Going Private

Forward - "From Done Deals to Trainwrecks."

Weblogs on private equity seem to be abortive.  They start, stagnate and then halt altogether.  Their half-finished efforts are left dangling for anyone with a search engine to wander across and wonder after.  "No updates in 6 months?  Hmmm."  This seemed odd to me.  What causes such half-failures?  Workload?  Discovery?  Boredom?  Litigation?  There must be some reason.

For a topic that seems to command so much rapt, even fanatical attention, there don't seem to be many personal diary style weblogs from practitioners.  I started off wondering why, aside from the obvious confidentiality issues and such, there weren't more that endure.  Even confidentiality hasn't stopped some other weblogs (with anonymous or public authors) from printing scandalous revelations about their work life.  Why the issue with private equity?  It could be that I am about to find out what the impediment is.

There are few fields today as well marketed to potential employees as private equity.  One discovers, as with most things, that actually practicing in the field is a much different thing than you are led to believe by the many, costly guides, consultants, recruiters, professors, lecturers, key-note speakers and associates who eagerly impart how exciting and pure the space is.  I thought I might inject a dose of "reality," if there is such a thing.

It turns out, that things are far less organized, professional or straight-forward than insiders might have you believe.  Having my eyes opened to this fact has been quite an experience.  Worth sharing?  You tell me.

It would be unfair to say that I am jaded.  A bit disillusioned maybe.  No longer blinded, perhaps, by the sparkling finish on the surface of private equity.  Irreverent?  Absolutely.  But I still enjoy what I do.  Perhaps more so after having discovered that, like all human endeavors, private equity is as full of nonsense and, inadvertent sometimes even unwitting, comic relief as any other field.  Maybe even more so.  If nothing else, that makes it fun.

I guess I don't know who my audience is.  Business school students?  Probably.  They certainly should have the most hungry ears for "the behind the scenes" story.  Bankers?  Sure.  Lawyers?  Why not?  Insiders?  Maybe.  Maybe not.  Egos run to the large side in the field.  Maybe what I have to say won't treat those with the kid gloves they have become accustomed to.  Oh well.

Of course, I am not crazy.  My name won't appear here.  If that is an issue for you, find another weblog to read.  I like my job, and my paycheck, after all.  And while some other insiders might piece together parts and end up guessing at the "real names" of some of the companies, institutions, deals and characters here, that's not my intention.

I start with Prologues I-VI.  Brief histories on how private equity got here, and how I got into private equity.  Of course, it would be nice if this gives newcomers a bit of an introduction and business students a glimmer of hope.

Following the prologues, my writings will fall into one of six categories:

"Done Deals" tracks the inner workings of deals my firm, or another firm, manages to close on.
"Getting In" revolves around recruiting and the process of getting into the business.
"Overheard" will be populated with witty (or frightening) quotes I overhear from time to time.
"Social Equity" concentrates more on the people inside private equity and their antics.
"The Business" will be filled with my blithe commentary on the world of private equity.
"Trainwrecks" will outline the flaming spirals of deals that go wrong.

Could be a fun ride.  Hop on.

-ep

Prologue - "Disillusioned."

Life seemed pretty dismal in June.  Like many of my ilk I had been lusting after a position in "private equity," to many the Holy Grail of finance endeavors, since before even applying to business school.  It is hard to explain to the unwashed the draw those simple words pull on a young and somewhat naive finance mind with.  Even their rhyme and meter serve to build a shining image and marketing sheen the likes of which DeBeers might envy.  "Private" smacks of smoky back room deals and silent professionals all "in the know" before the rest of the street.  "Equity"?  Well, it just sounds better than "debt" doesn't it?

Demand for positions in private equity outstrips by orders of magnitude the supply available to hopeful business students.  One sage advisor consolingly told me that for every private equity position available there were nearly 2,500 applicants.  I have no idea where this figure came from but it was delivered with such authority that it gained instant credibility in my mind.  Most employers in the field, he added, were looking for investment banking experience.  Perhaps a tenure in the "Dungeons of Investment Banking Analysis" would be the best stepping stone to a private equity position, he suggested.  Given my dismal record to that point in securing the interest of, or even a response from, a single private equity firm, I took his advice to heart.  What the hell else was I going to do?

And so I was on the path to a, hopefully brief, career in the mergers and acquisitions department of a large investment banking firm.  Still, I kept my eye out for private equity slots that turned up and threw a carefully polished resume at every opening I thought I saw.

It is one thing to have little or no success in running for the gold medal, but failing even to place in the qualifying rounds at the state level is another blow entirely.  So it was that, despite all my earnest, even desperate, efforts, I had managed to slip through the entirety of recruiting season- shades of prostitution, dress up in your best garb, sell yourself to an older man (or occasional woman) for 30 minutes, then on to the next John- without even a serious nibble from any of the major investment banks on which I had by then mortgaged my future (and probably the future of my children given the direction the interest rates on my loans were heading).  Consulting, in which I had no interest at all, was beginning to look like an important option.

BankWeek was just a ragged version of the New York Marathon, only it took place in the dead of winter with the participants in dress shoes and business suits.  LondonQuest would have been more fun, but it was called EuroTrek by then and a brief tenure as the significant other of a Marin County dilettante meant that I now possessed an, admittedly illogical, blind and raging hate for the many Stanford grads that seemed to haunt the proceedings.  I'll tell them what they can do with their on-campus golf course, believe me.  Not that I really had any faith in securing a position by that point anyhow.

Most of us had an uphill battle in the effort to convince skeptical European recruiters that we were actually committed to remaining on the continent beyond the few years it would take to visit every nearby pub and still manage to ski in St. Moritz a few times.  They could smell an MBA tourist at 50 meters.  I suspect that no one believed my honest protestations that I wanted to remain in Europe long-term.  Then again, I'm not sure how honest they were in the first place since my endgame was a spot in a buyout firm.  In any event, even if they did believe me, they certainly didn't express themselves in the form of offer letters.

My deepening disillusionment is easy to quantify by example.  I met Cindy, a smartish and quite elegant looking fellow hopeful during EuroTrek.  Well, I first saw her at EuroTrek.  I didn't really meet her until the aftermath of EuroTrek.  For some reason I didn't really seem to know anyone well at EuroTrek in the first place.  I don't think I was particularly alone in this as we all spent a lot of time in the first few days sitting or standing around in presentations not talking to each other and waiting for the chance to verbally demonstrate how witty and sharp we were at the expense of our peers.  Of course, appearing to be distinctly witty proved difficult when visiting banks staffed primarily with Londoners and it was important to apply at least a thin veneer over your barely contained hostility for anyone who might stand in the way of your clumsy efforts at flattery.

I was near to drifting off in the back row of one such presentation, delivered by a somewhat beleaguered looking VP in pinstripes and hearing for the sixth time in three days how "entrepreneurial" the bank's culture was, when I caught a misplaced hand out of the corner of my eye.  Cindy, looking as prim and proper as any eager MBA student from almost any angle, was none the less, being tactilely entertained by the equally formal appearing, chiseled featured Richard seated immediately next to her.  They must not have had any idea I was behind them, or that the angle afforded me far too revealing a view of their extracurricular activity.  For a minute I was stunned into staring.  Then I was offended.  How dare they debase this critical process?  What a poor example it would set if they were caught.  All of us would suffer reputationally.  Then something occurred to me.  In some fundamental way, these recruiting events are a farce.  Only the terminally dour, or intensely desperate, could take them entirely seriously.  No one cares about witty comments.  In a world where the wrong tie can ruin your chances it was folly to think that these employers were looking for unique and interesting.  They are looking for worker bees.  Worker bees with the potential to be managing directors one day, sure, but today, worker bees.  It was definitely an employer's market.

Taking things a bit less seriously might not have improved anyone's chances, but it sure made it easier to endure the process.  EuroTrek wound down slowly and towards the end I found myself standing at the bar in some club somewhere talking to a fellow hopeful.  The conversation had drifted to a review of the blandest company presentation when, across the room in a not-so-dark corner I recognized Cindy, lips clamped on the mouth of the still pinstripe clad, beleaguered looking VP.  Richard was nowhere in sight.  Later I would learn that she had been offered an associate position in the M&A group at the VP's bank.

Would it surprise you to learn that she was a Stanford grad?

-ep

Prologue II - "At What Price, Honor?"

Before even fretting about what it was to be a jobless second year, it might be helpful to understand the jading process that was first year on-campus recruiting.

As a first year business student it is not long before you realize the importance of the second years.  That is to say, it is not long before you are made by one twist of fate or another, to believe in their importance.

The on-campus recruiting process is a dismal one and, right or wrong, the perception is that small edges make large differences.  Most banks, one is told, hire for their full-time programs from their summer programs.  This makes one's acceptance to a summer program a critical element in career path.

It is not that second years are necessarily any smarter when it comes to the recruiting process, rather that they often sit in on the recruiting discussions their employers have following interviews.  You can hope for three things from them in this respect.  First, there is the mostly empty hope that they possess some dark and hitherto unknown secret code to gain admittance.  That you need only complete the right challenge-response phrase, as if you and the recruiter have together parachuted at night behind enemy lines.   "Flash!" "Thunder!"  A friendly fire incident narrowly averted.   Many second years, for entirely unaltruistic reasons, play up the importance of this illusion.  "When they ask you to name a personal flaw, and they will, tell them you lose track of time when engrossed in a project, and forget to eat or drink."  Because it never occurs to you that you aren't the only recipient of this critical secret, the baffled recruiter ends up wondering what kind of robots your MBA program is minting.

Beyond the secret codes, if you do enough kissing up, and here as elsewhere the competition is stiff, the second years might put in a good word during the whole 35 seconds in which your candidacy is reviewed.  Of course there is no way to know if they ever even made a peep during the review session, or if anyone bothers to even listen to summer interns during the discussions.  Still, in such an opaque process even faint hopes are hopes.  A few first years, having identified what they think is an edge, turned up all their seductive charms, figuring perhaps that this was the only currency in their possession and of sufficient value to trade for career admittance.  I must admit that I too fell for this trap, and while I did not go as far as some, I found myself looking up to people I never would have given the time of day to a year earlier.  My own machinations were, however, slight compared to those undertaken by some of my contemporaries.

Allison, a tallish blonde from California, was perhaps the most flagrant example of the perils of this carnal approach.  Within weeks of deciding that a famous Swiss bank was her first choice, she had identified the second years who had "summered" there, cross referenced them against the facebook of second years and shamelessly thrown herself at the two she regarded as the most attractive.  Of course, there were more than enough liquor inundated social events to lubricate her task and by the end of the first month she had gotten to Colin, her man on the inside.

We all politely looked the other way, well most of us did, but her overtures had been so overt it was hard to pretend not to notice what was going on.  If Colin knew, which we all suspected he did, he didn't let on and instead placated her with gentle wooing mostly revolving around what an excellent fit she would be and how perfect the Swiss bank would be for her.  It wasn't a week after they "met" that Allison could be seen daily getting a "ride home" in Colin's BMW, as if the two hour wait she often endured from the end of her classes until the end of his was convenient to her.  One can easily imagine the tone their nightly pillow talk took.  Easier, perhaps, the content of the mutters her many detractors frequently intoned.

I suppose the more old-fashioned among us might have been affronted by these sorts of shenanigans, but there were dozens of reasons not to be.  For one, such liaisons were not particularly uncommon.  Just in my class I can call forth three engagements and five marriages that were left on the rocky shores of business school antics when one or another classmate was awarded the none-too-rare Master of Infidelity Administration degree, and that's just off the top of my head.  I might add that my recollections include one couple who entered the program together married, and left the program engaged, both of them, to third parties.  I sat between them in a marketing class and was often the conscripted purveyor of the notes, filled with angry scrawls written with loud scratchings towards the end of the term, they exchanged.  That quickly came to an end when I, tired of being a runner by the 15th such note since the beginning of that class, flagrantly opened it and read it.  I could feel their hot and hateful but helpless stares as I absorbed the words, "No FUCKING way."  The "fucking" was underlined.  They stopped passing notes through me after that.

The end of Allison's tryst took a predictable route.  Though I was not there myself I heard from others, everyone heard it from someone else it seemed, that the same evening the callbacks came and Allison had not been invited to the second round she threw a drink into Colin's face and called him a "manipulative cocksucker" before storming out of the event and never, it was whispered, speaking to him again.  A more clear sense of irony in her choice of pejorative nouns I don't think I could have dreamed up myself.  I heard that Colin had an undergraduate soothing his ruffled feathers within a week.  Allison, who, so sure of her chances with Colin's employer, had not bothered to pursue any fallback plans, found herself entirely unemployed, and without another bedmate, that summer.

After all the antics the usefulness of the second years was confined to feedback on why one had failed at this or that bank.  In one case I heard a distraught first year pleading with his mentor, "My tie?  What's wrong with my tie?"  Admittedly, it was a pretty ugly tie.  One could, in theory, be shocked ("I am shocked, shocked to find that gambling is going on in here!") at the trivial strikes which could cause an intern candidate to be tossed from the game, but then in such a rarefied environment it didn't, in the end, really surprise anyone.

My feedback boiled down to three things.  Firstly, I was too intense.  Second, I wasn't driven enough.  (This comment from the interview where I refused to accept the recruiter's highly forward invitation to meet for drinks after the interview).  Third, I didn't seem committed to banking.  So arbitrary and capricious were these comments that it became clear to me that the selection process was more about popularity, and a strange version even of that, than merit.  Genuine effort was pointless.  Sleaze was the order of the day.  This last point was driven home brutally when I heard the tale of the three first years who had taken the entire recruiting team, minus the women, of a highly sought after bank out to a strip club after the interviews.  Unsurprisingly, all three were awarded summer positions at the same bank.

Nearly despondent, I slouched into summer with a middling internship in the mergers and acquisitions department of a large corporate.  In a way this was gratifying.  If this was the culture I was idolizing, perhaps I needed to revisit my assumptions.  I wasn't sure if I was happy I hadn't lowered myself to the level that seemed required to command a position, or upset that I had failed to capitalize on a clear opportunity.  At what price, honor?

-ep

Whisper Loudly

Business School Cafe Line - Tuesday Afternoon

Second Year One: "Are you going to the [bulge bracket bank] presentation?"
Second Year Two: "No, the [top consulting company] presentation is at the same time and three of their associates threw a huge blast at their hotel suite afterwards last year, so I need to find out where they are staying this year."
Second Year One: "Seriously?"
Second Year Two: "Yeah.  That was the party where Paul got really hammered and puked in the lobby of the Four Seasons.  He got an offer too."
Second Year One: "Oh.  Wait, was I at that?"

-ep

Prologue III - "On Gekko."

In 1952 Harry M. Markowitz published an article entitled "Portfolio Selection."  Markowitz had studied under Milton Friedman at the University of Chicago and his work eventually spurred an interest in key relationships between the concepts (diversification, risk and return, volatility) that now form the underpinnings of financial modeling.  Additional work from James Tobin, and William Sharpe, who's 1964 article "Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk," among others, eventually ended up in the body of theory we call "Modern Portfolio Theory" today.  He, along with others in the portfolio theory field, later won the Nobel Prize for their work.

This is important to our little tale here because a host of business school students, then a fast growing population and weaned on one or another early version of portfolio theory, increasingly ended up in general management positions in the largest companies in the United States.  Congress managed to fuel the fire early on back in 1950 by passing the Celler-Kefauver Act, which, among other things, made it quite difficult to acquire other firms in an industry you already had a substantial presence in.  Consequently, by the mid to late 1960s large corporations began to interpret the need for "diversity" to mean that they should acquire anything and everything they were able to pay for. The less relevant to their own underlying business, the better. This marked the beginning of the "conglomerate wave" where a flurry of mergers and acquisitions activity dominated thinking about how large firms should look and act. Like portfolios, it was argued. Diversified and large enough to enjoy economies of scale, of course.

Depending on how cynical you are, you might join the voices that actually attribute the rise of the Chief Operating Officer ("COO") position to the concept that mergers and acquisitions played such an important part in the success of the large 1960s and 1970s era firms that the CEO should be freed up from the bland and routine day-to-day functions of actually operating the business in order to pursue the mergers and acquisitions strategy of the firm full time. One might imagine the various ways this played into the hands (or egos) of the CEOs.

Neil Fligstein traces the evolving strategy of corporate America in these periods to the evolving networks of "experts" that progressively dominated the management teams of large firms.  The rise of business schools during this period is, consequently, no accident.  Growth was the key motivator.  Acquisitions were the vehicle to get there.  Stock price and, to a lesser extent in this period, leverage, was the currency to fund the acquisitions.  Fligstein's 1990 work, "The Transformation of Corporate Control," is really required reading for anyone interested in the sociopolitical changes in corporate America at the time.  That population should include anyone interested in private equity.

What could be called the "core competency" model came about somewhat differently.  Instead of being the result of close cabals of insiders, from the senior executives down to the dozens of Vice Presidents who dominated the halls of public companies, and all of whom were often divided between firms along graduate school alumni lines, the rise of more external forces in finance pushed the next evolution in corporate think.

As the importance of acquisitions as a strategy rose, so too did the importance of the intermediaries who performed the mechanics of such acquisitions.  The rise of large corporate law firms with mergers and acquisition specialties as well as the large investment banks, valued primarily for their ability to identify and help fund acquisitions, proved the undoing of the conglomerate wave.

Eventually, institutional investors moved towards a preference for specialization.  The stock price of well focused firms was well rewarded in keeping with the new thinking: Firms that confined their acquisition to areas in which they had expertise, "core competencies," were more likely to be able to convert management expertise into success and therefore were rewarded on the exchanges.  Large, and what had become unwieldy, conglomerates had failed to produce efficiencies (instead the reverse).  Their stock prices sunk as their increased costs (and bloated management corps) sucked away at their profits.  With their ready acquisition currency, their own stock, now devalued, they stagnated, and, perhaps worse, became weak and slow moving targets for what became the new paradigm: The Corporate Raider.

Percentage of Firms Receiving Hostile Takeover Bids (1983-1999 3 Year Moving Average)
Source: Zorn, Dobbin, Dierkes, Man-Shan Kwok
"The New New Firm: External Control of Organizations and Corporate Prototypes"

"Core Competency Theory" was formally named with the 1990 Pralahad and Hamel Harvard Business Review article "The Core Competencies of the Firm," but it existed far before that as an informal understanding in the "Market for Corporate Control," where a slipping stock price meant Michael Douglas swooped down in a corporate jet and liquidated your sagging firm.  And that's where the bulk of our private equity story begins.  In 1985, with Gordon Gekko.  With the sudden importance of debt, rather than stock price, as an acquisition tool.  No longer did you have to be a publicly held firm with a large market cap and shares to fund your acquisitions.  Now you could be a scrappy set of smart guys with a talent for convincing bankers to lend you millions.  With the rise of the dedicated takeover firm.  With the sudden liquidity in the market for corporate control.  Here marked the early height of the buyout firm.  For good or for ill this is the birthplace of private equity.

How far we have come.

-ep

Prologue IV - "Gekko. Again."

As the raiders pulled apart the large corporate blobs that had slowly, or not so slowly, coagulated since the 1960s, they created structures that, to this day, form the underpinnings of private equity transactions.  Still, it is tempting to succumb to Oliver Stone's somewhat simple vision of the Gordon Gekkos of the world.  "Greed is bad."  He can be forgiven for the moment, as while he filmed Wall Street in hindsight, it was only two years of hindsight.  Wall Street was released in 1987 and takes place in 1985.  It is, however, hard to quibble with some of his caricatures.  After all, we had Michael Milken, Ivan Boesky, Dennis Levine, and the perhaps more colorful figures of Sir James Goldsmith and Sir Gordon White- though it is hard to get more colorful than Boesky, who actually delivered a "Greed is Good" speech at University of California at Berkeley in 1986 and, it is claimed, occasionally wore a T-Shirt labeled "He who dies with the most toys wins."

There is no doubt that the Gekko character has served as an inspiration for the many Barb and Bud Foxs haunting business school classrooms.  This is ironic, as the actor himself has quipped.  Any number of young financial professionals have, on meeting him for the first time, credited their interest in banking to the inspiration they found in his character.  "I've given up saying 'But he was the bad guy,'" Douglas says.

Denounced in the late 1980s and early 1990s, the verdict is actually still out on LBOs, "Junk Bonds," now labeled "high yield debt," and takeovers in general, but only barely.  A host of studies from the late 1980s through today seems to have, aside from the criminal acts of a precious few, vindicated the LBO and, by extension, high yield debt.  High yield debt did, after all, fund the telecom boom.

Among the earlier works, Steven Kaplan's 1989 study, "The Effects of Management Buyouts on Operating Performance and Value," sets the tone for academic study on the subject and focuses our attention on two things.  1.  The role of debt as a negative incentive to corporate waste.  (Miss those regular debt payments and the bank will take the keys).  2.  The role of management equity, either as stock or options, as a positive incentive to building shareholder value.

Joseph Schumpeter called it "creative destruction."  The shifting of resources from inefficient, but sentimentally charged endeavors to newer, more efficient ventures.  Stone called it greed, in a sense.  I leave it to you to find your own definition.  Personally, I am inclined to agree with Schumpeter.  Are we suddenly surprised that LBOs have reemerged after the tech boom and bust?  The market, if nothing else, does have ways of dealing with inefficiencies.

Our real-world characters too, have seen a resurgence.  Carl Icahn has endured and has made himself a barbed thorn in Disney's side, where his "break it into four pieces" strategy (wsj, subscription required) sounds suspiciously like a line from a shareholder meeting in 1985.  Milken has experienced such a resurgence in public as to prompt one publication to pen an article titled, "The Resurrection of Michael Milken."  How the mighty have fallen.  And risen.

"Greed clarifies, cuts through, and captures the essence of the evolutionary spirit."

Given this history, you would think that corporations would stop focusing on diffuse and unfocused merger strategies as a proxy for growth. (Ahem, Time Warner).  You would be wrong.  Very wrong.  Instead, there is a constant, bustling market for acquisitions while corporates snatch up, try on, and often quickly discard one or another divestiture, division or stand-alone like so many wardrobe experiments.  Many times these acquisitions are well thought out.  More often, in my experience, they are not.  But then, failed acquisitions make for very interesting opportunities for private equity firms.

All this is a very long way of saying that the corporate mergers and acquisitions department that I finally scraped an offer out of after my first year of business school was a relic of a nearly bygone era.  That didn't stop me from taking the position, of course.

-ep

Prologue V - "Wild Corporate Ass Guesses." (insert commas to taste)

Life on the corporate side of the mergers and acquisition world is somewhat slow paced compared to the alternatives.  Decisions within a corporate development department of a large corporation on what to buy and what to sell usually involve long-winded meetings on strategy and "positioning" with the senior executive corps.  That in itself is a cat-herding like activity.  It often takes something as dramatic as a radical management change to spur any kind of real movement and by the time that comes along, well, usually the corporate development office gets swept out along with all the other old trash.  Suffice it to say that the corporate side was a bit less engaging as a career choice and the people who gravitated to it are perceived in the more rarefied circles, wrongly in my view, as those who couldn't cut it in the more intense deal driven professions.  The hours were definitely better, however.

I had braced myself for a flurry of training and "teambuilding" exercises.  Fall back into so-and-so's arms and the like.  I, like most business school students, had read Liar's Poker and was deeply prepared for the world of finance to be fully as intense and testosterone dominated as the book portrays it.  Never mind that Liar's Poker was about sales and trading and was written in 1989.  Some things never change.

If I expected that kind of dramatic welcome in the corporate development office of my new Fortune 500 home I was to be disappointed.  I walked in, introduced myself, was ushered into a very modest and messy office of what I assumed was a co-worker, and was promptly introduced to the CFO.  I almost laughed out loud, figuring it was a joke.  It wasn't.

It is not that big offices, expensive carpeting, and wood paneled conference rooms are important to me (well not only that) it is just that the recruiting process, where these palatial edifices are prized and flaunted centerpieces for a buffet of excess, transforms the one-upmanship of "total headquarters spend" by the larger investment banks into a sort of expectation.  The interview process exposes one only to such a rarified population that after the third or fourth headquarters visit it becomes hard to imagine that any place doing mergers and acquisitions work would have carpeting that cost the owners less than $350.00 per yard.

It is hard to overstate the sometimes outright gaudiness this seems to engender. Indeed, to face the harsh, neon glare of the Kohn Pedersen Fox designed Lehman Brother's building in Times Square (it was originally built for Morgan Stanley) you'd think you were standing on The Strip in Las Vegas and that the structure housed a casino.  In a way perhaps it does.  To know what used to be the highly conservative (almost aristocratic) history of the firm it seems hard to believe this is a shell they would ever want to inhabit.  Overhead inflation is a driving force.  Part of the deal.

This did not look like a mergers and acquisitions office.  Nope.  Not one bit.

My cube was typical and typically small.  I hadn't spent but two hours in it when I was called into a smallish conference room filled with a bunch of other me-like new employees and lectured to sternly on the problems sexual harassment presented in the workplace by a immensely tall, glowering and foreboding woman, the head of Human Resources, who looked like she could break Margret Thatcher in two.  It was pretty clear she took this entire process VERY seriously.

If the lecture was dull, the film, "Sexual Harassment - A High Price to Pay," was beyond funny.  I couldn't believe it had been produced with such deadpan seriousness.  This was a major issue.  The random girl next to me whispered, "Perhaps the prostitutes in the area are overly expensive?" and that set off the girl on the other side of me who could barely stifle her laughter.  It only went downhill from there as the entire room gradually began to snicker at the outrageously implausible situations portrayed in the film.  Two guys across the table were having the most serious problem even in the face of the increasingly annoyed look on HR's face.  She looked like she was ready to engage in some serious workplace violence.

And THAT was the highlight of my career in corporate mergers and acquisitions.  It is true, the position was for three more months.  It is also true that after that first day I literally spent the next two months and 26 days working on the divestiture of a call center.  The majority of the work involved trying to predict what the place would look like financially as a stand alone company.  With no fat-cat parent to pay its bills.  This seemed silly to the non-analytical side of me since another fat-cat parent was probably going to buy the place and start paying its bills.

All of the accounting was so tied into the parent company one had to make pretty wild assumptions to get an answer.  Guesses about how much of total general and administrative expense could be attributed to the call center, and how much was the rest of the company.  Ratios of employees to expenses times headcount used to extrapolate overhead.  The amount of guesswork was pretty severe.  The analytical side of me was rather uncomfortable with this much money hanging on my entirely inexperienced swags.  Of course, when I presented some of my guesses to my superior, he frowned and asked me to rework them so that the expenses looked lower.  We wouldn't want to depress the price a buyer paid, would we?

Three days before the summer was over senior management decided to keep the call center.  I spent the remaining three days making little paperclip sculptures.  I think the one of the chair looked best.

-ep

She Got The Job

Recruiter: "Would you hire you if you were me?"
Candidate: "No.  This interview has been a car wreck."

Unbalanced

First Year #1: "Did you hear about the [big foreign bank] presentation yesterday?"
First Year #2: "No."
First Year #1: "This managing director is up in front of the podium answering a question about work-life balance someone asked, the junior guys are sitting in chairs on the stage behind him.  Fifteen, maybe twenty seconds after the question one of the junior guys literally passes out and falls out of his chair onto the stage.  They called the paramedics and everything.  It was crazy."
First Year #2: "Is he ok?"
First Year #1: "Fine, apparently.  Exhaustion.  Just got off the plane from London, no sleep for a week because of a deal he was working.  Right after the managing director just talked about how great the work-life balance is."
First Year #2: "They have a London office?  Are they hiring for the London office?"

-ep

Prologue VI - "The Bounce"

Though I had the coveted "Mergers and Acquisition Intern" catchphrase on my resume after my summer in corporate development, it seemed to count for little when it came to my continuing job search.

By the end of the recruiting season I was high and dry without any semblance of gainful employment.  My classes seemed to get harder- the professors lightened up on the students a little during recruiting only to buckle down with a vengeance once the official season drew to an end- and the many tales of other dream-come-true offers that passed from the lips of my colleagues had a brutally demoralizing effect on me.

The impending approach of Graduation almost felt like an impending doom.  The career services department did not help with their constant publication of the running "percentage of second years with an offer for full time work" statistic.  (By the week before graduation those figures stood at 90something percent).

There was definitely a certain subliminal pressure lurking under the surface of things.  Parents started flying in.  Exams had to be completed.  Papers written.  And all under the constant reminder- which the dean of students office actually took the time to mass email to the students one afternoon- that failure was, literally, an option.

The buildup of pressure had two effects, really.  First, it caused some of us to spend even more time out drinking.  It was tradition at the business school to go out each Thursday to a bar selected randomly by the committee appointed for this purpose.  Sometimes you almost felt sorry for the poor, totally unsuspecting patron of the bar.  Going to be a slow Thursday.  No, Tina, you don't need to come in.  We only need one bartender for Thursdays.  Then, between 9 and 9:30, *Wham*  150 business school students descend from the heavens like thirsty paratroopers into the French countryside.

I attended my share of these in the final days of my MBA career, but I found no solace in them.  Everyone, it seemed, had scored a decent position and they were all to happy to tell you exactly where that was going to be.  I, on the other hand, was going nowhere and I wasn't about to share that fact with anyone.  Instead, I invented a destination.  The foreign office of a respectable bank in particular.  Enough to prevent sneers but obscure enough to avoid running into someone else destined for that office.  I just couldn't handle being thought of as a washout or some kind of failure and at these kinds of events you were supposed to be jolly and carefree.  Grade non-disclosure and graduation just around the corner was supposed to be second-semester-senior style inspiring.

Not all the effects of those last weeks were so benign.  The week before finals one classmate's girlfriend shot herself in the head in his apartment building while he was out with friends.  I heard that he had broken up with her a few days before after dating her for more than two years.  I'm not sure what it means that he was in class the next day.  It was the review session for the final.

I celebrated graduation just like everyone else.  Well, perhaps with a tad less enthusiasm.  They all seemed to be heading somewhere important.  On the verge of realizing big dreams.  I was on the verge of... not very much.

I went to visit my friend Kim in New York about a month after graduation.  I was going stir crazy back home and I needed a break from the job search.  She had landed a spot in the investment banking group of the bank that had been second on my list of favorites.  On getting to her apartment I was stunned to find a pale and drawn looking Kim hunched over a bunch of finance textbooks.  She had her degree already.  Why the textbooks?

"I have to study," she replied without looking up.  This was delivered totally deadpan.  She was serious.  "The bank has a training program and there are exams after each section."  I couldn't believe it.  I must have stood there for 3 minutes with my mouth open because she continued, "It's pretty tough stuff.  A lot of the class is spooked out."  The "class?"  I looked around the room.  Pizza boxes.  Empty Cup'o'Noodles cups tipped on their side with forks still in them.

"Do they actually fail people or something?" I asked.

"No, they fire you."  This was beyond preposterous to me.  I couldn't believe people put up with a second round of "financial accounting."  She continued.  "Just imagine you're some French language major for undergrad and you head to business school but don't take any serious accounting classes.  You're fucked.  We've lost 2 people already."  She'd only been at the bank for four weeks.  It was true though.  You could get through business school without really mastering many of the fundamental banking subjects, like statistics, accounting or financial modeling.  Why you would try to go into banking after that is sort of beyond me though.

"They fire you?"  I still couldn't get my arms around it.

"Yep.  Well, if you were really close you can retake it.  So sometimes people vanish from the classes but then mysteriously show up again after a week and a half or something.  You know they almost failed and got a 'talking to.'"  That sounded suspiciously like a euphemism for an abusive husband to me.

I had envisioned a week of at least a few outings to local pubs, or a night for Italian or something between old classmates.  Nothing doing.  Kim didn't once leave her apartment while I was there except to creep out to her mysterious, and cut-throat training program.  In a strange way this turned out to be a very lucky thing for me.

I had almost given up on ever finding a suitable position.  Like when you're looking for parking, the longer you look for a spot the wider the circle you drive in to find one.  By the fifth lap around your neighborhood the radius of your search area is 5 blocks wide.  The radius of my job search had descended into purchasing departments of middle market companies by this time.

Mostly out of despair I did something I swore I would never do.  I asked my mentor from undergraduate to meet me for lunch in Manhattan to give me career advice.  My pride was so battered by that point I didn't even care what anyone thought anymore.  And here, an odd thing happened.

My mentor had joined the board of a private equity firm in Manhattan.  This news was delivered over dinner at The Palm with almost emotionless nonchalance.  "I could make an introduction maybe."  I recognized the name of the firm immediately.  Buyouts.  The founder was famous for having started it with an interest free loan of $100,000 borrowed from a relative and creating a billion dollar private equity firm in less than a decade.  Thereafter he had steadfastly refused to lend his relatives even a single thin dime.  There was a price to pay, however.  The firm was famous for chewing up, sucking dry, and spitting out the bones of young associates before grinding them up into powder used for absorbing the coffee spilled by the partners.  Partner coffee desiccant seemed like just a dandy thing to be at that moment, however.

I shook through the entire dinner.  It took me a week to work up the courage to put in a reminder call to my mentor.  Sure enough, a meeting was arranged and days later I was at lunch with Ron, a former employee of the firm who had left to become President of one of the portfolio companies.  Ron began to discourage me from applying for a position from the moment I sat down.  I would be treated like a slave.  Sent to make copies.  Bind PowerPoint presentations.  Hole punch.  I wouldn't so much as see a client for the first three years.  I didn't care.  I even said so.

"Really, I don't care.  I want to break into the industry."  Ron was persistent.  He insisted that buyouts had become commoditized enough that associates were used and exploited without any chance of making partner in the big firms, as those rolls were all but closed.

About halfway though the conversation, he brought up an alternative.  A friend of his was 15 months into starting up a new buyout firm.  Maybe he had an open slot.  Why not join on the ground floor instead of hitching my future to a cart that had already left and was halfway to Idaho already?  A startup buyout firm didn't seem very interesting to me.  I was looking for experience in the industry.  A big name for my resume and to gain the experience I needed to one day start a fund of my own.  None of that was part of the deal.

"You're never going to get that at a larger fund," he insisted.  "You'll be lucky to work on two deals in a year.  And then, your involvement will consist of checking a spreadsheet or two for errors.  With a new firm you'll be in the thick of it from day one.  Plus this place I have in mind actually needs you.  You're going to love the founder.  Trust me."  Before I knew it, Ron was actually refusing to make an introduction to his old employer at all.  He had talked himself out of it in 75 minutes flat.  Instead, that weekend I found myself in the car with Ron, who I had spent an aggregate of 85 minutes with up to then, driving up to a multi-hundred acre estate in Connecticut.  And there, on the front lawn with a pair of champion whippets by his side, is where I first met my boss.

-ep

Distortions

It is quite difficult to avoid judging people by their possessions in our culture.  The way we define people has more to do with their surroundings, and the surroundings they create around themselves, than it does with who they are.  This was just not a problem with Armin.  Armin is a tall EU citizen of about 52 and though he was standing in the midst of the most remarkable estate I think I have ever seen, there was this light about him that made his surroundings just that.  Surroundings.

There was such a high contrast between him and everything and everyone else.  The things around him looked like mere accouterments because they stood out as so bland in comparison. Certainly he was very wealthy, but in the end those were just the rewards of doing very well what he did.

What he did for the past 15 years of his life, as I would later find, was serve in the senior executive corps of one or another Fortune 500 company, including presiding over two of the more spectacular breakups in U.S. corporate history.  Just to hear him talk about finance you could tell he dreamt in capitalization tables.

I can't even remember what any of the other people there that evening, his wife, his daughter, one of his employees, the housekeeper even said.  I was that lost in listening to him.  I had heard of Bud Tribble's "Reality Distortion Field" before, but Armin was the first person I had ever met who possessed one.  Granted, it wasn't hard to talk me into a private equity position, or any job at all, by this point, but he was so adept at the art of persuasion and I felt under his spell so naturally that later I would wonder exactly how voluntary it all was.

Everything around him had a sheen of perfection to it.  His wife was beautiful, and young.  His estate was the envy of even the more rarified segments of the local demographic.  His dogs were perfectly behaved, obeying three sentence verbal commands as if English was actually their first language.  He was in private equity.  I suppose it shouldn't have been surprising that he was also a gourmet chef.  Still, he might not have even bothered with dinner.

I had pretty much accepted the job before it was even described to me. It grew later and later.  My chauffer, Ron, showed no signs of departing and after his fifth glass of the most wonderful red wine I had no desire to be in the same car with him anyhow.  Armin didn't miss a beat. "You'll stay the evening, of course," he said.  What the hell else was I going to do?

Location, Location, Location

"The nice thing about being the founder," Armin was telling me, "is that you can put the company anywhere you like."  I was trying to play off as if I wasn't particularly impressed with all that I had seen since my dinner the night before.  I wasn't, I think, succeeding very well in my efforts at deception.

Some months after the attack on the twin towers, Armin's wife had literally drawn on a map of New York a 50 mile circle around Manhattan, where they had been living on 9-11, and said "anywhere outside here."  Armin actually took the map to the realtor who had proposed several options culminating in the property I was, at that moment, standing on.

It had been quickly, and quietly purchased from a quite famous "raider," still in the business today in New York, a name you would no doubt recognize, from the glory days of 1980s junk.  Though Armin claimed to hate going into New York because of the traffic and such, I suspect it had more to do with the serenity of surroundings here.

The estate was so big that every other room had one of those Motorola two-way radios sitting on a table in a charger.  If ever you went anywhere you would just grab one and take it with you around the grounds.  The result was that an intermittent beeping accompanied Armin around the grounds as he back-and-forthed with the staff, gave directions and otherwise managed the day to day affairs of the estate by remote control.

It is impossible to overstate the impact the estate had on me.  When I was younger my family were close friends with a well-known author and his family who had a similar, though admittedly smaller, estate I used to play on when I was young.  The kind of almost primeval spark that Armin's place set off in the lizard portion of my brain was potent.  In combination with the picture perfect weather Armin had managed to order down through whatever level of contacts are required to get that sort of thing done, it jolted me into a sort of suggestible trance or something.

He was going on about his motivations for starting the firm (a lust for "the deal" and a disdain for large corporations as a vehicle for growth), the firm's acquisitions philosophy (acquire majority stakes in midsized firms where there was an opportunity to positively adjust the capital structure and apply real management supervision), and what he was looking for out of a new member of the team (a "hunger" for "the deal," potent modeling skills and an interest in "having some fun together.")

As I looked around the estate, caught sight of a far off deer in the woods and began to fall into the favor of Lord Mountbatten and Admiral Nelson, Armin's two whippets, it all seemed like a dream come true.  By the next evening I was talking about timing for my start date.

The Final

Armin had two other general partners, and although they both had only minority interests in the firm, Armin treated them as equals for the purposes of major decision-making within the firm.  That included new hires.  I discovered this when Armin dropped a 5 inch sheaf of paper in front of me.  It was a deal.  Names were obscured.  Details black lined.  But it was definitely a deal.

"Of course, if it were up to me," he said, "I would have hired you already.  My partners are, well, they find people more opaque than I do.  But then, they are both former CFOs.  It is hard to blame them.  And, to complicate things even more they are not here to be charmed by you, like I am," he smiled at his own joke with this last.

After I picked the stack of paper up, it seemed to get heavier and heavier as Armin continued to speak.

"We prepared this case for you.  It is a real deal that we looked at about 6 months ago.  Run though it.  Put together a presentation.  Concentrate on creative deal structures.  Remember that we are a smaller firm and we have to be more nimble.  Smarter.  You'll present your conclusions to my partners and me via telephone on, oh, shall we say Wednesday?"  5 inches of mergers and acquisition case.  In 3 days.  Suddenly Kim's studying for her investment banking training program in her closet sized Manhattan apartment seemed benign, even desirable.

I had only planned to be gone the weekend and my welcome with Kim, who was a terrible hostess in her current state anyhow, was effectively worn out.  I had to go home.  I started reading the case on the way back to the airport but by the time I arrived I was so panicked and absorbed in its complex detail that I walked right through the terminal without even checking in and took the train from Newark airport to the city.  I checked in to the Hudson Hotel and I did it so blindly driven with fear I don't even remember having heard the room rate.  It didn't matter.

There was no way I was going to sit on a plane, deal with loud, flu carrying children back in coach class and try to salvage my intellect enough to work on a case for a shattered day before flying right back.  No.  Instead it was room service for 3 nights in a row.

The case was a complex LBO.  The target had a badly muddled capital structure.  Uncooperative shareholders who had to be bought with ever increasing amounts of increasingly expensive debt.  I was on the third theoretical tier and putting warrants underneath them to meet the stated IRR goals of the mezzanine fund before I had enough capital to do the deal.

I emerged from that marathon session with what I thought was some of my best work.  Time constrained.  Incomplete.  In some places not as polished as I would have liked, but still, all considered, some of my best work.

Presentation slides arranged.  Attached to email.  Sent to three addresses and I was on the phone with Armin & Partners.  I launched into the first 5 slides, my summary and introduction and then I hit the natural pause before I delved into the first detailed section.

"No," Armin said.  "Wrong."

Increasing Efficiency in the Market for Corporate Control

The Wall Street Journal is running an article (subscription required) today observing the anemic recent returns of merger arbitrage funds.  This is surprising, according to the article, because of the high number of deals tumbling in.  Last year was the most prolific since 2000.

The article quotes Mario Gabelli, manager of the scintillatingly named "Gabelli ABC Fund" thus: "Investors should think about this as an enhanced money-market return."  So much for an investment class that used to pull out 30+% annualized returns in the 1980s.  Of course, that was back when Ivan Boesky and company could boost returns by getting long on a target with huge leverage before the market was aware a deal was in the works.  I would love to see an analysis of the returns on an insider trading strategy.

So what keeps spreads (and therefore merger or risk arbitrage returns) so low?

One explanation is that we are seeing more "mergers of equals" and therefore the lack of price disparity and low spreads between such firms are more limited to begin with.  Lower spreads, lower returns.

Another explanation is that the funds investing in merger arbitrage opportunities all have effectively the same criteria and therefore invest in the same deals leaving less of a spread.  In other words, merger arbitrage is "oversubscribed."

A third explanation is that markets are getting more efficient.  They "sense" a deal before it emerges and price up targets.

A subset of this third explanation is that there is a clever and well funded insider trading network at work within the market and they are squeezing returns out of the law-abiding risk arbitrage gang.  Since this last option is the most conspiracy oriented it is also my favorite.

Of course, there is a long history of claiming that insider trading actually makes for more efficient markets.  Interested readers might start with Stephen M. Bainbridge's Florida Law Review Article, "The Insider Trading Prohibition: A Legal and Economic Enigma."  (True Gekkoists will want to ignore the fact that it was printed back in 1986).

Redemptions

Few people still think first of bootlegging money when the name "Kennedy" is mentioned, though this is still the most common explanation for the family's initial wealth.  Fewer still remember the stock pools, insider trading, and what today would be called outright securities fraud perpetrated by Joseph P. Kennedy, Sr. during the 1920s. Ironically it is the later, not the former, for which there is the most compelling evidence, and the former, not the later, that remains the most prominent figure of legend.

Bootlegging, with images of blacked out yachts quietly slipping alongside hidden east coast docks, unloading gin barrels in the dark of the night is far more romantic than insider trading.  Still, for Joe Sr. it was the insider trading stuff that got him both the first most difficult boost on his fortune, and also the Chairman of the SEC position, which he held from 1933.  Asked why someone with such a checkered past was worthy of such an appointment, President Roosevelt replied, "It takes a crook to catch a crook."

All this suggests to me that, at least in the United States, there is a certain romance associated with the rebel, the underdog.  Legitimacy is not so difficult to re-earn.  Claus von Bulow might have said it best.  "In America, it is fame that is important." I suppose this might account for the recent resurgence in takeovers, and to greater extent, greenmail as recent news from the Wall Street Journal on Carl Icahn's Disney assault suggests. (wsj article, subscription required).

I have written before about the resurgence of the likes of Michael Milken.   It would seem that greenmailers are back in vogue too, this time in the form of the old raiders and hedge funds (the new raiders).  Well, back in vogue except that now we call them "activist shareholders."

Carl Icon

Carl Icahn on the last hours of his negotiations with Time Warner:  "I had a martini or two and then I was back on the phone until about 2 a.m."

What a class act.

To LBO or Not to LBO

My LBO case was a small light manufacturing company.  I should say, actually, it was an assembling company.  They had outsourced all their component manufacturing and did only detailed quality assurance and inspection and assembly at their facilities in Northern New England.

I concentrated on three things.  First, doing a good discounted cash flow analysis.  This shouldn't have been difficult because there weren't a long series of non-recurring charges to pull out of the financials.  It was a pretty clean-cut and clear business this way.  The problems with my model were more subtle.

The company was only around $100 million in revenue.  At first I wasn't going to call it an LBO because it didn't fit the typical model.  Boring firm.  Lots of machinery or assets on the books to leverage against.  Steady cash flow.  Undervalued industry.  Here we had 5 years of 15% annual growth in revenue, positive, but hardly steady or consistent, a balance sheet with barely $12 million in assets to leverage, and most of these nearing the end of their useful life.  It was an expensive deal though.  Nearly $20 million in EBITDA and a banker for the seller who wanted 5x-6x EBITDA, or $100 - $120 million in cash.  The discounted cash flow I did was cumbersome.  How do you pick a beta to determine a discount rate for a small, totally privately held firm with no obvious industry peers?  Wild ass guess, that's how.  It came out to around $135 million.  I shaved that down by applying a "liquidity penalty" rather arbitrarily to the firm of 30%.  Nearly $95 million.  That was close.

Even at $95 million, an all equity deal would be painful, and it would make returns very difficult.  I doubted the firm could maintain 15% growth for another 5 years now that it had $100 million in sales.

I solved my quandary when I remembered a Wall Street Journal article on hedge funds and their increasing domination in the cash flow based leveraged finance business.  Large balance sheets weren't critical to an LBO, provided the lender could get comfortable with the cash flow.  Such "cash-flow" based leverage made it possible to do significant LBO deals on firms with weak balance sheets, albeit at more severe rates.

I threw myself into the LBO model with On-Demand movies playing in the background to keep me company in the hotel room.  Committed to the LBO model, I had to take some guesses as interest rates and how much a hedge fund with a leveraged finance desk, about which I knew quite little, would want to see.

I ended up with $30 million in equity and three "and a half" tiers of debt.  The Senior Secured with $40 million (two EBITDA turns) at 400 basis points over LIBOR.  The Senior Secured B with $20 million (one EBITDA turn) at 800 basis points over LIBOR.  The Senior Secured C with $20 million at 950 basis points over LIBOR and half of the interest payable as "payment in kind."  Below this I added some penny warrants so that the total return to the hedge fund was closer to 15% than not, figuring this was the kind of IRR they would need to do the deal.  This seemed like a reasonable structure and there was enough EBITDA to go around even with mandatory payments on the debt.

I threw in a very conservative 3 stage growth model, pulling revenue growth in year 5 down to 5%.  Even on this conservative model the equity was showing IRRs of nearly 27%.  Any decent sales performance would pay off more debt faster and boost those IRRs even higher.

I was confident I had the right answer, and I wasn't sure how any investor could snicker at those returns given how conservative I had been with growth.  Even with a rather severe contraction in revenue the debt holders were still made whole in the first several years.  Figure in a refinancing in year 4 or 5 and it was a pretty good looking deal.

I put all my arguments together, got a smattering of sleep and pitched the deal the next day.  Armin stopped me cold on my sixth slide.

"Your model looks fine, but this deal would never work."  I was frozen.  "Did you consider the ownership?"

"Well," I was at sea here.  "Yes.  I felt that this level of payout would convince all the shareholders it was a compelling deal.  I left some upside in the model and I think we could add another $10-$15 million in purchase price in order to..."

"No," Armin intoned again.  "Think PAST the numbers.  The purchase price is just one part of the story."  I was stuck.  There was a long pause.  Armin finally broke it.

"What percentage of the firm are we buying?"  I hadn't considered anything other than 100%, figuring that leaving old minority shareholders in was a bad idea and that a clean slate would be better."

"I guess I figured 100%."

"No.  Take another guess."

"51%?"

"No.  Tell me, what is the motivation of the seller here?"  I was stumped.  "Did you read about his family?"

"No," I admitted.

"You should have.  How old is the owner?"  I was about to try and guess when Armin answered for me.  "Seventy six.  He has five daughters.  All about one year apart.  What does that tell you?"  I was alarmed by this direction of the discussion.  The other partners were totally silent on the phone.  The silence continued.  "It tells you he probably wanted sons.  What are his daughters doing?"  I didn't know this either.  "Well, it doesn't matter, except that none of them want anything to do with the family business."  This had been in the materials, but I had ignored it.  "He wanted sons, instead he got a lot of minority shareholders, two of which have made a habit of suing him.  Do you think he is ready to retire?"  Again, I didn't get the chance to answer, "He's got three sailboats, two planes and a house in the islands, he's seventy six and he's still working at the business he built full time.  This guy is bored.  He isn't going to retire.  He wants to relive the glory days.  He's selling because the minority shareholders have driven him to madness.  He needs a partner again.  He needs... heirs."

"I... I see."

"Yes, I think you do now.  Let me tell you what really happened with this deal.  By hook and by crook we bought out the seven minority shareholders for $20 million in equity.  That got us around 30% of the company.  We then structured the rest of the deal as an earn out, slowly buying out the owner but letting him run the company and stay on the board.  We ended up paying about 80% of what you suggested.  If we kicked him out we'd have had to put in a whole new management team.  You have to think first about the people.  About the parties and their motivations.  Why are they selling?  How can you give them what they want without just throwing money?  Sometimes you can't.  This time we could.  All he wanted to do was be the big cheese for a few more years.  It was the lawyers telling him to sell."  I was crestfallen.  I had totally blown it.  "Your model was excellent.  We might even have done this deal as an LBO, but we didn't have to.  That was the key.  Well, we'll talk and I'll get back to you tomorrow."

That night was the longest of my life.

Crash and Burn

I was certain I had blown my big chance.  All those hours of learning how to construct complex models for every conceivable financial situation for naught.  Maybe I wasn't cut out of this sort of work after all.  It was about more than being a great analyst with a gift for modeling and little in Business School seemed to emphasize much else.

Sure, there was the occasional practitioner professor who would tell old "deal war stories," but nothing on the craft of the deal.  Nothing on what could be gleaned from the fact that a seller had 5 daughters and no sons.  Or that he never sailed on his boat.  These were the pieces of the puzzled I needed.

I was suddenly angry at my alma mater.  They were quick enough to pester me for money.  Why hadn't they given me the tools to ace this interview?  Had the Harvard people learned these "soft skills."  What was that class called?  "Deal making 202: The Inside Track?"

That night I emptied the entire minibar of those mini booze bottles.  My last remembered moments were highlighted by a spinning whirlwind of ugly upholstery, eye straining, power saving tube-bulb lighting and high traffic carpeting.  Somewhere in there I apparently drunk-dialed my ex too.  (I know this because the hotel bill the next afternoon included a $65.40 charge to that embarrassingly familiar number).

In the depths of my dreams I heard my cell phone ringing somewhere.  Because I was unable to muster forth sufficient clarity or conscious thought to compel my dehydrated body to pick it up, annoying, chirp like rings punctuated my dreams until 1pm the next morning (I changed my ring tone the next day) when the much louder and more insistent hotel phone began to take over with the front desk on the other end asking when I planned to check out.

I staggered out of the hotel, broken and beaten and into a grungy taxi to the airport.

I was dead asleep as soon as the plane was taxing.  Then, suddenly and without warning, I was jarred awake in terror when I heard the engines suddenly roaring unusually loudly as the captain firewalled the engine for some reason.  I felt the plane banking hard enough to press me against the window to my right.  I almost cried out in horror.

A part of me was resigned to this grim fate.  How fitting to die in a flaming crash after my flaming spiral interview crash.

Bracing myself for whatever we hit I felt something was wrong.  I glanced around the plane in a panic and saw that no one else in the entire plane was reacting as if anything were wrong whatsoever.  I looked quickly out the window and realized that the plane was not yet airborne.  The pilot had put on the power during the tail end of his left turn onto the runway, to get a running start, I guess.  The combination of the turn and the sudden roar made me think we were headed for certain death.

I tried to regain my composure but two people in my row were staring at me.

I was not much better once at home and finally lucid enough to listen to my voicemails.  The first one was Armin.

"We'd like you to come back and start work on a trial basis as soon as possible."  The other four messages were hang-ups which my phone reported as also being from Armin.  I had done it.  At least for now, I was in.

Debit or Credit?

Of a famous (or infamous) accounting professor known for sending his students checks for $0.05 for every mistake in his newly published accounting textbook they found:

Second Year #1:  "What the hell is that?"
Second Year #2:  "It's one of [accounting professor's] checks."
Second Year #1:  "What the hell did you frame it for?"
Second Year #2:  "It's going on my wall.  This way, his credits and debits will never balance out.  Not ever."

Wined and Dined

My deal was simple.  I would report directly to Armin, the Senior Partner and no one else.  I would be responsible for all of the serious M&A work.  Doing valuation and analysis.  Working the structure of a deal.  Developing post acquisition strategy and predicting what sort of gains we could expect to see by implementing our strategies.  I was to be paid more than I had ever made in salary before.  In three months we would talk about equity.  The other partners were primarily concentrated on financial due diligence and deal generation or business development.

What Armin needed, he said one of those early nights over a venison dinner, was some relief on the analysis, negotiations and mechanics of deal making.  I was nearly stunned by the level of responsibility (and by extension the workload) and I immediately felt badly under qualified.  Despite this, I kept my mouth tightly shut and spent a lot of time nodding as if the entire thing made perfect sense to me.  Of course, I would be immediately prepared to assume a level of responsibility traditionally reserved for partners.

It was a pretty lean shop from a body perspective.  Armin had his hand in both the majority of deal flow generation, where he utilized his substantial contacts both in New York and Europe to pull rabbit after rabbit out of old hats, and in structuring and negotiating the final deals.  He always seemed to be flying off somewhere to meet with one or another CEO, invariably an old friend from somewhere or another.  I was to begin accompanying him immediately to get a feel for the deal flow side of things.  To learn the practice of the schmooze, of which Armin was the master.

The rest of the time, at least in the early months, I would be spending on his estate, working through the way he liked to operate, the kinds of valuations he trusted, the verticals and industries he was interested in.  Learning the ropes, if you will.  Drinking the Kool-Aid.

Even as a small firm with only 4 partners and 3 junior people including me, we had quite a bit of help.  Armin had one of his speed dial buttons painted red.  That was the direct number to our Wall Street attorneys.  We used them liberally, given our own limited resources.  With that red button Armin probably put the kids of one or more of the senior partners in one of the top firms on the street through college all by himself.

Life on "The Estate" was strange.  I had expected to spend most of my time in the firm's Manhattan office, sitting in a cube and running spreadsheets.  I suppose I expected to be wined and dined a little bit, it being one of the rumors in b-school that such things went on for the first three months to lock in a worker bee before crushing work and total indifference to "work-life balance" was brutally applied by the firm.  Instead, I found myself living on what could have been a five star resort and quickly becoming Armin's "right hand."

I spent the first week working on a valuation for a small, privately held, environmental company we were considering purchasing.  There was no guidance.  No analysis plan.  Simply a mandate.  "Tell me how much I shouldn't pay," Armin said to me one day, laying the materials in front of me.

My "office" was actually the "English Study" (fireplace, wood paneling and all) in the main house of the estate.  In truth I was afraid to even write on the desk and instead took notes on my laptop most of the time.  I have to say, nothing seemed more foreign to me than the site of a modern laptop and an AT&T phone on that old, leather topped antique desk.

Every day, as soon as 5:30 came around, the butler would appear with a plate of smoked salmon, a fishbowl sized burgundy glass and a bottle of red wine on a silver tray and announce "Mr. Armin has asked you to join him in his office at your convenience," while he poured with great flourish what almost seemed an excessive amount of wine.  (I say "almost" because I am a big wine drinker).  I would finish up the salmon and whatever I had been working on and walk across the house, wine glass in hand, to the far wing, where Armin's office, a much larger version of the study I sat in, was.

He would stand whenever I walked in, gesture to one of the massive armchairs in front of his desk, and poll me on topics ranging from the wisdom of investing in small steel companies to the state of the German economy.  That sort of free-flowing discussion would continue until 7:30 when he would head off to the kitchen and put the finishing touches on whatever meal he had been preparing on and off since noon.

I would drift off back to my office and finish up whatever was left of my work before the butler arrived again and announced "Dinner is served," once again filling my wineglass.  It was hard to feel like I was working, though the hours were actually pretty intense.

Two Girls and a Guy

During interview wrap-up meetings for a "bulge bracket" bank:
Recruiter #1: "I actually know her quite well.  She isn't a team player.  Hard to see her working well in small groups."
Recruiter #2: (Whispered) "Weren't you two seeing each other as recently as last week?"
Recruiter #1" (Whispered) "Yeah, like I said.  Not a team player.  No small groups."

The Hunt Part I (Chase)

For the first many weeks I didn't even meet two of the firm's partners.  I was quietly ensconced at Armin's estate, or traveling with him to management meetings.  Ah, management meetings.  But I suppose that to understand what this means one has to understand the process of hunting down deals.

The structure of "the chase" for deals is in some ways convoluted.  First you have to find the deals.  There are a variety of methods.  At our firm we had two associates calling all day, every day into the senior executives or the "corporate development" departments of large, publicly held firms.

The pitch was simple.  We are a private equity firm.  We are buying (or in "acquisition mode").  The associate had noticed an article in the (Wall Street Journal/Barron's/Economist/Investor's Business Daily/Bathroom Wall) discussing XYZ Corporation's strategy shift and if any of the divisions or units had become undesirable or "non-core" as a result we hoped they would let us know so we could relieve them of said units.

Of course, the hope was that our associate was so suave that the large corporate wouldn't even bother to call an investment banker when they had something smaller to sell.  (Having associates who put out seems to be an advantage in this business).  See, we hate investment bankers.  Investment bankers sell their services by convincing a firm's owners that their firm is worth "X" and then, right or wrong, blocking even the hint of any deal that makes their wild ass guess of "X" look silly.  It is like hiring a real estate agent who promises to sell your $900,000 house for $1,000,000 and then refuses to even inform you about the 6 buyers offering $925,000. Well, ok.  That's not really fair.  Really we dislike them because Investment bankers mean negotiations and auctions.  Negotiations and auctions mean paying fair prices for what we buy.  We hate paying fair prices for what we buy.  We love free markets.  Except auctions.  Then we want illiquid markets.

In any event, the net effect of all this calling was a seemingly never-ending series of meetings with the CEOs, CFOs and COOs of large public companies.  "Business development."  This translated t: Lunch at the Yacht Club.  Afternoon drinks at the social club.  Dinner at the Estate.  Morning meetings in Manhattan offices.  Drinks after work on Friday at the Four Seasons.  Weekends who knows where.  Then, occasionally, a CEO would call you up, or more likely, he would tell the CFO to call you up.  They had something they were thinking of getting rid of.  Could we do it quickly and quietly?

If that doesn't work then our associates spent a lot of time calling investment bankers.  Did they have anything of interest for sale to us?  Any aerospace stuff?  Fast moving goods?  (I always thought aerospace and fast moving goods must overlap).  Processed meats company?  (I'm not kidding, we almost bought one).

Ok, I know I said we hate investment bankers.  Well, sometimes we don't hate investment bankers.  "Sometimes" is when they call us trying to avoid sounding desperate because the deal they had thought was all sewn up to sell a company they were trying to dump fell through at the last minute.  Their auction broke.  Maybe we had bid on it but come in second, or third.  Or not at all.  Suddenly we love investment bankers.  Illiquid market again.

No deals yet this week?  Ok, then there is a lot of talking back and forth with accountants, consultants and lawyers.  Any deals that look like they might be a problem?  Any large acquisitions that might be threatening to close a 500 person unit somewhere after the deal is inked when the surviving company looks to consolidate operations?  Give us a call.  Slip us a note.  Whisper in our ears over drinks.  Start your sentence with, "You didn't hear this from me but..."  That's like one of those EF Hutton commercials back when.  The entire table of private equity guys and gals just clams right up.

This is, of course, a popularity contest.  It is about showing these various professionals a better time and connecting with them on a deeper level than the rest of the private equity professionals who were chasing them.  I began, I thought, to suspect why Armin found me interesting.  I sailed.  I rode horses.  I could hunt.  I skied.  I played tennis.  I was a moderately talented faker when it came to golf.  I came from a bit of a leisurely background.  Perfect to connect, charm, seduce, whathaveyou, the CEx set.  This is why you constantly see former heads of state, presidents of banks, star athletes, some of whom have no finance background at all, joining private equity firms.  They know how to schmooze.  They have contacts.  Even with this realization, the mystery to me was still how Armin credited me with such potential in this area.

When you first "officially" hear about a deal you get a "teaser."  A one page document describing in general terms, and without any names, the nature of the business and the most basic of financials.  Well, that's not always true.  Sometimes there was no teaser.  You liked those deals.  That meant that there was no one who had the time to actually write a teaser.  That meant no banker.  That meant no resources to the transaction.  That meant "cheap."  If you get a teaser, and if you are interested, you sign a confidentiality agreement and a more detailed document, sometimes running into the hundreds of pages, is forwarded to you.  This is "the book."  Of course, some small or last minute deals had no "book."  Then you had a lot of guesswork to do and a lot of questions to ask.

From the book you are supposed to decide you are interested in bidding, forward a "letter of intent" outlining the fact that you are interested and schedule a management meeting (or several).  This is where you (duh) meet the managers, ask questions about the business and start deciding if you want to buy this sagging firm or if it is just too much trouble and too expensive.

Now, I pretty much glazed over the "sign a confidentiality agreement" step as if it were simple, but this process itself can take weeks as one haggles over terms and conditions.  Alternatively, sometimes neither party even reads the damn things before signing them.  This last point prompted me to put in some cute language in the middle of one of our standard NDAs just to test the waters:

Section 2: Information.

“Information” shall mean all data (whether provided orally, in writing or on computer disk), reports, plans, interpretations, designs, software, drawings, models, forecasts and records containing or otherwise reflecting any information not generally known to the public.  Information shall include, but not be limited to, any information supplied to either party prior to the proper execution of this Agreement and any additional information provided subsequent to the date of this Agreement; provided, however, that this term shall not include any portion of the Information which (A) is or becomes generally available to the public other than as a result of a disclosure by the Receiving Party or its representatives, (B) is a part of the Originating Party's ever growing collection of printed, online or multimedia pornography and/or other erotic materials, (C) becomes available to the Receiving Party on a non-confidential basis from a source other than the Originating Party or its representatives which has been represented to the Receiving Party (and which the Receiving Party has no reason to disbelieve after due inquiry) that it is entitled to disclose it or (D) was known to the Receiving Party on a non-confidential basis prior to the disclosure thereof to the Receiving Party by the Originating Party or its representatives.

A dangerous game, I know, but I managed to get signatures on that 4 page document from 5 parties, including one CFO at a household name type public company, before one of our associates, instead of printing off a new copy from the Microsoft Word template on our server, and in a fit of apathy that nearly cost him his job, made a Xerox of an executed copy of my version, whited out the names of the original parties wrote in new ones and faxed it out to a firm fairly famous for being nitpicky with such documents.  That was the end of my little "joke," though to this day no one knows where the "new" version came from.

We never got a deal from that firm again.

The Living Dead

Sell Side Managing Director (age: 53): "What you have to understand is that companies are not static.  They are dynamic.  They shift and move.  They pulsate with the beat of the economy.  They consume, they respirate, they are alive.  Living things."

Private Equity Associate (age: 26): "Maybe some companies, not this one."

1995 Called. It Wants Its Blog Back

I'm not usually catty.  Well, usually not usually.  Still, I couldn't help myself today.  I was inspired.

I'm not a venture person, of course, but I can't help but observe that, for someone who's only real claim to fame is that they worked for Apple back in the 1980s, started a failed software company in the 1990s and published a series of books, there is a lot of self-aggrandizement going on within the boundaries of Guy Kawasaki's blog, which dispenses critical advice essential to any aspiring founder like why you shouldn't start your company name with an X or Z, or that you should "sound different."

Of course, it's equally important, it seems, to "suck up to a blogger."  If that doesn't give you enough then you can always read about how Guy writes his blog entries, and how they differ from his book writing skills.  Oh, there are also lots of important looking pictures of Guy (obviously deeply contemplating weighty affairs).

No.  I am not making this up.

It's perhaps no wonder that, 4 years on, Kawasaki's fund, the "Garage California Entrepreneurs Fund, LP," which somehow managed to tear $5,000,000 from CalPERS and another $5,000,000 out of other investors is looking at a sad -2.4% IRR and has only managed to invest half its committed capital.

Really, if you're going to hold yourself out as an expert on venture capital and write books on "The Art of the Start" shouldn't you at least have a fund with more than $10 million in committed capital available?  And shouldn't it be doing well?

We wrote $15 million in equity last month and you don't see me writing a book.

Because of the long-term nature of investing in private equity, funds can produce low or negative returns in the early years of the partnership. In the first few years management fees are drawn from partner's capital and portfolio companies are held at cost leading to an understatement of ultimate value.

Yeah, ok.  One year on our firm doesn't seem to have an issue, though we are a buyout firm, not a VC.  Neither does Carlyle High Yield Partners IV, LP, which also is a vintage 2002 fund and also has $10 million in committed capital and has somehow managed to show a 19% net IRR.

But then, success in building companies doesn't seem to be his dream.  How can I describe his dream exactly?  Oh, let's let Guy do it himself in his own words from an entry he calls "How to be a Mensch."  I don't think I could sum it up better.

But The Goal is to spend eternity in first class--specifically Singapore Airlines first class. Here your seat reclines to a completely flat position, and there's a power outlet, personal video player, wireless access to the Internet, and noise-cancelling [sic] headphones. There are also chefs, not microwave ovens.

You've got a way to go, Guy.  Your 2% management fee on $10 million is only $200,000 per year by my count.

Wait.  Did I mention he's a Stanford grad?

-ep

On Tech, Debt, Bets

The Economist this week carries an article (subscription required) on Private Equity firms, buyout firms specifically, and their renewed interest in tech and telecom.  Most importantly, in my view, the article points out the new depths within target balance sheets that buyout firms have been able to bury their equity investments.

It wasn't so long ago that debt was limited to around 3 times EBITDA for deals like this.  Today 7 times is not unheard of and one notable deal for Serena Software peaked at 11 times EBITDA, with Silver Lake Partners paying $24.00 a share to scoop up the firm.

At 11 times PE firms are banking on massive growth to pay off the debt the deal takes on in a reasonable time.

It's not surprising that Silver Lake, and co-Founder David Roux, would be so optimistic.  An investment of $874 million by Silver lake in combination with Texas Pacific Group and others in Seagate in 2000 is worth nearly $6.8 billion presently.  Silver Lake retained around 20% of the new firm.

Just to name one interested party, Silver Lake's 1999 fund had given CalPERS a 66% IRR on its $64 million investment as of August 2005.

But buyout firms have been burned on tech before.  Names like Prime Computers, Rhythm NetConnections, XO Communications are the reason no one wanted to lend on weak balance sheets.  Until recently.

One thing is certain, there are a lot of nervous private equity associates tracking the telecom and tech sectors.

Inverted

I love economic phenomenology.  Finding abnormal states and making predictive guesses based on them seems like a blast to me.

So, of course, like a good little b-school grad, I've been watching the interest rate inversion carefully.  More for the reactions of the many experts in the financial world than any real expectation that it will tell me what's about to happen.

For the uninitiated, short term interest rates (the return you'd get on say a 3 month term) are usually lower than long term rates.  This is because your money is tied up for less time and therefore there is less risk of something adverse happening.

Intuitively this should be fairly easy to follow.  There is a greater chance of some large upheaval causing problems with money you have "at risk" for 30 years than money you have "at risk" for 30 days.  Therefore, the return (interest rate) should be higher to compensate you for the risk.  The more risk I want you to take the more return you will want in compensation.  Finance 101, really.

The various returns versus time of maturity for debt make up the interest rate curve.  Presently the shape of that curve is "inverted."  That is, short term rates are actually higher than long term rates.  This is an unusual circumstance, and one that many have argued predicts a recession.

Of course, not everyone thinks so.  No less than former Fed Chairman Alan Greenspan has pooh-poohed the ability of the yield curve to do any signaling.  According to him the economy is too complex now for it to be of any use.

If you're still interested, there's more than you could ever want to know about interest curves out there.  Start with Potters, Bouchad, Cont, et. al. "Phenomenology of the Interest Rate Curve."  From the abstract:

This paper contains a phenomenological description of the whole U.S. forward rate curve (FRC), based on an data in the period 1990-1996. We find that the average FRC (measured from the spot rate) grows as the square-root of the maturity, with a prefactor which is comparable to the spot rate volatility. This suggests that forward rate market prices include a risk premium, comparable to the probable changes of the spot rate between now and maturity, which can be understood as a `Value-at-Risk' type of pricing. The instantaneous FRC however departs form a simple square-root law. The distortion is maximum around one year, and reflects the market anticipation of a local trend on the spot rate. This anticipated trend is shown to be calibrated on the past behaviour of the spot itself. We show that this is consistent with the volatility `hump' around one year found by several authors (and which we confirm). Finally, the number of independent components needed to interpret most of the FRC fluctuations is found to be small. We rationalize this by showing that the dynamical evolution of the FRC contains a stabilizing second derivative (line tension) term, which tends to suppress short scale distortions of the FRC. This shape dependent term could lead, in principle, to arbitrage. However, this arbitrage cannot be implemented in practice because of transaction costs. We suggest that the presence of transaction costs (or other market `imperfections') is crucial for model building, for a much wider class of models becomes eligible to represent reality.

If you are still hungering for more after that work you are a true bond lover.  Meanwhile, hemlines, the world series, and cardboard box sales are still probably better prediction tools.

Study Habits

After winter quarter abroad in Switzerland:
Second Year:  "Switzerland doesn't have a visa problem really.  Switzerland is just a place where they keep exchanging your large bills for smaller bills until finally you have to go home."

Inverted Again

An outstanding review of inverted rate curves (complete with very sexy animation of the curve going back to March 1977).  You have to like a financial website that has an entry prone to remind one of a flipbook.

Not sure I agree with this sentiment, however:

Inverted yield curves are rare. Never ignore them. They are always followed by economic slowdown — or outright recession — as well as lower interest rates across the board.

And I have Alan Greenspan and Wharton on my side.

The Hunt Part II (Seduction)

Somewhere in here, someone like me makes a 50 page spreadsheet that "models" the company based on the financial information I have or am able to find.  "Models."  That is, predicts the revenues, costs and profitability the firm will experience in the years to come.  Usually as many as 5-7 years to come.  Of course, this is a bit silly since if I could predict the performance of a company in the 5-7 years to come I'd just make millions in technical analysis by analyzing publicly held firms.  Still, we have to start somewhere.  We have to be able to impose our will in an educated way on the company.

Modeling is an art and a science.  A good model allows you to quickly answer questions like: "Will we be able to reduce 10% of the General and Administrative costs starting in year 2 by eliminating that Florida office and moving the people to Bufu, Indiana?"  "What if interest rates shoot up 3% in year 4?  Will the company melt down?"  Or "What happens if Hillary Clinton wins in 2008 and the economy tanks to the tune of 15% and takes our revenues along with it?"  "How much will the debt each year cost?"  "How many licks does it take to get to the tootsie roll center of a tootsie pop?"

With a model the most attention goes to something called "EBITDA."  "Earnings Before Interest Taxes Depreciation and Amortization."  This is really a complex way of saying "profits."  We ignore taxes, interest, depreciation and amortization because we want to see what the "earnings potential" of the firm is independent of these factors, all of which are in turn dependent on the structure of the firms capital and operations, which we may well change.  In other words, "all structural factors being equal, how much does this firm make compared to other firms with different capital structures, more or less debt and more or less machinery?"  EBITDA, for all its faults, is the lifeblood of the model and arguments over $500,000 in EBITDA can ruin a deal or reduce the amount of debt you can put in to the point where you lose an auction.

Based on the model we come up with a basic idea of what we think the company is worth by predicting its "free cash flow" (calculated from EBITDA) and using a "discounted cash flow" or "comparables" model to come up with a value range for the company.

Of course, since we are an LBO shop, eventually we have to find the "L" in LBO.  The debt.  That means talking to leveraged finance desks.  That means schmoozing the leveraged finance desks of a few (or many) firms in order to win their trust and (in theory) improve the interest rates you get on debt since the risk of us screwing them is lower.  I highly recommend martinis as a means to reduce "reputation risk" in this way.  Three martinis, ($60.00) can buy you 0.05% in interest which, over 7 years, is more than $1,750,000 in interest on a $500 million dollar deal.  I don't have any figures yet on what sleeping with the debt people will get you.

"L" also means, nowadays, talking to hedge funds, which are trying actively to muscle in on the leveraged finance groups in investment banks.  Dealing with the "debt guys" and occasionally "debt gals" was a job that increasingly fell to me, invariably entailing a number of "after-work" outings in Manhattan with free-flowing vodka as a central attraction.

Having fought over how much debt was a good idea (since it means less money out of our pocket, we want more, bankers and hedge funds want less) we then fight over the interest rates.

Then we fight over prepayment penalties (what we get charged if we pay it off early, which we want to do any time we can since we are probably paying interest rates near 13-15% on some of the debt and the faster we get rid of it the more money we make).

Then we fight over "covenants" (what conditions can trigger nasty letters and eventually lawsuits from our lender, like missing payments, falling short of revenue targets, selling all the furniture in the building on eBay over a quiet weekend, etc).

When all that is done we get a term sheet.  Then, if we are feeling ornery, we quietly go to another bank and ask them to beat the terms we just hammered out with the first bank.  I know.  We are big ole' meanies.  Hey, you drive around looking for a few cents off on a gallon of gas, right?

Having figured out what we think our debt will cost and how much of it we can get, we then fill the rest of our proposed purchase price with "equity."  In our context equity is short for: "Armin, you need to write a big fucking check.  Now."  Debt to Equity usually looks like around 2.5:1 to 4:1 (rarely) today.  (It was nearly 14:1 in 1987).  The higher this ratio is, the more money the buyout fund (us) makes.  So on a $500 million dollar deal we might have to kick in a check for $150 million and borrow $350 million.  Our first quarterly interest payment might be as high as $9,500,000.  That's before we even touch the principal, which we are probably mandated to do each quarter.

The sum of our debt and equity (usually we calculate this back according to what we think the company can actually pay in quarterly debt and principal or the "debt service") becomes our bid for the company.  As you will quickly see, if there is an auction, success usually goes to the party who can put the most leverage on the deal.  Of course, like a submarine you only get to see how deeply into debt you can go once.  Miss a few payments (or one if the lender is nervous enough) and it is good night.  Your $150 million check is gone and the company is in the hands of the lender.  Picking the right debt levels is a delicate balancing act between fear of losing the auction and fear of the lender foreclosing.

All through this process we query the company.  We ask for assurances that the revenue figures are correct.  We ask how much customer concentration there is.  (Would the bankruptcy of a single customer destroy 15% of revenue?  What if Hillary Clinton got into office the month after that happened?  Ouch).  We ask about lawsuits.  We ask for the color of the CEOs underwear.  Boxers or briefs?  We want to know everything and we are convinced all along that management is lying through their tightly clenched teeth to us, seeking to keep the nasty stuff hidden and pump the good stuff up to great stuff.  As to this assumption, usually, we are right.

Finally, the day comes and we submit our "bid."  A long agonizing process of review begins by the selling firm until they either announce a winner or try to convince us that "you are very close, but we'd like everyone to sharpen their pencils a bit more" and we squeeze what is probably now a mildly imprudent amount of additional debt and equity into the transaction.

Then we agonize again and then, maybe, a winner is announced.  God forbid we actually win because then we have to go into "exclusive due diligence," where we descend on the place like as many paratroopers and REALLY go through the books.  We look under every rug until we are satisfied everything is (near as we can tell) as it appears and then we work towards the closing.  The day of the closing we spray champagne around but then reality sinks in.  Now we have to run the damn thing.  Now all the little things we missed crawl out of the woodwork to haunt us.

Then we have to make that merciless quarterly debt payment every quarter.  Not a penny short.  It is like being on an episode of the Sopranos.  If you have to dip into the college fund, you dip.  Sell the factory?  Done.  Fire 25% of the workforce?  Bye!

That, with a dozen shortcuts and skipped explanations is a transaction.  Let me tell you: In practice, it is much less straightforward.  The soap-operaesque, insane drama that unfolds in one way or another in every transaction is pure madness.  And the reason I will never want to do anything else for a single day of my life.  I think.

Fly, My Pretties, Fly!

Second Year #1: "I'm totally mortgaging my future.  An MBA is beyond expensive.  I'm going to be so far in debt after next quarter.  It's scaring the piss out of me."
Second Year #2: "What's different about next quarter?"
Second Year #1: "Oh, I'm going abroad to Italy for winter quarter."
Second Year #2: "Yeah?"
Second Year #1: "Yeah, I'm just going to ski the entire time.  I heard from the class who went last year that the workload is a serious joke."

At Least They Were Warm

Armin spends a lot of time entertaining on the Estate.  I suppose I would too if I owned such a place.  I don't know exactly what it cost but getting curious one night and looking at similar acreage and nearby zip codes on some online high-end realtors websites, well, let's just say he better be focused on getting a return when that much capital is in play.  Not to mention that getting a return on an asset like that is about more than what you expect to sell it for later in life, or what rent you are collecting from tenants (and so far as I could tell the only Tenant Armin had was me).

At first I was a little creeped out.  I had a whole room to myself.  Well, almost a wing really.  I didn't even see the Manhattan office for three weeks.  Eventually, however, I woke up and realized that I was actually lamenting the fact that I wasn't sitting in an office 90 hours a week.  That wasn't normal.

As this had all gone before, I was quite happy to be present for the various dinners Armin hosted.

This particular evening we were hosting the CEO and majority owner of a middle market company, a fast-talking mid-40something guy you just knew worked his way up from nearly a lifetime in sales.  The CTO of the firm, who was so thin and frail looking that I was afraid the breeze in the outer hall might blow him gingerly away and out into the cold night.  I think he said 20 words in the entire evening.  His 15 year old daughter, a black-eyeliner, black dyed, bob haircut goth, who somehow had been talked into bringing her violin to play for everyone.  The CTO's wife, a nervous looking fret of a mother who constantly worried after her daughter's every move and tried to engage anyone who would listen into a barely contained, frantic sounding conversation about child development.  With her for a mother, I'd be a goth too.  And their lawyer, a corpulent, bearded pig who spent the majority of the evening name dropping names I didn't recognize (neither did Armin).  I never discovered if he was their personal lawyer or the general counsel.  I doubt he was particularly effective in either role.

After dinner we retired to the front room and sat around the fireplace to listen to the goth girl play violin.  I sank into one of the deep armchairs in the far corner.  She began to play- she was quite good, and coaxed out some very difficult classical pieces.  I closed my eyes, tilted my head gingerly back as the three glasses of red wine were beginning to take deeper effect.

In the middle of what must have been a Mozart piece I opened my eyes for some reason and saw the CEO, CTO and the lawyer all sitting against the far wall and suddenly realized they were all wearing slightly different colors of the same knit Mr. Rogers sweater.  I immediately began to sink into a spasm of uncontrollable laughter which I had to suppress by imitating sneezing.  It was entirely unrealistic sneezing, so I tried to play it off as if I had aspirated wine, converting my crude snarfing into coughing.  This wine thing was hard to substantiate, as my wine glass was sitting, empty, in the other room on the dining room table.  Everyone looked at me, including the goth girl, who, to her credit, kept playing.

I shook my head as if to indicate I was alright and finally stifled the laughter.  I could barely contain myself.  I was in the middle of a gothic violin recital for a fucking Mr. Rogers convention.

We didn't buy the company.