What is Lower Middle Market & Middle Market Investment Banking?
- August 10, 2019
- Posted by: admin
- Category: Blog
Investment Banks & Capital Markets:
Investment banks act as an intermediary between the build-side (uses of capital) and the buy-side (sources of capital). The investment bank will analyze, structure and market the financial product (perpetuity or annuity) to the appropriate sources of capital that match with the investment mandate.
For financing product of IB, the investment bank does a private placement of either debt or equity (IPO?). The investment bank underwrites the financial product (perpetuity or annuity) and packages it, and then markets it and takes a fee for doing so. Acts as an intermediary between the build-side and the capital markets (buy-side).
Investment bankers underwrite, package, market and sell financial products with variable interest rates into perpetuity, called perpetuities. They are the go between the build-side and the buy-side. The perpetuities they sell typically grows at about 5 to 6 percent per year in revenues, earns about a 13 percent return on equity (IRR), and has a 9 percent cost of capital. The resulting P/E ratio (multiple) is 15x. Buyers of perpetuities are financial buyers called private equity and strategic buyers called corporations. Interest rates vary by industry. There is a difference between interest rate and rate of return where there is movement in the valuation of the perpetuity due to market demand.
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:
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.
Valuation Football Field and the Midpoint is the final valuation of the company.
Calculate NPV and IRR to the sponsor in LBO or EPS Change and Balance Sheet Effects in Merger
Compare NPV and IRR OR compare EPS change and BS effects to other strategic alternatives and choose the highest return/EPS alternative
Ultimately, as an investment banker, you are to:
Use valuation methodologies to determine valuation ranges of each strategic alternative and see if capital sources match uses. IBankers should provide the client with tight ranges on valuation.
Use an operating model of the target (and acquirer if strategic) and then tailor it to the specific client:
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:
Comps and comp transactions (where are multiples)
Operating model creation + tailored to transaction client (LBO or Merger)
Manage M&A process
Personal contacts at firms to win engagements