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:
- Business Services
After choosing your coverage, the investment banker is then to build an index for each of the verticals and sub-verticals made up with the public comps. The index and the changes in the index are going to provide a measuring stick within which to evaluate targets against.
It is important for the investment banker to have a strong understanding of multiples in the M&A marketplace in general and then in his/her sector and sub-sector. In general in the middle market, we typically see 7x – 7.5x EBITDA for companies that are larger than $25M in TEV. For companies that are smaller than $25M in TEV, we typically see 5x – 5.5x EBITDA. There are adjustments that need to be made for size and predictability of revenues as well as for certain sectors (ex. software).
For those just getting started in investment banking, it is preferable to start with the lower middle market and middle market building relationships with financial and strategic buyers as well as potential targets. This means building your rolodex. Obtain the investment mandates from the strategic and financial buyers and establish a fee arrangement for buy-side deals. This will end up being the Lehman scale for the fee on the buy-side.
The investment banker will often focus on a product group (i.e. M&A) and/or an industry (industrials, healthcare, technology). Proper coverage comes in the form of maintaining a coverage index for a sector and its sub-sectors which is broken down in the following manner:
- Industry macroeconomics
- Industry spending
- Sub-sector spending
- Stock market performance of industry
- Public sub-sector financial and valuation performance
- Sub-sector index
- Sub-sector index: financial performance
- Sub-sector index: public market multiples
- Sub-sector index by product category
- Sub-sector index by product category: financial performance
- Sub-sector index by product category: public market multiples
- Industry M&A Market Update
- Industry M&A deal volume and spending
- Industry M&A exit multiples
- Sub-sector M&A deal volume and spending
- Sub-sector M&A exit multiples
- Sub-sector M&A deal volume by product category
- Sub-sector M&A exit multiples by product category
- Sub-sector index key metrics
- Sub-sector index key metrics by product category
- Industry most active buyers
- Sub-sector most active buyers
- Sub-sector most active buyers by product category
In the lower middle market and middle market, for each target geography (ex. Florida, New York, California, Texas) and each vertical, the investment banker is going to want to build his rolodex to approximately 2,000 to 10,000. This means having:
- The name of the company
- Name of the CEO or owner
- Email of CEO or owner
- Phone number of CEO or owner
- Initial contact (ex. Yes, no, timeline)
The investment banker is going to want to inquire as to whether the company is willing to take an offer on their business every six months as new scenarios emerge within the coverage companies which change exit dynamics.
After getting the initial contact, the investment banker can begin providing coverage to the individual company which includes providing sector and sub-sector coverage including:
- Industry macroeconomics
- Public sub-sector financial and valuation performance (public comps)
- Industry M&A market update
From this data and information the investment banker can advise on strategic alternatives including capital raising, M&A and growth advisory. Key questions include:
- Which way are multiples going?
- Whom are likely acquirers?
- What are likely multiples for the acquisition?
- What precedent transactions can we point to in order to justify a premium valuation?