 Inquiry

After receiving initial response, you will then message them that you will email them when you have the offers and ask

for the price of the business. The following is the email that should be sent:

John,

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

Best,

Michael

Step 4: Phone Call Request (by Sellers) or Meeting Request

After requesting price, some sellers will request a phone call and provide their contact information. If the seller provides

price information, they reply with the following email:

John,

Alright. 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.

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Please let me know.

Best,

Michael

After hearing back from the heads of M&A, let them know that the seller has requested that we represent the buyer and

that the buy side fee will be 1.5%. You then ask them to accept in writing to the fee and once they do you can tell them

the target name and then proceed to contact the seller and let them know that there is interest and ask what multiple

range they are targeting for a sale. From there you send an advisor NDA and request financials. After giving financials to

buyer, the company is assessed and a valuation range is determined and an IOI with this valuation range is submitted to

the seller.

Step 5: Phone Call or Meeting

Phone call:

During the phone call you will introduce yourself and state that you work on behalf of private equity firms in locating

quality cash flowing companies and that is how you found their company. From there you will state that you want to get

an initial understanding as to the price of the business. After the price of the business is found, ask how the business

performed last year (revenue and net income). Finally, request a meeting at the end of the call (in person). The following

is your outline for the phone call:

Price:

Revenue:

Net Income:

Meeting:

Meeting:

During the meeting you will introduce yourself and state that you work on behalf of private equity firms in locating

quality cash flowing companies and that is how you found their company. From there you will state that you want to get

an initial understanding as to the price of the business. After the price of the business is found, ask how the business

performed last year (revenue and net income). If this information is already known, you can move straight to giving the

seller the signed NDA and explaining that any information that we receive is confidential and will not be shared without

the approval of the business owner. Next you discuss the structure of the engagement that you are requesting a non-

exclusive relationship whereby you only get paid when your buyers purchase the company. You can hand them the

Registered Buyer Commission Agreement and have them sign right there or to have them review it. Finally, you ask if

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

Step 6: Add Backs Calculated and Teaser Created

After the meeting, you now have the financials or financial data needed to do add backs to get to an 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 Marketplaces

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Once the teaser is finished and financials recasted, you can contact the buyer list of strategic and financial buyers and

put the deal on the M&A marketplaces including BizBuySell for smaller deals and Axial for larger deals.

Step 8: NDAs Signed with Buyers

Once inquiries are received from buyers from the M&A marketplaces, you will send NDAs to the buyers which they will

then sign and send back to you.

Step 9: Teaser with Name Given to Buyer

Once the NDA is received, you can give the buyer the name of the business on the teaser and request an IOI from the

buyer after reviewing the teaser and summary financials. The following is the email to accompany the teaser:

Buyer,

After reviewing the teaser and summary financials, please submit your initial indication of interest (IOI) and we will set up

a buyer/seller meeting.

Best,

Michael

Step 9: Teaser with Name Given to Buyer

Often times a call will be requested by the buyer. On the phone the M&A professional finds out the following, taking

notes on the call:

Industry interest:

Questions (that the buyer has):

Multiples that buyer is seeing or that they typically do:

Step 10: IOI from Buyer

After reviewing the teaser and summary financials, the buyer will notify you that they are interested in purchasing the

company (IOI).

Step 11: Buyer Seller Meeting

After submitting the IOI, you will arrange an in person meeting with the seller which is called the buyer seller meeting. If

the buyer is unavailable due to distance or timing, a phone call can be set up.

Step 12: Purchase Agreement Given to Seller

After 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 Terms

After 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 Diligence

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After 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 Diligence

After 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 Cut

After 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 Methodology

After determining one’s coverage and then initiating coverage in the form of index-building, it is important for the

investment banker to then begin matching investment mandate’s of strategic and financial buyers to targets within the

investment banker’s coverage. The Mandate/Target Matching Methodology is the following:

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

2. Indicate your interest in sourcing deals on their behalf and obtain their investment mandate. This will usually be

detailed in a one-page teaser or presentation that they will send to you

3. Screen for companies that match the mandate(s) in Salesgenie and obtain CEO/owner emails and phone numbers

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

strategic buyer

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

6. Collect historical financial data for the last three years

7. Introduce the financial and/or strategic buyer to the opportunity with the summary financial information and have

them sign an NDA

8. Have a call with the financial and/or strategic buyer and then make the formal introduction to the CEO/owner and

have a buyer/seller meeting

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Chapter 25:

Deal Structuring

After matching a financial or strategic buyer’s mandate with a target, it is up to the investment banker to work with the

buyer and seller to structure a deal. Deal structures can be along the following lines:

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

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Part XIV: M&A Process

When the owner of a perpetuity has decided to grow inorganically or exit the perpetuity, the M&A process must be

executed/run.

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Chapter 26:

M&A Process

From Origination to M&A Execution

Once the investment banker has originated 8 to 10 multimillion dollar listings, one should transition from origination to

M&A execution process creating a shortlist for each deal (10 in the shortlist). The investment banker should concurrently

prepare the marketing package which includes the teaser and the executive summary. Once the teaser is finished, the

investment banker should begin emailing the shortlist with the teaser. From this shortlist, a percentage will reply seeking

additional information on the target. NDAs should be sent out and after being signed, the executive summary should be

sent to the shortlist member. After the executive summary is sent, a percentage will decide to request a buyer/seller

meeting. After the buyer/seller meeting, a percentage will decide to make an offer.

Building the Buyer Shortlist

The shortlist should include strategic and financial buyers and the investment banker should screen each that make it

onto the shortlist for financial capacity to pay. The investment banker should use Salesgenie to pull the geographic

competitors (geography screen with SIC code screen) and have 10 strategics. The investment banker should use the

massinvestor database to determine which 10 financials to include in shortlist:

Strategic

Competitors - synergies

Indirect Competitor

Financial

Hybrid strategic – financial buyer with asset in the sector

Pure financial

For deals that are $500k earnings and above, BizBuySell.com and DealNexus.com should be used to find buyers. For

deals below $500k in earnings, only BizBuySell.com should be used.

The Teaser

The teaser will contain an overall financial profile: three years of historical revenue and EBIT/EBITDA and at least two

years of projected revenue and EBIT/EBITDA

Indicate type of transaction

Professional font (Times New Roman or Arial)

Send as PDF

Do not capitalize words or use flowery language

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No grammar or spelling errors

Indicate sustainable growth potential based upon competitive advantage:

Customer entrenchment and high switching costs (ex. Software)

Long term contracts (ex. Equipment service companies)

Brand recognition (ex. Consumer products)

Intellectual property

Stable management teams

Culture

The NDA

The NDA in a sell side engagement is a unilateral NDA meaning that only one side has to not disclose confidential

information

Teaser With Name of Business & Financials

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

The CIM

Executive summary

Company history

Sales process and/or manufacturing capabilities

Management team structure

Growth opportunities

Competitive landscape or industry outlook

Intellectual property overview and/or company assets

High-level financials (preferably five years of historical data and projections, if available)

The IOI (Indication of Interest)

Approximate price range. This can be expressed in a dollar value range (e.g., $10-15 million) or stated as a multiple of

EBITDA (e.g., 3-5x EBITDA).

Buyer's general availability of funds, including sources of financing

Necessary due diligence items and a rough estimate of the due diligence timeline

Potential proposed elements of the transaction structure, e.g., asset vs. equity, leveraged transaction, cash vs. equity, etc.

Management retention plan and role of the equity owner(s) post-transaction

Time frame to close the transaction

The Buyer/Selling Meeting

First conference call

In person meeting & tour the facilities

In person handshake meeting

The LOI (Letter of Intent)

Official deal structure and terms. Acceptance of engagement means that company cannot receive other offers

Deal Structure. Defines the transaction as a stock or asset purchase. Generally, the seller prefers a stock transaction from

a tax and legal perspective. Asset transactions are preferred by the buyer to protect against prior liabilities and provides

a stepped-up tax basis.

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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

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

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Digital deal rooms are now used (ex. Firmex and V-rooms). Due Diligence is usually 60 to 90 days

The Purchase Agreement

Incorporates all terms of the LOI and is written to address issues discovered in due diligence. The agreement will lay out

a structure to handle this (a hold back account, deductions from future payments, price adjustment, etc.)

Pitchbook Table of Contents (exploring strategic alternatives to win a mandate):

I. Executive summary

II. Industry specific market update (discuss control premiums and multiples)

III. Review of company’s strategic priorities

IV. Potential strategic targets

a. Vertical I

b. Vertical II

c. Vertical III

Sell side after winning the mandate:

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

II. Discuss valuation range (“I believe that you can get $_____, providing that these things hold true”)

III. Process and timing

IV. Tax consequences

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

Confidential Information Memorandum (CIM) Table of Contents:

I. Executive summary

II. Key investment considerations

III. Growth opportunities

IV. Industry overview

V. Company overview

a. Overview

b. Products and services

c. Sales and marketing

d. Operations

e. Organization

VI. Financial overview

Confidentiality – Discuss in terms of project name, never mention name of company. “No comment” and refer press to

PR department.

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

1. Defining exit options and strategies (4 types: auction process, controlled sale, targeted high level solicitation, closed

negotiation)

2. Valuation

3. Recast financials

4. Presentation and packaging

5. Buyer qualifications

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6. Marketing

7. Management coaching

8. Due diligence facilitation (data room)

9. Price and contract negotiation

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

Auction Process:

100-150 companies initial call

4 months; 6-12 months actual

Initial call interest, then send teaser

If interested after teaser, sign NDA, send CIM

Controlled Sale:

10-12 companies

4 months, 6-8 months actual

Targeted High Level Solicitation:

4-5 companies

2-4 months

Closed Negotiation:

1-2 parties

1-3 months

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

I. Growth story

II. Well operating story

Presentation and Packaging

CIM (1st round):

Week 1: interviews with CEO, CFO

2-3 weeks to create

70, 80, 90 pages

Teaser (1st round)

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

Buyer Qualification:

Finalize to list of 50, bankers begin making phone calls

Marketing:

Sign NDAs, send CIM

Weekly calls with client to update (buyer list updates)

Pitching:

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To win new business. Pitching can take years. This is ultimately deal sourcing with MDs calling on clients for 10-15 years.

Bake Off to Win Mandate:

To win sell side mandate there are 9 to 10 banks with 2 to 3 banks in the next round. They present to management and

the board.

The Pitchbook to Win Business:

I. Intros and quals

II. Industry overview

III. Capital market overview (capital markets and products perspective (ex. M&A and IPO))

IV. Company and situation overview

V. Valuation (football field)

VI. Process

VII. Buyers/investors

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Part XV: Investment Bank Management

Since the M&A market is so fragmented in the middle market, it may become necessary for the investment banker to

run his own M&A practice.

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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 cover

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

6. Utilize Coverage & Origination Methodology to advise targets on strategic alternatives

7. Utilize Mandate/Target Matching Methodology to match strategic and financial buyers' mandates to targets

8. Gather financials, recast & IB deliverables (adjusted EBITDA, valuation, teaser, CIM, management presentation)

9. Offer analysis

10. Purchase agreement drafting/structuring

11. Due diligence data room

12. Closing & flow of funds

Decide on the industry/industries that you will cover, read/research the value themes/players/multiples in the industry

on the following levels:

1. Large cap

2. Mid cap

3. Small cap

4. Middle market

5. Lower middle market

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

1. Manufacturing

2. Software

3. Business Services

4. Healthcare

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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. Manufacturing

a. Durable consumer

b. Non-durable consumer

c. Aerospace & defense

d. Building products

e. Industrial

f. Medical

6. Software

a. Traditional software

b. SAAS

c. Internet

7. Business Services

a. Education & Training

b. Business Process Outsourcing

c. Facility Services and Industrial Services

d. Human Resources

e. Information Services

f. Marketing Services

g. Real Estate Services

h. IT Services

i. Specialty Consulting

8. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

The indices for AltQuest Group look like the following:

1. Manufacturing

a. AltQuest Durable Consumer Index

i. Newell Brands Inc. NYSE:NWL

ii. Whirlpool Corp. NYSE:WHR

iii. Hanesbrands Inc. NYSE:HBI

iv. Gildan Activewear Inc. NYSE:GIL

v. Brunswick Corporation NYSE:BC

vi. Tupperware Brands Corporation NYSE:TUP

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

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viii. La-Z-Boy Incorporated NYSE:LZB

ix. Culp, Inc. NYSE:CFI

x. Flexsteel Industries Inc. NasdaqGS:FLXS

xi. Johnson Outdoors Inc. NasdaqGS:JOUT

xii. CSS Industries Inc. NYSE:CSS

xiii. Delta Apparel Inc. AMEX:DLA

xiv. Escalade Inc. NasdaqGM:ESCA

xv. Black Diamond, Inc. NasdaqGS:BDE

b. AltQuest Non-Durable Consumer Index

i. Colgate-Palmolive Co. NYSE:CL

ii. General Mills, Inc. NYSE:GIS

iii. Campbell Soup Company NYSE:CPB

iv. The Clorox Company NYSE:CLX

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

vi. Coty Inc. NYSE:COTY

vii. Edgewell Personal Care Company NYSE:EPC

viii. Avon Products Inc. NYSE:AVP

ix. Inter Parfums Inc. NasdaqGS:IPAR

c. AltQuest Aerospace & Defense Index

i. Honeywell International Inc. NYSE:HON

ii. The Boeing Company NYSE:BA

iii. General Dynamics Corporation NYSE:GD

iv. Airbus Group SE ENXTPA:AIR

v. Mohawk Industries Inc. NYSE:MHK

vi. TransDigm Group Incorporated NYSE:TDG

vii. Textron Inc. NYSE:TXT

viii. Spirit AeroSystems Holdings, Inc. NYSE:SPR

ix. B/E Aerospace Inc. NasdaqGS:BEAV

x. Bombardier Inc. TSX:BBD.B

xi. HEICO Corporation NYSE:HEI

xii. Curtiss-Wright Corporation NYSE:CW

xiii. Esterline Technologies Corp. NYSE:ESL

xiv. Triumph Group, Inc. NYSE:TGI

xv. RBC Bearings Inc. NasdaqGS:ROLL

xvi. Aerojet Rocketdyne Holdings, Inc. NYSE:AJRD

xvii. Ducommun Inc. NYSE:DCO

d. AltQuest Building Products Index

i. Mohawk Industries Inc. NYSE:MHK

ii. USG Corporation NYSE:USG

iii. Armstrong World Industries, Inc. NYSE:AWI

iv. Advanced Drainage Systems, Inc. NYSE:WMS

v. Apogee Enterprises, Inc. NasdaqGS:APOG

vi. Builders FirstSource, Inc. NasdaqGS:BLDR

vii. American Woodmark Corp. NasdaqGS:AMWD

viii. Gibraltar Industries, Inc. NasdaqGS:ROCK

ix. Continental Building Products, Inc. NYSE:CBPX

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x. Insteel Industries Inc. NasdaqGS:IIIN

xi. Armstrong Flooring, Inc. NYSE:AFI

e. AltQuest Industrial Index

i. United Technologies Corporation NYSE:UTX

ii. Illinois Tool Works Inc. NYSE:ITW

iii. Eaton Corporation plc NYSE:ETN

iv. Ingersoll-Rand Plc NYSE:IR

v. Parker-Hannifin Corporation NYSE:PH

vi. Rockwell Automation Inc. NYSE:ROK

vii. Crane Co. NYSE:CR

viii. Hubbell Inc. NYSE:HUBB

ix. Colfax Corporation NYSE:CFX

x. Barnes Group Inc. NYSE:B

xi. Actuant Corporation NYSE:ATU

xii. Albany International Corp. NYSE:AIN

xiii. EnPro Industries, Inc. NYSE:NPO

xiv. Chart Industries Inc. NasdaqGS:GTLS

xv. Columbus McKinnon Corporation NasdaqGS:CMCO

f. AltQuest Medical Index

i. Medtronic plc NYSE:MDT

ii. DENTSPLY SIRONA Inc. NasdaqGS:XRAY

iii. Hologic Inc. NasdaqGS:HOLX

iv. Abaxis, Inc. NasdaqGS:ABAX

v. Analogic Corporation NasdaqGS:ALOG

vi. Integer Holdings Corporation NYSE:ITGR

vii. AngioDynamics Inc. NasdaqGS:ANGO

viii. Misonix, Inc. NasdaqGM:MSON

ix. Amedica Corporation NasdaqCM:AMDA

x. Allied Healthcare Products Inc. NasdaqCM:AHPI

2. Software

a. AltQuest Traditional Software Index

b. AltQuest SAAS Index

i. 2U TWOU NasdaqGS

ii. Amber Road AMBR NYSE

iii. Athenahealth ATHN NasdaqGS

iv. Bazaarvoice BV NasdaqGS

v. Benefitfocus BNFT NasdaqGS

vi. Callidus Software CALD NasdaqGM

vii. Castlight Health CSLT NYSE

viii. ChannelAdvisors ECOM NYSE

ix. Cornerstone OnDemand CSOD NasdaqGS

x. Covisint COVS NasdaqGS

xi. Ebix EBIX NasdaqGS

xii. FireEye FEYE NasdaqGS

xiii. Fleetmatics FLTX NYSE

xiv. HortonWorks HDP NasdaqGS

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xv. HubSpot HUBS NYSE

xvi. inContact SAAS NasdaqCM

xvii. IntraLinks Holdings IL NYSE

xviii. J2 Global JCOM NasdaqGS

xix. Jive Software JIVE Nasdaq

xx. Live Person LPSN NasdaqGS

xxi. Marin Software MRIN NYSE

xxii. Medical Transcript MTBC NasdaqCM

xxiii. Medidata Solutions MDSO Nasdaq

xxiv. Netsuite N NYSE

xxv. New Relic NEWR NYSE

xxvi. Paylocity Holding PCTY NasdaqGS

xxvii. Q2 Holdings QTWO NYSE

xxviii. Qualys QLYS NasdaqGS

xxix. RealPage RP Nasdaq

xxx. RingCentral RNG NYSE

xxxi. Salesforce.com CRM NYSE

xxxii. Service-now.com NOW NYSE

xxxiii. SPS Commerce SPSC NasdaqGS

xxxiv. Tableau Software DATA NYSE

xxxv. Tangoe TNGO NasdaqGS

xxxvi. The Ultimate Software Group ULTI NasdaqGS

xxxvii. TrueCar TRUE NasdaqGS

xxxviii. Upland Software UPLD NasdaqGM

xxxix. Veeva Systems VEEV NYSE

c. AltQuest Internet Index

i. 1-800-FLOWERS.com FLWS NasdaqGS

ii. 58.com WUBA NYSE

iii. 8x8 EGHT NasdaqGS

iv. Akamai Technologies AKAM NasdaqGS

v. Alibaba BABA NYSE

vi. Amazon.com AMZN NasdaqGS

vii. Angie's List ANGI NasdaqGS

viii. Baidu.com BIDU NasdaqGS

ix. Bankrate RATE NYSE

x. Bitauto Holdings BITA NYSE

xi. BlueNile NILE NasdaqGS

xii. Brightcove BCOV NasdaqGS

xiii. BroadSoft BSFT NasdaqGS

xiv. Carbonite CARB NasdaqGS

xv. Care.com CRCM NYSE

xvi. ChangYou.com CYOU NasdaqGS

xvii. Chegg CHGG NYSE

xviii. Cimpress CMPR NasdaqGS

xix. Coupons.com QUOT NYSE

xx. Criteo SA CRTO NasdaqGS

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xxi. Ctrip CTRP NasdaqGS

xxii. DemandMedia DMD NYSE

xxiii. eBay EBAY NasdaqGS

xxiv. eHealth EHTH NasdaqGS

xxv. Everyday Health EVDY NYSE

xxvi. Expedia EXPE NasdaqGS

xxvii. Facebook FB NasdaqGS

xxviii. GoDaddy GDDY NYSE

xxix. Google GOOG NasdaqGS

xxx. Groupon GRPN NasdaqGS

xxxi. GrubHub GRUB NYSE

xxxii. Harmonic HLIT NasdaqGS

xxxiii. Interactive Intelligence ININ NasdaqGS

xxxiv. LendingClub LC NYSE

xxxv. LifeLock LOCK NYSE

xxxvi. Limelight Networks LLNW NasdaqGS

xxxvii. LinkedIn LNKD NYSE

xxxviii. Liquidity Services LQDT NasdaqGS

xxxix. Mail.ru Group 61HE.L LSE

xl. MakeMyTrip MMYT NasdaqGS

xli. MaxPoint Interactive MXPT NasdaqGM

xlii. Mercadolibre MELI NasdaqGS

xliii. Mitel Networks MITL NasdaqGS

xliv. Monster Worldwide MWW NYSE

xlv. NCSoft 036570.KS KSE

xlvi. Netease NTES NasdaqGS

xlvii. Netflix NFLX NasdaqGS

xlviii. Overstock.com OSTK NasdaqGS

xlix. Pandora P NYSE

l. PetMed Express PETS NasdaqGS

li. Priceline PCLN NasdaqGS

lii. QuinStreet QNST NasdaqGS

liii. Renren RENN NYSE

liv. Rocket Fuel FUEL NasdaqGS

lv. SeaChange International SEAC NasdaqGS

lvi. ShoreTel SHOR NasdaqGS

lvii. Shutterfly SFLY NasdaqGS

lviii. Shutterstock SSTK NYSE

lix. SINA SINA NasdaqGS

lx. Sohu.com SOHU

lxi. Sonus Networks SONS NasdaqGS

lxii. Stamps.com STMP NasdaqGS

lxiii. Synacor SYNC NasdaqGS

lxiv. Tencent Holdings NNN1.F

lxv. The Rubicon Project RUBI NYSE

lxvi. TheStreet.com TST NasdaqGM

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lxvii. Travelzoo TZOO NasdaqGS

lxviii. Lending Tree TREE NasdaqGS

lxix. Tremor TRMR NYSE

lxx. TripAdvisor TRIP NasdaqGS

lxxi. TubeMogul TUBE NasdaqGS

lxxii. Tucows TCX NasdaqCM

lxxiii. Twitter TWTR NYSE

lxxiv. VeriSign VRSN NasdaqGS

lxxv. WebMD Health WBMD NasdaqGS

lxxvi. Wix.com WIX NasdaqGS

lxxvii. XO Group XOXO NYSE

lxxviii. Xunlei XNET NasdaqGS

lxxix. Yahoo! YHOO NasdaqGS

lxxx. Yandex YNDX NasdaqGS

lxxxi. Yelp YELP NYSE

lxxxii. YuMe YUME NYSE

lxxxiii. YY YY NasdaqGS

lxxxiv. Zillow Z NasdaqGS

3. Business Services

a. AltQuest Education & Training Index

i. Graham Holdings Company NYSE:GHC

ii. GP Strategies Corp. NYSE:GPX

iii. Pearson plc LSE:PSON

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

v. Capella Education Co. NasdaqGS:CPLA

vi. Bridgepoint Education, Inc. NYSE:BPI

vii. Strayer Education Inc. NasdaqGS:STRA

viii. K12, Inc. NYSE:LRN

ix. DeVry Education Group Inc. NYSE:DV

x. Career Education Corp. NasdaqGS:CECO

b. AltQuest Business Process Outsourcing Index

i. Wipro Ltd. BSE:507685

ii. Cognizant Technology Solutions Corporation NasdaqGS:CTSH

iii. Sykes Enterprises, Incorporated NasdaqGS: SYKE

iv. Convergys Corporation NYSE: CVG

v. West Corporation NasdaqGS:WSTC

vi. TeleTech Holdings Inc. NasdaqGS:TTEC

vii. Virtusa Corporation NasdaqGS:VRTU

viii. Unisys Corporation NYSE:UIS

c. AltQuest Facility Services and Industrial Services Index

i. Cintas Corporation NasdaqGS:CTAS

ii. ABM Industries Incorporated NYSE:ABM

iii. SP Plus Corporation NasdaqGS:SP

iv. Aramark NYSE:ARMK

v. Iron Mountain Incorporated NYSE:IRM

vi. UniFirst Corp. NYSE:UNF

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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

xviii. CECO Environmental Corp. NasdaqGS:CECE

xix. Team, Inc. NYSE:TISI

d. AltQuest Human Resources Index

i. Robert Half International Inc. NYSE:RHI

ii. ManpowerGroup Inc. NYSE:MAN

iii. WageWorks, Inc. NYSE:WAGE

iv. On Assignment Inc. NYSE:ASGN

v. 51job Inc. NasdaqGS:JOBS

vi. Insperity, Inc. NYSE:NSP

vii. TriNet Group, Inc. NYSE:TNET

viii. Korn/Ferry International NYSE:KFY

ix. TrueBlue, Inc. NYSE:TBI

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

xi. Kforce Inc. NasdaqGS:KFRC

xii. Automatic Data Processing, Inc. NasdaqGS:ADP

xiii. Heidrick & Struggles International Inc. NasdaqGS:HSII

e. AltQuest Information Services Index

i. Thomson Reuters Corporation TSX:TRI

ii. Acxiom Corporation NasdaqGS:ACXM

iii. Gartner Inc. NYSE:IT

iv. Alliance Data Systems Corporation NYSE:ADS

v. The Dun & Bradstreet Corporation NYSE:DNB

vi. comScore, Inc. NasdaqGS:SCOR

vii. Fair Isaac Corporation NYSE:FICO

viii. Experian plc LSE:EXPN

ix. Equifax Inc. NYSE:EFX

x. The Advisory Board Company NasdaqGS:ABC

xi. Verisk Analytics, Inc. NasdaqGS:VRSK

xii. CoreLogic, Inc. NYSE:CLGX

xiii. CoStar Group Inc. NasdaqGS:CSGP

xiv. FactSet Research Systems Inc. NYSE:FDS

xv. Moody's Corporation NYSE:MCO

xvi. Forrester Research Inc. NasdaqGS:FORR

xvii. IHS Markit Ltd. NasdaqGS:INFO

f. AltQuest Marketing Services Index

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i. WPP plc LSE:WPP

ii. Omnicom Group Inc. NYSE:OMC

iii. Publicis Groupe SA ENXTPA:PUB

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

v. MDC Partners Inc. NasdaqGS:MDCA

vi. InnerWorkings Inc. NasdaqGS:INWK

vii. Ipsos SA ENXTPA:IPS

viii. UBM plc LSE:UBM

g. AltQuest Real Estate Services Index

i. CBRE Group, Inc. NYSE:CBG

ii. CoStar Group Inc. NAsdaqGS: CSGP

iii. Jones Lang LaSalle Incorporated NYSE:JLL

iv. Realogy Holdings Corp. NYSE:RLGY

v. SouFun Holdings Ltd. NYSE: SFUN

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

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

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

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

h. AltQuest IT Services Index

i. International Business Machines Corporation NYSE:IBM

ii. Accenture plc NYSE:ACN

iii. Cognizant Technology Solutions Corporation NasdaqGS:CTSH

iv. CGI Group Inc. TSX:GIB.A

v. Booz Allen Hamilton Holding Corporation NYSE:BAH

vi. Leidos Holdings, Inc. NYSE:LDOS

vii. Teradata Corporation NYSE:TDC

viii. EPAM Systems, Inc. NYSE:EPAM

ix. Interxion Holding NV NYSE:INXN

x. CACI International Inc. NYSE:CACI

xi. ManTech International Corporation NasdaqGS:MAN

xii. Virtusa Corporation NasdaqGS:VRTU

xiii. The Hackett Group, Inc. NasdaqGS:HCKT

xiv. Unisys Corporation NYSE:UIS

xv. ServiceSource International, Inc. NasdaqGS:SREV

i. AltQuest Specialty Consulting Index

i. CEB Inc. NYSE:CEB

ii. FTI Consulting, Inc. NYSE:FCN

iii. Exponent Inc. NasdaqGS:EXPO

iv. The Advisory Board Company NasdaqGS:ABC

v. Huron Consulting Group Inc. NasdaqGS:HUR

vi. ICF International Inc. NasdaqGS:ICFI

vii. Navigant Consulting Inc. NYSE:NCI

viii. Resources Connection, Inc. NasdaqGS:RECN

ix. CBIZ, Inc. NYSE:CBZ

4. Healthcare

a. AltQuest Dental Product Index

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i. Zimmer Biomet Holdings, Inc. NYSE:ZBH

ii. DENTSPLY SIRONA Inc. NasdaqGS:XRAY

iii. Henry Schein, Inc. NasdaqGS:HSIC

iv. Align Technology Inc. NasdaqGS:ALGN

v. Patterson Companies, Inc. NasdaqGS:PDCO

vi. Cantel Medical Corp. NYSE:CMN

vii. BIOLASE, Inc. NasdaqCM:BIOL

viii. Milestone Scientific Inc. AMEX:MLSS

ix. Pro-Dex Inc. NasdaqCM:PDEX

b. AltQuest Dental Providers Index

i. Birner Dental Management Service OTCPK:BDMS

c. AltQuest Medical Devices & Products Index

i. Medtronic plc NYSE:MDT

ii. Abbott Laboratories NYSE:ABT

iii. Stryker Corporation NYSE:SYK

iv. Becton, Dickinson and Company NYSE:BDX

v. Boston Scientific Corporation NYSE:BSX

vi. Baxter International Inc. NYSE:BAX

vii. Intuitive Surgical, Inc. NasdaqGS:ISRG

viii. Zimmer Biomet Holdings, Inc. NYSE:ZBH

ix. St. Jude Medical Inc. NYSE:STJ

x. Edwards Lifesciences Corp. NYSE:EW

xi. CR Bard Inc. NYSE:BCR

xii. ABIOMED, Inc. NasdaqGS:ABMD

xiii. Integra LifeSciences Holdings Corporation NasdaqGS:IART

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

xv. Johnson & Johnson NYSE:JNJ

d. AltQuest Medical Product Distribution Index

i. Danaher Corp. NYSE:DHR

ii. Stryker Corporation NYSE:SYK

iii. McKesson Corporation NYSE:MCK

iv. Cardinal Health, Inc. NYSE:CAH

v. AmerisourceBergen Corporation NYSE:ABC

vi. Henry Schein, Inc. NasdaqGS:HSIC

vii. Patterson Companies, Inc. NasdaqGS:PDCO

viii. Owens & Minor Inc. NYSE:OMI

ix. PharMerica Corporation NYSE:PMC

x. Aceto Corp. NASDAQGS:ACET

e. AltQuest Specialty Providers Index

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

ii. DaVita HealthCare Partners Inc. NYSE:DVA

iii. MEDNAX, Inc. NYSE:MD

iv. AmSurg Corp. NasdaqGS:AMSG

v. HEALTHSOUTH Corp. NYSE:HLS

vi. Surgical Care Affiliates, Inc. NasdaqGS:SCAI

vii. American Renal Associates Holdings, NYSE:ARA

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viii. Adeptus Health Inc. NYSE:ADPT

ix. LHC Group, Inc. NasdaqGS:LHCG

x. AAC Holdings, Inc. NYSE:AAC

f. AltQuest Pharma Services Index

i. CVS Health Corporation NYSE:CVS

ii. Express Scripts Holding Company NASDAQGS:ESRX

iii. Perrigo Company plc NYSE:PRGO

iv. Allscripts Healthcare Solutions, Inc. NasdaqGS:MDRX

v. Magellan Health, Inc. NasdaqGS:MGLN

g. AltQuest Practice Management Index

i. WellCare Health Plans, Inc. NYSE:WCG

ii. HealthEquity, Inc. NasdaqGS:HQY

iii. Team Health Holdings, Inc. NYSE:TMH

h. AltQuest Provider Services Index

i. Cerner Corporation NasdaqGS:CERN

ii. Healthcare Services Group Inc. NasdaqGS:HCSG

iii. HMS Holdings Corp. NasdaqGS:HMSY

iv. The Advisory Board Company NasdaqGS:ABCO

v. Omnicell, Inc. NasdaqGS:OMCL

vi. Evolent Health, Inc. NYSE:EVH

vii. Providence Service Corp. NasdaqGS:PRSC

i. AltQuest Long Term & Behavioral Care Index

i. National HealthCare Corporation AMEX:NHC

ii. The Ensign Group, Inc. NasdaqGS:ENSG

iii. Civitas Solutions, Inc. NYSE:CIVI

iv. Acadia Healthcare Company, Inc. NasdaqGS:ACHC

v. SunLink Health Systems Inc. AMEX:SSY

vi. AAC Holdings, Inc. NYSE:AAC

The investment banker then spreads each public comp and the financial data feeds into the median and average for the

vertical and sub-vertical which ultimately ends up in the research (industry report, newsletter), pitchbooks, and CIMs of

the investment bank. For investment banks with an equity research department, financial statement models will be built

for each public comp that is being covered and consensus EPS data taken from research reports will be used to establish

the value of the public comp.

The investment banker ultimately uses the vertical index and sub-vertical index to perform proprietary research and

develop industry reports and newsletters which will aid in coverage and ultimately origination. The research, which we

will go into greater detail on later in the book focuses on vertical and sub-vertical trends in margins, multiples, and

M&A.

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

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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.

How to Advise on Strategic Alternatives?

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.

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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 Deliverables

Investment 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 EBITDA

III. Valuation

IV. Teaser & CIM (sell side mandate)

V. Purchase Agreement

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Chapter 36: Adjusted EBITDA

After receiving the financials for the target, the investment banker must calculate adjusted EBITDA. The calculation

for EBITDA looks like the following:

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Chapter 37: Valuation

After arriving at adjusted EBITDA, the investment banker will determine public comps and extrapolate a multiple

for the target company adjusting for size of the company. From there, precedent transactions will be spread to

determine a mean multiple. Finding the midpoint of the valuation methodologies can be used for determining

valuation but the range is often communicated to the client or potential buyers:

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Chapter 38: Teaser

After finding adjusted EBITDA and determining valuation, the investment banker can build the marketing material

for the target company which includes a teaser and a CIM. The teaser can be broken down in the following

manner:

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Chapter 39: CIM (Confidential Information Memorandum)

After creating the teaser, the investment banker goes into greater detail in a marketing document called a CIM.

This document is distributed to buyers after the teaser and is for the serious buyers to do an in depth analysis of

the target.

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Chapter 39: Purchase Agreement

After the strategic or financial buyer decides to draft an LOI and proceed with an acquisition of a given target, the

purchase agreement will need to be drafted. In the LMM, the investment banker may draft the agreement

himself/herself, but as transactions get larger, M&A attorneys will be involved and take the lead with the creation

of the purchase agreement. The investment banker will stay actively involved in the drafting of the agreement.

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BUY-SIDE

For those that have already built perpetuities and their representation, there is another category known as the buy-side.

The buy-side is made up of financial (private equity) and strategic buyers (corporate).

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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:

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.

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)

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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:

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 buyout

Growth

Mezzanine

While each of these private equity firms have different hurdle rates, each perform an LBO analysis to determine whether

or not to purchase a perpetuity. There are two types of private equity plays:

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

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

Private equity firms have 7 to 8 years to invest and get returns and be done with the fund. They have a 2% management

fee generally. They are targeting 20% to 25% and think in terms of spread over treasuries. IRR is the name of the game

which the main drivers of returns being; acquisition price, amount of debt raised, and future operating performance

(model projections). There is an aspect of buy low, sell high regarding multiples (ex. 11x entry and 13x exit). You can use

the following as a general rule of thumb for a private equity group:

15% IRR don’t do the deal

25% IRR do the deal

30% IRR, you must do the deal

Regarding ideal private equity targets, the private equity firm will specialize in a few sectors and does not want a lot of

discretionary CAPEX. They will however do maintenance CAPEX. They will look to rework AR and AP contracts.

Furthermore, after an acquisition, the PE group will look to pay debt down as fast as possible. They ideally want dividend

recaps (add additional cash and then pay self a dividend after paying back additional debt).

The PE firm when considering an investment will run multiple cases to determine what case to bid on. They will do

sensitivity tables as well.

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The PE group will work with LevFin, SLF & DCM within a given investment bank with SLF syndicating the loans and then

selling the paper. The IB charges a financing fee, advisory fee, and syndication fee.

Leveraged Buyout (LBO) Analysis:

1. Locate financial information

2. Build the operating model

3. Input transaction structure

4. Complete LBO model with new structure

5. Run the LBO analysis

Notes:

Banks want 20% to 30% for financial sponsor. This depends on the industry; 50% necessary for technology company.

Bank looks at leverage ratios and interest coverage to determine which covenants to put in place.

Construction of LBO Model

Purchase price and considerations

Sources and uses

Cap structure alternatives (sources)

Integrate proforma BS into operating model (change in debt level and intangibles)

IS, BS, and SCF projections integration

IRR analysis for FS and hybrid debt lender (to find what is EBITDA, how much is cash and how much is debt

Sensitivity tables

Credit ratios

PIK allows you to get more leverage

LBO model is an M&A & DCM transaction in one

EBITDA multiple determined from midpoint of the football field

Transaction fees:

Financing fees – SLF & DCM

IB fees – M&A

Legal – Lawyer

Other fees

Leverage is spoken in terms of x leverage which means x EBITDA

SLF & DCM go through cases of operating model to find optimal tranche of debt to provide highest leverage to the FS

but can still be sold in the marketplace

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

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

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Assumptions for projects:

Operating model start with base case without transaction

Sponsor upside case

Sponsor downside case

Each case underneath line item in Assumptions tab

Use choose function to choose case

Key question: Is capital structure correct to allow you to pay down amortized debt and other tranches of debt?

Look at net cash flow being generated and then determine if unsecured needs to be PIK (if not enough net CF, then

need PIK)

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

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

Financial sponsors want to see sensitivity table with highlighted options that make sense. Sensitize entry multiple and

exit multiple for IRR.

Reverse LBO: If I have a hurdle rate of x%, what is the max price I can pay for the asset? Also get an implied entry

multiple.

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

Credit officer meeting:

25-30 page deck

Industry

Sponsor thesis

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

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

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

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

How quickly does this company get delivered?

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

PE interview:

Interview 1 – Experience

Interview 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 information

2. Build the standalone operating model for target & acquirer

3. Input transaction structure

4. Complete merger model with new structure

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

Notes:

Merger Modeling

2 operating models put together with synergies

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

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

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

Dilution is proforma decrease in EPS. What causes dilution?

Buyer with higher PE multiple than target, then accretive as the target is less expensive. If target has PE that is higher

than the acquirer, always dilutive. If premium paid causes PE of target to be higher, then dilutive.

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

Proforma ownership structure want to control 50.1% of company

Pretax synergies required to break even: How much synergies does acquirer need to have for the transaction to be

accretive:

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

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

Know where your stock’s value is going:

If undervalued, then don’t use stock

If overvalued, then use stock to fund the transaction

Collars: When announce transaction, establish exchange ratio as the stock price will move so have either:

A. Fixed value collar – favors target

B. Fixed share collar – favors acquirer

Sensitivity tables are used to help structure deals and in negotiations

Surviving entity (acquirer)

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Chapter 45:

Perpetuity Science & Portfolio Theory

One should not diversify away from perpetuities but rather concentrate wealth In them. Diversification is not to be

among asset classes but among perpetuities; asset classes that are not perpetuities In nature are commodities and thus

not actually investments.

Perpetuities are investments, commodities are not.

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Chapter 45:

How to Start a LMM Search Fund

For those just getting started in private equity and are looking to buy a perpetuity, it is advisable to begin in the LMM

with TEVs south of $25M. There are fund sponsors dedicated to working with PE search funds. They partner with

operators that have access to perpetuities being sold by owners. The typical structure to this process is to meet with the

fund sponsor and demonstrate the capabilities and plan for taking a perpetuity to the next phase. An example of this

would be taking a job shop and turning it into a perpetuity or taking a perpetuity and turning it into a growing

perpetuity. One should be intimately familiar with Perpetuity Science and have participated on at least one side of the

perpetuity with a track record. The real key is access to a quality perpetuity where the principle of investing can be

applied.

The search fund does not commit capital directly but instead forms an agreement that capital will be supplied providing

that a target meets hurdle criterion set forth by the fund sponsor. It is the LMM PE search fund’s responsibility to find the

target and negotiate with the owner.

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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

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.

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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:

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In terms of converting followership into usership, the following are the conversion metrics after we started

requesting that our followers become users:

The following is the FameLinked Perpetuity Presentation by Founders Ventures:

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Chapter 40:

Asiansbook

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.

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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:

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:

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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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The following is the Asiansbook Perpetuity Presentation by Founders Ventures:

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Chapter 40:

DegreeLinked

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.

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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:

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:

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In terms of converting followership into usership, the following are the conversion metrics after we started

requesting that our followers become users:

The following is the DegreeLinked Perpetuity Presentation by Founders Ventures: