DegreeLinked Book

DEGREELINKED: THE STUDENT NETWORK & MARKETPLACE

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Michael Herlache MBA

Doctor of Business Administration Candidate

VP, M&A at AltQuest Group

Svitlana Herlache

Analyst, M&A at AltQuest Group

DegreeLinked The Student Network & Marketplace


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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 perpetuity training program associated

with this text, the Unicon University (www.VCFounders.com) course’s syllabus is based

upon the content of this book.

http://www.vcfounders.com/


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Contents

PERPETUITY:

Chapter 1: How to Build a Perpetuity Methodology

Chapter 2: DegreeLinked

PERPETUITY SCIENCE:

Part I: Perpetuity Methodology

Chapter 1: What is Business?

Chapter 2: What is a Perpetuity?

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 7: How to Build a Benefit Stream?

Chapter 8: How to De-Risk the Benefit Stream?

Chapter 9: The Value Perpetuity

Part II: Perpetuity Analysis

Chapter 10: How to Be a CEO?

Chapter 11: How to Be a Consultant?

Part II: Perpetuity Engineering

Chapter 10: How to Be an Engineer?

Chapter 10: Knowledge Engineering

Chapter 10: Content Engineering

Chapter 10: Platform Engineering

Part III: Perpetuity Management


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Chapter 12: Perpetuity Management

Chapter 13: Valuation Methodologies

Chapter 14: Framing Valuation

Chapter 15: The Market for Perpetuities

Chapter 16: Index Building & Benchmarking

Chapter 17: Financial Data Sources

SELL-SIDE:

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 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)


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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

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

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

build-side, with individuals possessing IB/PE and platform development talents to use in

the building of perpetuities? Shouldn't that be the logical course of events with

individuals taking their knowledge of valuation and industries and putting them to use

in building the next unicorns?

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

run called Founders Ventures (www.VCFounders.com) to work on concepts that have a

legitimate chance of being a unicorn. Rather than leaving one's job to join a

questionable startup, join a startup lab and be directly involved in the build-side, even if

it part-time. The work of the build-side is syndication.

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


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Perpetuity

The primary output in a capitalist economy is the perpetuity. The inputs include industry

as the uses and the capital markets as the sources of capital. The perpetuity is an asset

with a benefit stream that extends into the future continuously.


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Chapter 1:

How to Build a Perpetuity Methodology

At Founders Ventures, we are often asked, “How to build a perpetuity?” so we decided to

take our approach and build an official methodology around the process.

How to Build a Perpetuity Methodology:

1. The Case for a Perpetuity

2. MVP

3. Value Perpetuity

4. Financial Perpetuity

5. Growing Financial Perpetuity

6. Diversified Perpetuity


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Chapter 2:

DegreeLinked

DegreeLinked

Challenge & Opportunity: Applying to undergraduate and graduate school is a time-

consuming and tedious task. It requires first selecting the right school and then filling

out numerous applications including different essays. 75% of prospective students say

that they would have applied to more schools if the admissions process were less

tedious and time-consuming. DegreeLinked simplifies the university admissions process

by standardizing and consolidating it into one singular platform. Connect directly with

university admissions representatives, share academic performance and write one

application used for all target universities at www.DegreeLinked.com

Key Question: How to Connect Students with University Admissions & Employment

Opportunities?

DegreeLinked Methodology:

Provide a networking platform that connects former, current and prospective students

with university admissions and employment opportunities. The student marketplace

allows universities to run the admissions process through the platform and students get

to make one application for all target universities.


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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.


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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 however, the student can better synthesize the various moving parts

of industry and the capital markets.

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

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

perpetuity can be modeled with the following formula:

Perpetuity value = CF / r

Where CF represents the benefit stream associated with the perpetuity and r represents

the discount rate associated with the perpetuity’s risk of receiving the benefit stream.


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

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

value being offered will be different. We investigate each industry according to these

variables by building an index for each industry and then sub-sector within the industry.

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

chain and leaders in each part of the value chain. We then build financial statement

models for the leaders in each section of the value chain and understand the drivers of

performance.

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

where they are now and the next steps that they can take to move to the next phase. In

doing so, one begins to think in terms of being a CEO. The CEO’s role is to bring the

company/opportunity through the stages of the perpetuity by building recurring benefit

streams (i.e. cash flows) and at the same time de-risking those benefit streams. In doing


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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:


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Key Question: How to Buy a Perpetuity?

Capability: The capability to buy a perpetuity

Capabilities that each business student should have are associated with the 3 key

questions of Perpetuity Science:

Perpetuity Science:

I. Build side: How to build a perpetuity?

II. Sell side: How to sell a perpetuity?

III. Buy side: How to buy a perpetuity?

The key questions are associated with capabilities to be built learning perpetuity science.


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From this methodology, Investment Banking University has built a body of knowledge

which turned into the course, How to Become an Investment Banker. The book,

Investment Banking, is meant to accompany the course which can be taken online, in the

weekend workshop, or in the month-long training.


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

asking four questions simultaneously:

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

2. How to physically build the perpetuity?

3. How to sell/exit the perpetuity?

4. How to buy a perpetuity?

For each question, Investment Banking University has developed proprietary

methodologies which are the basis for building a capability which is the ultimate answer

to the question.

When the individual implements these models and builds the capabilities in finance, the

build side, the sell side and the buy side, one may claim to have become an investment

banker.


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Part I:

Perpetuity 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


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In order to increase standard of living without sacrificing quality of life, one is to build,

sell or buy perpetuities.

Perpetuity

Perpetuities increase standard of living without sacrificing quality of life by possessing

recurring revenue and automated work processes to achieve the revenue.

I. Building Perpetuities

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

as entrepreneurship or corporations.

II. Buying Perpetuities

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

here are Private Equity (PE) or Corporate M&A Departments for major corporations.

III. Selling Perpetuities

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

bankers (Wall Street).

The Lab of Perpetuities

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

Excel

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

perpetuities.

Demand for Perpetuities

There is always demand for perpetuities and especially by institutional investors which

means that the market for corporate control more closely 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:


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I. Commodity

a. Durables

b. Non-durables

II. Platform

a. Digital

b. Physical

III. Content

a. Educational

b. Entertainment

IV. Service

a. Analysis

b. Allocation

c. Engineering

d. Logistics

e. Management

f. Advocacy

g. Relationship

V. Infrastructure

a. Private

i. Real estate

b. Public

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

existence we arrive at industries associated with the perpetuities (according to Aswath

Damodaran at NYU):


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

helpful to understand the nature of the perpetuities including risk (as represented by the

discount rate in the perpetuity formula), return, growth, margins, multiples, and cash

flow:


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Risk (discount rate) on the following page:

Return:

Growth:


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Margins (Cash flow):

Multiples:


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Business: The Science of the Perpetuity

Introduction to Business

Business is the science of the perpetuity

Perpetuity value = CF / Discount rate

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

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

The Corporation’s Goal

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

processes.

2. Become a growing perpetuity

Value of growing perpetuity = CF / r – g

g decreases the discount rate

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

is associated with a single benefit (cash flow) or a finite benefit stream, whereas the

benefit stream of a perpetuity is continuous into the future.

What is Intrinsic Value?

Something is intrinsically valuable inasmuch as it is a perpetuity. Perpetuity provides

certainty that the benefit stream will be recurring in the future and is thus, the basis for

intrinsic value. Perpetuities allow us to improve our standard of living while not

sacrificing quality of life by continually dealing with a problem/opportunity in nature

and yielding passive benefits.

How to Become Wealthy?


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

perpetuity is an asset that generates a benefit stream continuously into the future. This

yields passive benefits rather than active benefits of which the middle class works for.

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

perpetuities. There are three sides to the perpetuity:

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

a. How to Build a Benefit Stream?

i. Case for Value Perpetuity and Financial Perpetuity

ii. MVP

iii. Value Perpetuity

iv. Financial Perpetuity

v. Growing Financial Perpetuity

vi. Diversified

b. How to De-Risk the Benefit Stream?

i. Customer Concentration

ii. Owner Dependence

iii. Recurring Revenue

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

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

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

rather than 20th century functional specialists that will remain in the middle class.

In terms of order, the process is usually:

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

coverage and syndicate within a vertical & sub-vertical)

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

(within existing investment bank or start own boutique investment bank)

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

search fund


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FOUNDATIONS OF

VALUATION

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

a strong understanding of the foundations of valuation. This helps us to understand why

it is that the investment banking industry exists and where investment bankers fit into

the bigger picture.


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Part 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:


Accounts and Accounting

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

create accounts for each item of it’s financial existence. These accounts are the basis of

valuation. Valuation is the basis of actions taken in a capitalist economy.

Accounts, Accounting & Excel

Excel is the software used to model the accounts of the enterprise and determine the

valuation of the perpetuity (i.e. business).

Account Filings & Public Data

10-K annual

10-Q quarterly

Account Statements: P&L

Income statement (P&L):

Revenues

COGS

Gross Profit

Operating Expenses

EBIT

Interest Cost

EBT

Taxes


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Earnings

Account Statements: Balance Sheet

Assets = Liabilities + Shareholder’s Equity

Total Assets = Total Liabilities + Shareholder’s Equity

Current Assets + Long Term Assets = Current Liabilities + Long Term Liabilities + Value

of Shares Previously Issued + Retained Earnings – Treasury Stock

Account Statements: Statement of Cash Flows

CF from Operating

CF from Investing

CF from Financing

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

sheet.

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

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:


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.


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*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.

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)


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Projected financial statements

Free cash flow calculation (FCFs)

Terminal value calculation

Valuation calculation

Sensitivity table for major value drivers to see range of valuation

Once the financial model is complete (i.e. accounting statements have been projected),

we can use the model to:

Value the firm by projecting free cash flows (FCFs)

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

Using a Financial Model for Decision Making: The Financing Decision

All companies must decide how to finance their activities

Proportion of debt and equity

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

cash flows being discounted.

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

Compute annualized IRR

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

investment. The relationship of individual asset returns to the risk is called the security

market line (SML). You can use SML to get the discount rate for individual investments.

The SML is used for private companies.

The cost of capital of an organization is related to the risk of the combined riskiness of

the investments in the portfolio. The relationship of portfolio returns to the risk is called

the capital asset pricing model (CAPM). You use CAPM to get the discount rate (i.e. cost

of capital). When the investment is a public security, you use CAPM since the buyer of

the security will have a portfolio to diversify away risk.

Portfolio risk is associated with statistics.


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Wealth Maximizing Decisions

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

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

Cash is King

Wealth maximization has to do with maximizing cash. Cash in the context or

organizations is known as cash flow.

Return is a word for cash flows

Cash Flow Definition (FCF)

Profit after taxes

+ Depreciation (noncash expense)

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

liabilities)

Capital expenditures (CAPEX)

+ After-tax interest payments

= Free Cash Flow (FCF)

Role of the Finance Professional

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

alternatives available to the individual or organization.

Investment bankers compute the IRR and NPV of strategic alternatives.

Capital Markets

The capital markets is made up of cash flows and discounts

Capital Markets and Information

Information is valuable in determining investment and financing decisions in the capital

markets. Overall, markets are weak form efficient meaning that their valuations reflect

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


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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


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

of interest which incorporates inflation. The real rate of interest is determined by using

the real cash flows.

Inflation acts as a discount rate

Strategic Alternatives Analysis

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

investing including:

Minimum NPV

Hurdle rate (IRR)

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

rate. The discount rate is associated with the financing decision

Cash Flows and Risk

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

Cost of Capital and Opportunity Cost

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

The Discount Rate

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

total capital structure is known as the Weighted Average Cost of Capital (WACC):

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


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

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

activities.

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

Market valuation:

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

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

Accounting Value vs. Finance Value

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

Finance value is forward looking and consistent with the fact that the owner of an

organization or security has claims on the future cash flows of the business.

FCF and DCF

Free cash flow (FCF) calculations is DCF

Portfolio Analysis and the Capital Asset Pricing Model (CAPM)

Discount rate is a measure of risk associated with:

Horizon

Safety

Liquidity

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.


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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

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


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

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

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

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

Security Market Line & CAPM

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

asset’s beta (i.e. sensitivity to the market).

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

Security Market Line & Investment Performance




Security Market Line & Investment Performance




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


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Market portfolio proxy is S&P 500

Beta is measure of riskiness of security

Alpha measures excess return

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

CAPM & Investment Performance

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

alternatives

Is there risk adjusted overperformance or underperformance?

Is performance commensurate with risk?

Excess Return

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

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


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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

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:


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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

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


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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


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

levels of development of the perpetuity including:

1. Levels of customer concentration where:

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

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

2. Levels of recurring revenue where:

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

levels of recurring revenue correspond with a low EBITDA multiple

3. Levels of owner dependence where:

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

low levels of owner dependence correspond with a high EBITDA multiple

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

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

In doing so, the perpetuity scientist builds a highly sought after perpetuity for both

strategic and financial buyers corresponding with a premium valuation.

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

perpetuity scientist should follow these steps:

Stage of the Perpetuity:

1. Syndication:

(Getting to PMT)

Initial revenue generation

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


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active involvement. If the owner no longer works in the syndication, the syndication will

cease to operate.

The market here is inefficient.

2. Job Shop:

(From PMT1 to PMT2, PMT3, etc)

The initial efforts create a job shop

The key here is taking a syndication that has demonstrated product/market fit and

turning it into a job shop with multiple projects as represented by PMT1, PMT2, PMT3.

This demonstrates product market fit between the minimum viable product/platform

and allows the owner to invest additional time/energy/resources into turning the

syndication into a perpetuity. The job shop’s valuation is based upon a multiple of its

EBITDA and is usually in the range of 3x to 5x. The job shop is not entirely reliant on the

owner’s active involvement and there is thus a larger, albeit still inefficient market for the

prospective perpetuity with likely buyers being individuals and LMM strategic and

financial buyers.

The owner’s primary responsibility is to first turn the company into a project or job shop

(PMT representing a given job). The company is looked at solely as the sum of the value

of its projects/jobs meaning that the valuation of the company is backward looking.

3. Perpetuity:

(From PMTi to CF/r)

Transitioning from a job shop to a recurring revenue stream

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

turning it into a perpetuity with a predictable if not recurring benefit stream. The

perpetuity’s value is based on a larger EBITDA multiple since there is a semi-strong

efficient market for perpetuities with likely buyers being middle market strategic and

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

involvement.

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

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

organizational structure with division of labor, automated processes with technology,


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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


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

in an integrated platform. Platform is ultimately the basis for becoming a perpetuity.

Mod is associated with a specific functionality.

The Value of Technology & Science

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

Technology and science in isolation has no value.

The Consumption Process & Growth Hacking

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

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

person at a time and consumption follows a definite process which is the following:

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

email

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

a follower

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

is willing to experiment with usage

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

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

become users

6. Active users willing to pay for usage

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

should be consistent with this fact. The Growth Hacking Methodology means manually

connecting with individuals on various 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


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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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72


73


74


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







76


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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?


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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:

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

players at:


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2. Sub-Vertical

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

for Perpetuities chart:


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For example, we can take a look at the Oil & Gas machine manufacturing sub-vertical

and see where the various players at:

3. Corporation

As discussed, a corporation is merely a portfolio of perpetuities. As such, we can map

the corporation in terms of its perpetuities and see the stage of each individual

perpetuity:


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An example of Perpetuity Analysis at the corporate level would be Berkshire Hathaway,

which we have mapped below:


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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.


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

the owner and at the same time maximizes it’s valuation.

Though applicable to all industries, the focus industries of perpetuity science are thus

those that do not require significant capital outlays which could otherwise be used to

invest in a diversified portfolio. These industries include:

1. Technology

2. Media

3. Education

4. Business Services

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

information arbitrage and/or network arbitrage. While it is possible to structure

arbitrage in other industries by preselling various products and services, knowledge

working industries offer genuine information/network arbitrage as well as allowing for

recurring revenue business models rather than being one time commodity or project-

based. You will also notice that margins are much larger in knowledge working

industries which translates into larger EBITDA multiples. Thus, the owner of the

perpetuity is rewarded multiple times more for the value that their perpetuity creates

than they would for commodity or project-based syndications.

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

within which to invest (energy, capital), one should invest their time in knowledge

working industries and build perpetuities there first. Only after a perpetuity has been

built in a knowledge working industry should the owner explore other non-knowledge

related industries.

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


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II. Perpetuity Building

III. Perpetuity Management

Perpetuity Exit

Market Analysis

GDP

Industry Spend

Sub sector spending

Sub sector spending by product


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Value Chain Analysis

General

Industry

Sub-sector

Sub-sector by product

Gap Analysis

General

Industry

Sub-sector

Sub-sector by product

Product/Platform Analysis

Base

Mods

Perpetuity Science: A methodology that synthesizes industry and the capital markets in

relation to the perpetuity. The science of building, selling and buying perpetuities.

I. Nature of the Perpetuity

II. Phases of the Perpetuity

III. Sides of the Perpetuity

IV. Perpetuity Analysis:

Industry and sub-industry indices


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Determining where leaders are at in Perpetuity Phases

Build financial statement models for each

Compare Perpetuity Phase to intrinsic value

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

relation to intrinsic value?)

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


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Chapter 10: How to Be a CEO?






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

perpetuity.

As the perpetuity changes, the formula for valuing the perpetuity changes as well. There

are five phases of perpetuity building. As we move through the phases, the role of the

owner of the perpetuity becomes more passive and the valuation becomes larger due to

size of EBITDA increasing, EBITDA multiple increasing, and the discount rate decreasing.

The perpetuity becomes less dependent on the owner to exist and run as an

organizational structure is formed coinciding with the division of labor, processes are

automated, and revenue becomes recurring.

Phases of the Perpetuity:

I. Syndication (Getting to PMT)

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

III. Perpetuity (From PMTi to CF/r)

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

V. Diversified (Perpetuity 1 + Perpetuity 2)


90


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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


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

the 21st century when most individuals will have multiple jobs and roles throughout

their careers and lives.

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

known as Perpetuity Science. Perpetuity Science is the body of knowledge,

methodologies, and optimization models related to the building, selling, and buying of

perpetuities. It explains how perpetuities can be built, managed and exited from to

create wealth. Perpetuity science is a paradigm shift in business and finance education in

that it replaces the siloed subjects traditionally taught in undergraduate and graduate

business schools with a holistic methodology that integrates industry and the capital

markets into one framework.

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

accounting, marketing, etc., we have an initial taxonomy broken down in relation to the

perpetuity, namely:


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


Within each of the three, we have various methodologies and optimization models that

may touch on various subjects such as accounting, finance, economics. By starting with

perpetuity science, the student can better synthesize the various moving parts of

industry and the capital markets.

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

one should first understand the nature of the perpetuity, which is the basis for industry

& the capital markets. The perpetuity can be modeled with the following formula:




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,


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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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Chapter 48: How to Be an Engineer?

Engineer Methodology:

1. Identify challenges/opportunities in nature

2. Form key question

3. Develop methodology to answer key question

4. Build platform consistent with methodology

5. Turn platform into 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


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The Role of the CEO

Perpetuity Management

Valuation


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102

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


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Value Metrics

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

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

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

of a company or total returns to shareholders (TRS)

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

Intrinsic value of chosen strategic alternative translated into short and medium term

financial targets and then targets for operating and strategic value drivers

Performance assessed by comparing results with targets on both financial indicators and

key value drivers. Managerial rewards linked to performance on financial measures and

key value drivers

Value Metrics: Market Value Added & Total Return to Shareholders

Market Value Added is the difference between the market value of a company’s debt

and equity and the amount of capital invested. Measures financial market’s view of

future performance relative to capital invested in business.

Total Return to Shareholders measure performance against the expectations of financial

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

the target set by market expectations

Value Metrics: DCF vs. Earnings Multiple

DCF is intrinsic value. Earnings multiples are market values.

Earnings alone is inadequate without understanding the investment required to

generate the earnings. Should know ROIC

Cash Flow


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

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

Perpetuity Management Capability

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

2. Determine which phase is the goal

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

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

next phase

5. Execute the plan

Perpetuity Lifecycle:


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Chapter 16: Valuation Methodologies

1. Public Company Valuation

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

years projections or equity research comp reports to get forward multiples (x Revenue

or x EBITDA ) which may be used as the basis for this valuation. You can get comps from

the general overview as it will discuss the target’s comps in the 10K. Find comps with

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

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

10Q, analyst reports to get TEV for each comp then divide by line item to get multiple.

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

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

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

tab). To get MVE, use TSM method. TSM = Exercisable options outstanding x (share

price – strike) / share price.

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

metric for each comp and get mean and median of comps for the metrics (ex.

TEV/EBITDA)


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

EBITDA to get the valuation range for your target company.

Notes:

The better the company, the higher the multiple and the better valuation you get.

In IB/PE/CorpFin, you need to know comp companies and transaction comps. “Here are

the comps in your sector…”

Higher multiple because…

Operating in better markets, better operations

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

better.

Sell side key question:

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

3. Precedent Transactions – comp transactions

a. Select universe of comp transactions

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

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

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

transaction MVE (implied)

d. Benchmark precedent transactions

e. Determine implied valuation

Notes:

20% to 25% control premium paid with the transaction multiple being an implied one

based upon the valuation.

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

good premiums (control premiums).

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.


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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.

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


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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


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

Calculate benefit stream (synergistic vs. owner benefit)

Determine required rate of return given the phase of the perpetuity and the buyer

(discount rate)

Convert benefit stream into present value at the discount rate

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

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

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

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

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


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Chapter 19:

Investment Banking

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

discussions around investment banking typically relate to M&A. M&A is the selling of a

perpetuity in the form of a corporation to either a financial or strategic buyer. Financial

and strategic buyers have what is known as investment/corporate M&A mandates which

detail the size and industry of prospective targets for acquisition. The investment banker

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

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

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

relative to the index in terms of:


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Revenue

EBITDA

Multiples

The investment banker monitors trends in these variables and determines the optimal

time to sell (when multiples are strong) or acquire (when multiples are weak) and

advises target management accordingly. When a target agrees to sell via an investment

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

by the investment banker. During the M&A process, there are definite steps and

deliverables including a teaser, CIM, and management presentation. The M&A process

can include many prospective buyers (broad auction) or few prospective buyers

(targeted or negotiated sale).

The investment banking core product is M&A. As such, the investment banker’s role is to

aid in the growth of perpetuities via an inorganic strategy (merger, acquisition).

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

and valuation is merely for decision support and deals often get done simply based

upon precedent transactions analysis. Thus, the priority of the investment bankers is to

obtain a base level understanding of financial modeling & valuation but then to

immediately start originating sell side and buy side mandates.

Investment bankers explore strategic alternatives (value creation opportunities) with

corporation’s CEO’s/owners.

Notes:

Valuation Football Field and the Midpoint is the final valuation of the company.

Calculate NPV and IRR to the sponsor in LBO or EPS Change and Balance Sheet Effects in

Merger

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:


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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


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3. Small cap

4. Middle market

5. Lower middle market

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

coverage groups were the following:

1. Manufacturing

2. Software


4. Healthcare

After choosing your coverage, the investment banker is then to build an index for each

of the verticals and sub-verticals made up with the public comps. The AltQuest Group

coverage is broken down in the following manner:

1. Manufacturing

a. Durable consumer

b. Non-durable consumer

c. Aerospace & defense

d. Building products

e. Industrial

f. Medical

2. Software

a. Traditional software

b. SAAS

c. Internet


a. Education & Training

b. Business Process Outsourcing

c. Facility Services and Industrial Services

d. Human Resources

e. Information Services

f. Marketing Services

g. Real Estate Services

h. IT Services

i. Specialty Consulting


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4. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

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

the median and average for the vertical and sub-vertical which ultimately ends up in the

research (industry report, newsletter), pitchbooks, and CIMs of the investment bank. For

investment banks with an equity research department, financial statement models will

be built for each public comp that is being covered and consensus EPS data taken from

research reports will be used to establish the value of the public comp.

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

perform proprietary research and develop industry reports and newsletters which will

aid in coverage and ultimately origination. The research, which we will go into greater

detail on later in the book focuses on vertical and sub-vertical trends in margins,

multiples, and M&A.

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

vertical as well as establishing relationships with strategic and financial buyers within the

vertical and sub-vertical, the investment banker may begin advising targets on their

strategic alternatives using information gleaned from the vertical and sub-vertical

indices. Regarding the vertical index and sub-vertical index, the investment banker

ultimately tracks trends in:

Growth rates

Margins

Debt to Equity


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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


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mandate or I will structure it as a buy side deal and receive the fee from the

strategic/financial buyer.

Looking forward to year two, here are the projections:

1,000 introduction emails

50 sell side pitches (phone and in person)

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

8 IOIs from strategic/financial buyers

2 closed M&A deals

$110,000 in M&A fees received

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

working on the weekends.

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

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

quote your fee, you make your money when you close the deal. The point is that I would

rather win an engagement and give up 1% to 2% of the fee than have the seller think

that I am not being fair. The Lehman scale simplifies this a bit but often times the seller

will want to know the exact % that they will be paying you.

Large cap – Lehman scale

Mid cap – Lehman scale

Small cap – Lehman scale

Middle market – Double Lehman structure

Lower middle market – 3% to 10%


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Part XI:

The Middle Market

The majority of perpetuities are in what is known as the middle market, a classification

for mid-sized perpetuities. This is where the majority of the transactions occur and

where the average investment banker will make his living.


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Chapter 21:

The Middle Market

Because of the wide range of company sizes within the definition, the middle market can

be further broken down into the following:

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:


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

Notice how the multiples increase as the size of the perpetuity increases due to the

scarcity value of larger perpetuities (increased demand for large perpetuities and less of

them).

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:


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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:

Next, the following is a chart that depicts the % of deals getting done with some aspect

of an earnout, meaning portion of the purchase price contingent on future performance

of the business:


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


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Part XII:

Investment Banking Coverage

Methodology

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

market and particularly for the industries that they cover.


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Chapter 29:

Investment Banking Coverage

Methodology

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

to cover (ex. public co's, middle market, lower middle market). From there, the

investment banker chooses an initial vertical and sub-verticals to cover. With AltQuest

Group, our initial coverage groups were the following:

1. Manufacturing

2. Software


4. Healthcare


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


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strategic buyers as well as potential targets. This means building your rolodex. Obtain

the investment mandates from the strategic and financial buyers and establish a fee

arrangement for buy-side deals. This will end up being the Lehman scale for the fee on

the buy-side.

The investment banker will often focus on a product group (i.e. M&A) and/or an industry

(industrials, healthcare, technology). Proper coverage comes in the form of maintaining

a coverage index for a sector and its sub-sectors which is broken down in the following

manner:

I. Industry macroeconomics

a. Industry spending

b. Sub-sector spending

c. Stock market performance of industry

II. Public sub-sector financial and valuation performance

a. Sub-sector index

b. Sub-sector index: financial performance

c. Sub-sector index: public market multiples

d. Sub-sector index by product category

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

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

III. Industry M&A Market Update

a. Industry M&A deal volume and spending

b. Industry M&A exit multiples

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

d. Sub-sector M&A exit multiples

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

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

IV. Appendix

a. Sub-sector index key metrics

b. Sub-sector index key metrics by product category

c. Industry most active buyers

d. Sub-sector most active buyers

e. Sub-sector most active buyers by product category


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Regarding the vertical index and sub-vertical index, the investment banker ultimately

tracks trends in:

Growth rates

Margins

Multiples


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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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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149


150


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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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153


154


155


156


157


158


159


160


161


162


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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


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The following methodology describes the primary work of the investment banker,

origination. The methodology arose through the work of Michael Herlache in his M&A

career and the lack of content about the actual work of senior M&A professionals. There

is plenty of knowledge around the technical support work of investment bankers

including financial modeling and valuation, but there are no current texts on origination,

let alone a methodology.


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Chapter 23:

M&A Origination Methodology

The M&A origination methodology is the following:

1. Determine coverage industries and sub-sectors

2. Build industry and sub-sector index

3. Pull national screens for the coverage area from Salesgenie

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

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

6. Obtain sell side mandate

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

clarifying that the target is not running a process and that you do not have the mandate

but that you have been in talks with their CEO/owner. The target is willing to listen to

reasonable offers


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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 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:


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John,

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

price of your business?

Best,

Michael

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

Please let me know.

Best,

Michael


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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


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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

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:


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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

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


173


174

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


175

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.


176

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


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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

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


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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.

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.


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Closing Conditions. Lists the tasks, approvals, and consents that must be obtained prior

to or on the Closing Date.

Exclusivity Period (Binding). It is common practice for a buyer to request an exclusive

negotiating period to ensure the seller is not shopping their deal to a higher bidder

while appearing to negotiate in good faith. Expect to see requested periods of 30 to 120

days. The duration may be negotiable, but the presence of the exclusivity term rarely is.

Break-up Fee (Binding). A fee to be paid to the buyer if the business owner decides to

cancel the deal. Break-up fees are relatively common in larger deals (above $500

million). The fee can either be a percentage (typically 3%) or a fixed amount.

Management Compensation. Outlines plan for senior-management post-sale. This term

describes who in the management will be provided employment, equity plans, and

employment agreement. This term is often vaguely worded to provide the buyer with

latitude since they may not be prepared to make commitments to senior management.

Due Diligence. Describes the buyer’s due diligence requirements, including time frame

and access.

Confidentiality (Binding). Although both parties have probably signed a confidentiality

agreement at this point, this additional term ensures all discussions regarding the

transaction are confidential.

Approvals. Lists any approvals needed by the buyer (e.g., board of directors) or seller

(e.g., regulatory agencies, customers) to complete the transaction.

Escrow. Provides the summary terms of the buyer's expected escrow terms for holding

back some percentage of the purchase price to cover future payments for past liabilities.

The escrow is typically highly negotiable and often excluded from the LOI and presented

for the first time in the purchase agreement.

Representations and Warranties. This clause will include indemnifications in the

purchase agreement. It is best practice to include any terms that may be contentious or

non-standard.

Due Diligence


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Financial books and records

Incorporation documents

Employee benefits, policies and compliance issues

Internal systems and procedures

Customer contracts

Intellectual property

Condition of assets

Any key area of concern identified while negotiating the letter of intent

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

90 days

The Purchase 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


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III. Growth opportunities

IV. Industry overview

V. Company overview

a. Overview

b. Products and services

c. Sales and marketing

d. Operations

e. Organization

VI. Financial overview

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

“No comment” and refer press to PR department.

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

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

high level solicitation, closed negotiation)

2. Valuation

3. Recast financials

4. Presentation and packaging

5. Buyer qualifications

6. Marketing

7. Management coaching

8. Due diligence facilitation (data room)

9. Price and contract negotiation

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

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


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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:

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:


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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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185


186


187

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.


188

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


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3. Small cap

4. Middle market

5. Lower middle market

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

coverage groups were the following:

1. Manufacturing

2. Software


4. Healthcare


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


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


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8. Healthcare

a. Dental Product

b. Dental Providers

c. Medical Devices & Products

d. Medical Product Distribution

e. Specialty Providers

f. Pharma Services

g. Practice Management

h. Provider Services

i. Long Term & Behavioral Care

The indices for AltQuest Group look like the following:

1. Manufacturing

a. AltQuest Durable Consumer Index

i. Newell Brands Inc. NYSE:NWL

ii. Whirlpool Corp. NYSE:WHR

iii. Hanesbrands Inc. NYSE:HBI

iv. Gildan Activewear Inc. NYSE:GIL

v. Brunswick Corporation NYSE:BC

vi. Tupperware Brands Corporation NYSE:TUP

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

viii. La-Z-Boy Incorporated NYSE:LZB

ix. Culp, Inc. NYSE:CFI

x. Flexsteel Industries Inc. NasdaqGS:FLXS

xi. Johnson Outdoors Inc. NasdaqGS:JOUT

xii. CSS Industries Inc. NYSE:CSS

xiii. Delta Apparel Inc. AMEX:DLA

xiv. Escalade Inc. NasdaqGM:ESCA

xv. Black Diamond, Inc. NasdaqGS:BDE

b. AltQuest Non-Durable Consumer Index

i. Colgate-Palmolive Co. NYSE:CL

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


191

vii. Edgewell Personal Care Company NYSE:EPC

viii. Avon Products Inc. NYSE:AVP

ix. Inter Parfums Inc. NasdaqGS:IPAR

c. AltQuest Aerospace & Defense Index

i. Honeywell International Inc. NYSE:HON

ii. The Boeing Company NYSE:BA

iii. General Dynamics Corporation NYSE:GD

iv. Airbus Group SE ENXTPA:AIR

v. Mohawk Industries Inc. NYSE:MHK

vi. TransDigm Group Incorporated NYSE:TDG

vii. Textron Inc. NYSE:TXT

viii. Spirit AeroSystems Holdings, Inc. NYSE:SPR

ix. B/E Aerospace Inc. NasdaqGS:BEAV

x. Bombardier Inc. TSX:BBD.B

xi. HEICO Corporation NYSE:HEI

xii. Curtiss-Wright Corporation NYSE:CW

xiii. Esterline Technologies Corp. NYSE:ESL

xiv. Triumph Group, Inc. NYSE:TGI

xv. RBC Bearings Inc. NasdaqGS:ROLL

xvi. Aerojet Rocketdyne Holdings, Inc. NYSE:AJRD

xvii. Ducommun Inc. NYSE:DCO

d. AltQuest Building Products Index

i. Mohawk Industries Inc. NYSE:MHK

ii. USG Corporation NYSE:USG

iii. Armstrong World Industries, Inc. NYSE:AWI

iv. Advanced Drainage Systems, Inc. NYSE:WMS

v. Apogee Enterprises, Inc. NasdaqGS:APOG

vi. Builders FirstSource, Inc. NasdaqGS:BLDR

vii. American Woodmark Corp. NasdaqGS:AMWD

viii. Gibraltar Industries, Inc. NasdaqGS:ROCK

ix. Continental Building Products, Inc. NYSE:CBPX

x. Insteel Industries Inc. NasdaqGS:IIIN

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


192

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


193

xii. FireEye FEYE NasdaqGS

xiii. Fleetmatics FLTX NYSE

xiv. HortonWorks HDP NasdaqGS

xv. HubSpot HUBS NYSE

xvi. inContact SAAS NasdaqCM

xvii. IntraLinks Holdings IL NYSE

xviii. J2 Global JCOM NasdaqGS

xix. Jive Software JIVE Nasdaq

xx. Live Person LPSN NasdaqGS

xxi. Marin Software MRIN NYSE

xxii. Medical Transcript MTBC NasdaqCM

xxiii. Medidata Solutions MDSO Nasdaq

xxiv. Netsuite N NYSE

xxv. New Relic NEWR NYSE

xxvi. Paylocity Holding PCTY NasdaqGS

xxvii. Q2 Holdings QTWO NYSE

xxviii. Qualys QLYS NasdaqGS

xxix. RealPage RP Nasdaq

xxx. RingCentral RNG NYSE

xxxi. Salesforce.com CRM NYSE

xxxii. Service-now.com NOW NYSE

xxxiii. SPS Commerce SPSC NasdaqGS

xxxiv. Tableau Software DATA NYSE

xxxv. Tangoe TNGO NasdaqGS

xxxvi. The Ultimate Software Group ULTI NasdaqGS

xxxvii. TrueCar TRUE NasdaqGS

xxxviii. Upland Software UPLD NasdaqGM

xxxix. Veeva Systems VEEV NYSE

c. AltQuest Internet Index

i. 1-800-FLOWERS.com FLWS NasdaqGS

ii. 58.com WUBA NYSE

iii. 8x8 EGHT NasdaqGS

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


194

ix. Bankrate RATE NYSE

x. Bitauto Holdings BITA NYSE

xi. BlueNile NILE NasdaqGS

xii. Brightcove BCOV NasdaqGS

xiii. BroadSoft BSFT NasdaqGS

xiv. Carbonite CARB NasdaqGS

xv. Care.com CRCM NYSE

xvi. ChangYou.com CYOU NasdaqGS

xvii. Chegg CHGG NYSE

xviii. Cimpress CMPR NasdaqGS

xix. Coupons.com QUOT NYSE

xx. Criteo SA CRTO NasdaqGS

xxi. Ctrip CTRP NasdaqGS

xxii. DemandMedia DMD NYSE

xxiii. eBay EBAY NasdaqGS

xxiv. eHealth EHTH NasdaqGS

xxv. Everyday Health EVDY NYSE

xxvi. Expedia EXPE NasdaqGS

xxvii. Facebook FB NasdaqGS

xxviii. GoDaddy GDDY NYSE

xxix. Google GOOG NasdaqGS

xxx. Groupon GRPN NasdaqGS

xxxi. GrubHub GRUB NYSE

xxxii. Harmonic HLIT NasdaqGS

xxxiii. Interactive Intelligence ININ NasdaqGS

xxxiv. LendingClub LC NYSE

xxxv. LifeLock LOCK NYSE

xxxvi. Limelight Networks LLNW NasdaqGS

xxxvii. LinkedIn LNKD NYSE

xxxviii. Liquidity Services LQDT NasdaqGS

xxxix. Mail.ru Group 61HE.L LSE

xl. MakeMyTrip MMYT NasdaqGS

xli. MaxPoint Interactive MXPT NasdaqGM

xlii. Mercadolibre MELI NasdaqGS

xliii. Mitel Networks MITL NasdaqGS

xliv. Monster Worldwide MWW NYSE

xlv. NCSoft 036570.KS KSE


195

xlvi. Netease NTES NasdaqGS

xlvii. Netflix NFLX NasdaqGS

xlviii. Overstock.com OSTK NasdaqGS

xlix. Pandora P NYSE

l. PetMed Express PETS NasdaqGS

li. Priceline PCLN NasdaqGS

lii. QuinStreet QNST NasdaqGS

liii. Renren RENN NYSE

liv. Rocket Fuel FUEL NasdaqGS

lv. SeaChange International SEAC NasdaqGS

lvi. ShoreTel SHOR NasdaqGS

lvii. Shutterfly SFLY NasdaqGS

lviii. Shutterstock SSTK NYSE

lix. SINA SINA NasdaqGS

lx. Sohu.com SOHU

lxi. Sonus Networks SONS NasdaqGS

lxii. Stamps.com STMP NasdaqGS

lxiii. Synacor SYNC NasdaqGS

lxiv. Tencent Holdings NNN1.F

lxv. The Rubicon Project RUBI NYSE

lxvi. TheStreet.com TST NasdaqGM

lxvii. Travelzoo TZOO NasdaqGS

lxviii. Lending Tree TREE NasdaqGS

lxix. Tremor TRMR NYSE

lxx. TripAdvisor TRIP NasdaqGS

lxxi. TubeMogul TUBE NasdaqGS

lxxii. Tucows TCX NasdaqCM

lxxiii. Twitter TWTR NYSE

lxxiv. VeriSign VRSN NasdaqGS

lxxv. WebMD Health WBMD NasdaqGS

lxxvi. Wix.com WIX NasdaqGS

lxxvii. XO Group XOXO NYSE

lxxviii. Xunlei XNET NasdaqGS

lxxix. Yahoo! YHOO NasdaqGS

lxxx. Yandex YNDX NasdaqGS

lxxxi. Yelp YELP NYSE

lxxxii. YuMe YUME NYSE


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lxxxiii. YY YY NasdaqGS

lxxxiv. Zillow Z NasdaqGS


a. AltQuest Education & Training Index

i. Graham Holdings Company NYSE:GHC

ii. GP Strategies Corp. NYSE:GPX

iii. Pearson plc LSE:PSON

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

v. Capella Education Co. NasdaqGS:CPLA

vi. Bridgepoint Education, Inc. NYSE:BPI

vii. Strayer Education Inc. NasdaqGS:STRA

viii. K12, Inc. NYSE:LRN

ix. DeVry Education Group Inc. NYSE:DV

x. Career Education Corp. NasdaqGS:CECO

b. AltQuest Business Process Outsourcing Index

i. Wipro Ltd. BSE:507685

ii. Cognizant Technology Solutions Corporation NasdaqGS:CTSH

iii. Sykes Enterprises, Incorporated NasdaqGS: SYKE

iv. Convergys Corporation NYSE: CVG

v. West Corporation NasdaqGS:WSTC

vi. TeleTech Holdings Inc. NasdaqGS:TTEC

vii. Virtusa Corporation NasdaqGS:VRTU

viii. Unisys Corporation NYSE:UIS

c. AltQuest Facility Services and Industrial Services Index

i. Cintas Corporation NasdaqGS:CTAS

ii. ABM Industries Incorporated NYSE:ABM

iii. SP Plus Corporation NasdaqGS:SP

iv. Aramark NYSE:ARMK

v. Iron Mountain Incorporated NYSE:IRM

vi. UniFirst Corp. NYSE:UNF

vii. FirstService Corporation TSX:FSV

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


197

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


198

xvii. IHS Markit Ltd. NasdaqGS:INFO

f. AltQuest Marketing Services Index

i. WPP plc LSE:WPP

ii. Omnicom Group Inc. NYSE:OMC

iii. Publicis Groupe SA ENXTPA:PUB

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

v. MDC Partners Inc. NasdaqGS:MDCA

vi. InnerWorkings Inc. NasdaqGS:INWK

vii. Ipsos SA ENXTPA:IPS

viii. UBM plc LSE:UBM

g. AltQuest Real Estate Services Index

i. CBRE Group, Inc. NYSE:CBG

ii. CoStar Group Inc. NAsdaqGS: CSGP

iii. Jones Lang LaSalle Incorporated NYSE:JLL

iv. Realogy Holdings Corp. NYSE:RLGY

v. SouFun Holdings Ltd. NYSE: SFUN

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

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

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

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

h. AltQuest IT Services Index

i. International Business Machines Corporation NYSE:IBM

ii. Accenture plc NYSE:ACN

iii. Cognizant Technology Solutions Corporation NasdaqGS:CTSH

iv. CGI Group Inc. TSX:GIB.A

v. Booz Allen Hamilton Holding Corporation NYSE:BAH

vi. Leidos Holdings, Inc. NYSE:LDOS

vii. Teradata Corporation NYSE:TDC

viii. EPAM Systems, Inc. NYSE:EPAM

ix. Interxion Holding NV NYSE:INXN

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


199

i. CEB Inc. NYSE:CEB

ii. FTI Consulting, Inc. NYSE:FCN

iii. Exponent Inc. NasdaqGS:EXPO

iv. The Advisory Board Company NasdaqGS:ABC

v. Huron Consulting Group Inc. NasdaqGS:HUR

vi. ICF International Inc. NasdaqGS:ICFI

vii. Navigant Consulting Inc. NYSE:NCI

viii. Resources Connection, Inc. NasdaqGS:RECN

ix. CBIZ, Inc. NYSE:CBZ

4. Healthcare

a. AltQuest Dental Product Index

i. Zimmer Biomet Holdings, Inc. NYSE:ZBH

ii. DENTSPLY SIRONA Inc. NasdaqGS:XRAY

iii. Henry Schein, Inc. NasdaqGS:HSIC

iv. Align Technology Inc. NasdaqGS:ALGN

v. Patterson Companies, Inc. NasdaqGS:PDCO

vi. Cantel Medical Corp. NYSE:CMN

vii. BIOLASE, Inc. NasdaqCM:BIOL

viii. Milestone Scientific Inc. AMEX:MLSS

ix. Pro-Dex Inc. NasdaqCM:PDEX

b. AltQuest Dental Providers Index

i. Birner Dental Management Service OTCPK:BDMS

c. AltQuest Medical Devices & Products Index

i. Medtronic plc NYSE:MDT

ii. Abbott Laboratories NYSE:ABT

iii. Stryker Corporation NYSE:SYK

iv. Becton, Dickinson and Company NYSE:BDX

v. Boston Scientific Corporation NYSE:BSX

vi. Baxter International Inc. NYSE:BAX

vii. Intuitive Surgical, Inc. NasdaqGS:ISRG

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


200

xv. Johnson & Johnson NYSE:JNJ

d. AltQuest Medical Product Distribution Index

i. Danaher Corp. NYSE:DHR

ii. Stryker Corporation NYSE:SYK

iii. McKesson Corporation NYSE:MCK

iv. Cardinal Health, Inc. NYSE:CAH

v. AmerisourceBergen Corporation NYSE:ABC

vi. Henry Schein, Inc. NasdaqGS:HSIC

vii. Patterson Companies, Inc. NasdaqGS:PDCO

viii. Owens & Minor Inc. NYSE:OMI

ix. PharMerica Corporation NYSE:PMC

x. Aceto Corp. NASDAQGS:ACET

e. AltQuest Specialty Providers Index

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

ii. DaVita HealthCare Partners Inc. NYSE:DVA

iii. MEDNAX, Inc. NYSE:MD

iv. AmSurg Corp. NasdaqGS:AMSG

v. HEALTHSOUTH Corp. NYSE:HLS

vi. Surgical Care Affiliates, Inc. NasdaqGS:SCAI

vii. American Renal Associates Holdings, NYSE:ARA

viii. Adeptus Health Inc. NYSE:ADPT

ix. LHC Group, Inc. NasdaqGS:LHCG

x. AAC Holdings, Inc. NYSE:AAC

f. AltQuest Pharma Services Index

i. CVS Health Corporation NYSE:CVS

ii. Express Scripts Holding Company NASDAQGS:ESRX

iii. Perrigo Company plc NYSE:PRGO

iv. Allscripts Healthcare Solutions, Inc. NasdaqGS:MDRX

v. Magellan Health, Inc. NasdaqGS:MGLN

g. AltQuest Practice Management Index

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


201

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.







Growth rates

Margins

Debt to Equity


202

Multiples







How to Advise on Strategic Alternatives?







Growth rates

Margins

Debt to Equity

Multiples








203


204

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.


205

Part XVI: Investment Banking

Deliverables

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

through sell side representation.


206

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


207

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:


208


209

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:


210

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:


211

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.


212

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.


213

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).


214

Part XVII:

How to Buy a Perpetuity?

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


215

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.


216


217

Chapter 41:

How to Become the Next Warren Buffett

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

the perpetuity, which is the basis for finance and his approach. Finance is the set of

concepts, methodologies, and optimization models associated with the perpetuity. The

perpetuity can be modeled with the following formula:




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


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



218

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

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

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

to make this determination. Financial statement modeling begins with the building of

the operating model of the company.

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

company/opportunity is a perpetuity, strategic and financial buyers attempt to maximize

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

contributed capital to acquire the opportunity. The difference between these two is the

real wealth transfer from the seller to the buyer in today’s dollars. For example, if the

NPV (i.e. intrinsic value) of a company is $100M based upon a DCF and the acquirer

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

from the seller to the buyer in the amount of $25M in today’s dollars. This is the game of

buying perpetuities.

Wealth Increase in Today’s Dollars From Opportunity/Company (Margin of Safety) = DCF

NPV – Contributed Capital

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

larger the perpetuity the better. Characteristics of a perpetuity include:

Low CAPEX as a % of EBITDA

Predictable if not recurring revenue model

Low levels of customer concentration


219

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.


220

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).


221

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


222

30% IRR, you must do the deal

Regarding ideal private equity targets, the private equity firm will specialize in a few

sectors and does not want a lot of discretionary CAPEX. They will however do

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

Furthermore, after an acquisition, the PE group will look to pay debt down as fast as

possible. They ideally want dividend recaps (add additional cash and then pay self a

dividend after paying back additional debt).

The PE firm when considering an investment will run multiple cases to determine what

case to bid on. They will do sensitivity tables as well.

The PE group will work with LevFin, SLF & DCM within a given investment bank with SLF

syndicating the loans and then selling the paper. The IB charges a financing fee, advisory

fee, and syndication fee.

Leveraged Buyout (LBO) Analysis:

1. Locate financial information

2. Build the operating model

3. Input transaction structure

4. Complete LBO model with new structure

5. Run the LBO analysis

Notes:

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

necessary for technology company. Bank looks at leverage ratios and interest coverage

to determine which covenants to put in place.

Construction of LBO Model

Purchase price and considerations

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


223

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

how much is debt

Sensitivity tables

Credit ratios

PIK allows you to get more leverage

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

EBITDA multiple determined from midpoint of the football field

Transaction fees:

Financing fees – SLF & DCM

IB fees – M&A

Legal – Lawyer

Other fees

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

SLF & DCM go through cases of operating model to find optimal tranche of debt to

provide highest leverage to the FS but can still be sold in the marketplace

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

changes)

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

fees.

Assumptions for projects:

Operating model start with base case without transaction

Sponsor upside case

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?


224

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


225

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?


226

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

If target has PE that is higher than the acquirer, always dilutive. If premium paid causes

PE of target to be higher, then dilutive.

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

Proforma ownership structure want to control 50.1% of company

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

have for the transaction to be accretive:

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

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

Know where your stock’s value is going:

If undervalued, then don’t use stock

If overvalued, then use stock to fund the transaction

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

move so have either:

A. Fixed value collar – favors target

B. Fixed share collar – favors acquirer

Sensitivity tables are used to help structure deals and in negotiations

Surviving entity (acquirer)


227

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.


228

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.


229

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).


230

Chapter 40:

FameLinked





company.


231


232

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:


233

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:


234

In terms of converting followership into usership, the following are the conversion

metrics after we started requesting that our followers become users:


235

The following is the FameLinked Perpetuity Presentation by Founders Ventures:


236

Chapter 40:

Asiansbook





company.


237


238

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:




239




240




241

The following is the Asiansbook Perpetuity Presentation by Founders Ventures:


242

Chapter 40:

DegreeLinked

Glad to be connected with you. My name is Svitlana and I am the co-founder of

DegreeLinked. DegreeLinked is the student network and marketplace, allowing students

to connect with eachother and track their academic progress. I wanted to invite you to

take a look at the platform. We will send you a trial login so you can try it out; it is free

to use for students. Please let me know.

Best,

Svitlana

It is a platform for all students to network, track their academic progress and connect

with university admissions (undergraduate and graduate).


243


244

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:




245




246



The following is the DegreeLinked Perpetuity Presentation by Founders Ventures:

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