Diluted Shares Outstanding In A DCF

“I’m confused about how shares outstanding work in a DCF.  When calculating the fully diluted shares outstanding using the Treasury Stock Method, we need the current share price.  But shouldn’t we use the “intrinsic share price” obtained from the DCF to calculate diluted shares?

I realize this would create a circular reference because the DCF depends on the diluted shares outstanding, but the diluted shares outstanding depend on the share price in the DCF.

Can you clarify?”

Inquisitor:

You’re talking about 2 separate issues here - what a company actually costs to acquire and what a DCF tells you it’s worth.

When you calculate a company’s fully diluted shares at a given share price, you take the basic shares outstanding and factor in the dilution from options (and warrants/convertibles) at that share price.  Then you multiply that number by the share price to get the company’s fully dluted market cap.

A DCF, or any other valuation technique like public comps or M&A comps, is used to tell you what a company should be worth, not what it would actually cost to acquire it today.

In other words, you would never use the implied per share value from a DCF to determine how much it would cost to buy a company.

If you’re doing a DCF the correct way, you do get a circular reference because the per-share price output depends on the fully diluted share count - but the fully diluted share count depends on the per-share price.

To do this correctly, calculate the fully diluted shares using the Treasury Stock Method and use the per-share price in the DCF as the input for fully diluted shares, then use the fully diluted shares output as input in the DCF.  Make sure iterations are turned on in Excel (Alt T + O + C + Alt M + Alt I) and let it iterate (F9) to calculate the correct number.

Career Switch: IT To Investment Banking

“I am looking for advice on how to proceed with my career, and am hoping you might point me in the right direction.  I am currently working in the IT department of a top 5 investment bank after having graduated from a top 10 university with a Computer Science degree 2 years ago.

The IT role hasn’t met my expectations at all and I have decided I would rather go into an investment banking front-office role.

For someone with my background, can I realistically switch over?  Would recruiters look favorably upon my experience?”

Inquisitor:

Generally it is quite difficult to transition from a back-office role (IT, for example) into a front-office role at an investment bank.  Since the firms are so large you tend to get pigeonholed into one area, and no matter how much interest/aptitude you have for front-office work, your requests to transfer will usually fall on deaf ears.

As I wrote in my article on how to get a finance job with an engineering background, there are typically 2 viable options:

1. Take advantage of your quantitative background and go to a hedge fund.  They like recruiting Computer Science graduates and other quantitative majors, and your experience at a bank gives you an edge here. They understand that if you’re smart and quantitative you can pick up anything finance-related along the way.
2. Go to an MBA program and come into banking as an Associate.  The only issue is that with just the IT role at the bank on your resume, you will probably need more experience to get into business school/get into a bank afterward.

I don’t mean to discourage you, but from what I’ve seen it is just incredibly difficult to “lateral” into banking from a field that isn’t closely related (e.g. consulting).  Going outside banking to the hedge fund world or going back for an MBA are higher-probability ways of getting in, especially in a bear market.

Corporate Finance At A Fortune 500 Company

“I was wondering what you thought of Corporate Finance training programs at Fortune 500 companies, such as GE’s Financial Management Program.  Are these at all useful for breaking into investment banking?  If I have the opportunity to do something similar this summer, should I take it?”

Inquisitor:

Corporate Finance at a large company can be one path you take to get into banking, but I would recommend only doing a summer internship rather than a full 2-year program if you do not want to ultimately work at a Fortune 500 company.

Although you do learn lot and will gain a useful skillset, recruiters do not view these programs in the same way they would view experience at an investment bank, private equity firm or hedge fund.  Those 3 are all seen as more “rigorous” - in other words you work a lot more, (perhaps) learn more finance and you’ll be better-prepared for the non-existent work/life balance of investment banking.

If you don’t have or can’t get an internship in one of those 3, it is definitely better to do Corporate Finance at a Fortune 500 than to do something in a completely unrelated field.

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Typically I stay away from explaining the actual job because I think it’s more interesting to write about how to break into banking or just how high investment banker salaries are, but feel free to send in more questions on what investment bankers actually do.

Nonprofit To Private Equity

“Hi there.  For the past 5-10 years, I’ve done nonprofit work, specifically in microfinance and international development.  I’ve done a lot of consulting and due diligence work and have worked with many international governments.  I’m trying to change careers now and want to work at a boutique private equity firm focused on emerging markets.

How hard is it going to be to transition into private equity, and will my background help me at all?  I realize this is a very nontraditional career path.  Also, how critical is it to develop financial modeling skills before starting?”

Inquisitor:

You certainly have a unique background.  It’s going to be tough to break into very large private equity firms, but it sounds like you’re not interested in them anyway.  The boutique PE firms you are targeting will definitely be your best bet, although you will still face an uphill battle.

The biggest issues will be your lack of financial experience and not being used to the lifestyle/environment at PE firms, so you should focus on how to overcome those and present a “story” that shows you can handle the hours and have studied some finance independently.

One advantage you have is your consulting background - many consultants get into private equity, so if you can spin yourself as being an “international/emerging markets consultant,” you can get your foot in the door more easily.

I don’t think they would expect you to be able to model like a bulge bracket investment banking analyst or anything, but it is important to develop some of those skills before you start interviewing because they will ask you to build models in interviews.

It’s not that difficult to learn how to build a relatively simple Leveraged Buyout Model, so you should focus on that as well as learning the necessary accounting/finance concepts (mostly how to link the 3 statements and how different items flow through the statements).

I would focus on using your alumni network and all the friends/contacts you have.  It’s probably not worth contacting headhunters for someone in your position as they’re most helpful for people with traditional backgrounds.

It’s going to take some time to get in and it will be an uphill battle with your background, but I would continue to focus your efforts on networking and developing a “story” that proves you can handle the work and know enough about finance to jump straight into the job.

For more on interviewing, networking and resumes, check out my posts on getting an investment banking job, networking into investment banking and private equity resumes.

Much of the advice in those posts applies to any job in financial services.

Good luck!

What Do Accounting Firm Do?

“I’m interested in M&A/advisory work after I graduate.  I’m curious to understand what roles the auditing firm (PricewaterhouseCoopers, Ernst & Young and Deloitte), the investment banks, and the strategy consulting firms (McKinsey, Boston Consulting Group and Bain) play in M&A work.  Who does the valuations, negotiations and integration work?  Is it spread out among the three or does each one compete for different parts?  I’ve talked to people on all sides and they give conflicting reports.”

Inquisitor:

Generally here is how it works for a sellside M&A deal:

1. The investment bank will do the upfront marketing work and prepare sales documents for the company, contact buyers and set up management meetings.  They will also do some valuation work to set price expectations.
2. The bank will conduct an auction process with multiple rounds of bids until the buyer is finalized.
3. As each buyer moves further into the process, they will bring on board accountants, lawyers and consulting firms to do diligence on the seller and look at the seller’s accounting, legal issues, market dynamics and pretty much anything else of interest.  Audit/accounting firms will be involved with due diligence and verifying that the seller’s financial statements are accurate.
4. The bank and the law firms involved will negotiate the purchase agreement with the buyer and seller.  Generally the accounting and consulting firms are not involved with this at all, it’s really just the investment bank and the law firm.
5. After the parties reach agreement and the deal gets done, the accounting firms will again get involved in deciding how to allocate the purchase price and perhaps with some of the financial integration work.

The likes of PwC would never be involved with the negotiations or the marketing/positioning of a company.  Even with valuations, they just allocate the purchase price and value intangibles like customer relationships, patents and intellectual property rather than valuing the whole company like bankers do.

The only exception occurs when an accounting firm is hired as the financial adviser on the deal.  Most of the big accounting firms have financial advisory practices, and in that capacity they act as the M&A bankers on the deal.  However, they are not as well-known or well-developed as the bulge brackets‘ M&A divisions.

Startup Business Development Internship vs. Marketing Internship

“I’m debating between two opportunities this summer, and I’m wondering which one will ultimately look better on a resume for applying to banking jobs next year.  My two choices are to either do Marketing / Public Relations for a large, blue-chip company and handle advertising and working with a sales executive, or to go do business development for a tech startup.  The blue-chip one sounds more prestigious, but the business development one could give me even better experience.  Which do you think I should do?”

Inquisitor:

I think it really depends on what the Business Development internship will offer you - specifically what you’ll be doing on a daily basis.

If it’s just going to be assisting the other people and you won’t learn much about making deals happen or evaluating partnerships/acquisition opportunities, I would go with the big company marketing opportunity.

However, if you do get a great deal of responsibility it would be better to just go with the startup.

From an interviewing / banking resume selection perspective, seeing the title “Business Development” in your work experience to me implies that you did something much closer to banking compared to a Marketing/Public Relations type role.

However, many startups are poorly managed and are not great learning opportunities.  Others, by contrast, are fantastic environments in which you can grow and develop, so it’s critical to do some diligence of your own and figure out what category this one falls under.

I would lean toward doing the Business Development internship because it is more similar to a banking job, but I would ask a lot of questions first and establish exactly what your role will be, because it’s often vague at startups.

If you get the hint that it’s poorly managed or you’ll just be doing menial tasks, go with the marketing internship.

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-Hicks Musings, The Leveraged Sellout

One common question I’ve been getting lately goes something like this:

“Inquisitor, I just started as a freshman at Harvard.  I am majoring in economics and finance and I’m in the stock market club, the investment banking club, and I even borrowed $500,000 of my Dad’s money to invest in my personal accounts.  So far I’ve earned a 50% return in 6 months.

How can I make sure that I work at Blackstone by the time I’m 25?“

Another variant of this same question:

“I am only doing investment banking so that I can pay off all my student loans in 2 years, but I have no interest in ever doing it again.  What are the exit opportunities like for Associates at boutique banks who want to get into hedge funds?”

For those breaking into investment banking, the exit opportunities are always a big motivation.

It makes sense on paper: you go from working 90-100 hours a week and doing mindless work to working 60 hours a week and doing meaningful work 100% of the time, right?  Right?

The Hours

Lifestyle is a common reason for switching from investment banking into private equity or hedge funds.  Specifically, people assume that they will actually be able to have lives for once rather than sitting in front of a computer for 18 hours a day.

Private Equity Hours

If you go to a large private equity firm, like Blackstone, KKR, TPG or Bain, this assumption is false.  You will be working banking hours for another 2-3 years - bet you can’t wait for that.

I’m amazed at how many people don’t realize this until they get to interviews with these places or until (gasp) they actually start working there.

If you go to a smaller PE or growth equity firm like Summit Partners or TA Associates, then you won’t be working 100 hours a week.  But you will still be doing 60-70 - significantly more than a normal job - and on top of that you will have to travel quite a bit, so forget about a consistent schedule.

And when a deal heats up and you’re close to acquiring a company, your hours may remind you of what it was like to be an investment banking analyst: weekend work and sleeping under your desk for a few nights each week.

Hedge Fund Hours

Hedge funds tend to be better than private equity in terms of consistent schedules.  You work market hours, and weekend work is not required unless you work at a PE-like fund that acquires companies.

However, some travel can still be required for doing “channel checks” (e.g., checking to make sure that the toy retailer you’re acquiring still has Wii stockpiles even in its Minnesota office).

And if you’re at a West Coast hedge fund, you now get to wake up at 5 AM every day so that you’re at work before the market opens on the East Coast.

Bottom Line

Some exit opportunities can indeed offer a better lifestyle, but you’ll never be working 40 hours a week in any of these industries.  And you’ll almost always have a difficult time getting a consistent lifestyle with anything in finance.

Before diving into your next job, figure out what the lifestyle is really like so that you aren’t surprised by the mandatory weekly visits to the Yukon Territory in the middle of winter while doing diligence on an oil company.

The Pay

Yes, private equity and hedge fund pay tends to be higher than those investment banking salaries you always hear about… but that’s not the whole story.

Private Equity Pay

At private equity firms, you will make about as much per year as post-MBA Associates at banks make (e.g. significantly more than you made as an Analyst).  At smaller places and growth equity firms, the difference in pay is not as huge, but it does tend to be higher than banking at the equivalent levels.  At bigger places, it can be much higher than entry-level banking Associates; some even guarantee $500,000 or so per year.

However, the pay difference is much greater at the Managing Director/Partner level than it is at the more junior levels of private equity and investment banks.

So it would not be rational to want to switch into private equity solely because of higher pay, unless you are a very senior hire.

Hedge Fund Pay

Hedge fund pay can vary wildly between different funds.  The standard seems to be a base salary of $100,000 for those coming in directly from banking, plus a bonus that will take you to the $200,000 - $300,000 total compensation level (very similar to private equity Associates).

This is much higher than what you could get as a 3rd year investment banking analyst, and is about on par with what post-MBA Associates at investment banks make.

Depending on the fund, their performance, and your performance, the bonus could be significantly more or less than this; if you have really bad luck, you might just get nothing as the fund collapses before your eyes! (ok, this is unlikely)  And if you do really well, you might make closer to $500,000 total.  That scenario is unlikely except for the largest funds.

However, as with private equity pay, there is a significantly greater difference at the Partner level, where top hedge fund managers can pull in over $1 billion in cash per year.  That is more than private equity Partners make and far, far more than even the CEO of Goldman Sachs made last year.

It should also be noted that hedge fund managers making $1 billion are exceptions rather than the norm and most managers don’t make anything close to that, though in general they still make more than investment banking Managing Directors.

Exceptions Apply

One exception to all these salary figures is prop trading and certain small hedge funds / prop trading firms that could potentially pay you an unlimited bonus.  I know of at least one place that actually pays you 50% of what you earn from trading, and there are several recent college graduates earning millions of dollars per year there.

But most people going into buyside jobs are not going to suddenly be earning millions of dollars at age 24.  Your salary will almost certainly increase, but the really substantial increases over investment banking salaries come at the more senior levels.

The Work Itself

This is where people have some of the most incorrect ideas about private equity and hedge fund jobs.

Yes, there is a lot of stupid grunt work in investment banking that everyone hates doing… changing periods and commas in presentations, editing text in documents 500 times… formatting PowerPoint graphs.

The amount of stupid work you do certainly decreases when you move onto private equity or hedge fund jobs.

But guess what?

If you don’t like Excel or you think analyzing companies, doing valuations, or modeling are boring, you’re not going to like the buyside very much.

The work is just not that different.

You still do financial modeling… you still do diligence, and you still have to do some annoying grunt work.  When private equity firms acquire companies and work with banks, for example, the Associate will be tasked with writing “bid letters” and working with banks on financing, which can often require a lot of number scrubbing and attention to detail.

Sourcing

Not only is the work fairly similar to what you do in investment banking, there is also a new type of work that most people despise: sourcing.

“Sourcing” is a euphemism for cold-calling.  This is more prevalent at growth equity places (Summit is notorious for making its Associates cold-call companies all day) than at large private equity firms.

It may sound impressive at first to say that you’re in charge of bringing in deals.  You may even think to make it part of your private equity resume.

But actually, you’re just in charge of cold-calling; the Partner still owns the deal, even if you “sourced it.”  Some private equity firms do pay their Associates a bonus for closing deals they generated, but it’s paltry compared to what the Partners will make off it.

Managing Directors in finance source deals via their long-standing relationships and through regular communication with prospects.  They don’t cold-call every company on the Inc. 5000 list until someone says, “yes.”

You, by contrast, will be doing this, or at least some form of it.  And it’s one of the most common reasons why people don’t go into private equity or at least avoid the firms with a “sourcing model.”

The Social Aspect

This is one of the most overlooked aspects of investment banking vs. buyside jobs.  With banking, you have a group of other Analysts working alongside you and you chat with them in your downtime, go to Starbucks together and enjoy models and bottles with them outside work.  It’s almost like living in a dorm in college all over again.

With buyside jobs, this disappears.

You might be the only Associate; you might even be the only person under 30 in your office, depending on the firm.

Private equity firms and hedge funds tend to be much smaller than banks and don’t have as much of a need for an army of Analysts and Associates to do work… there simply isn’t as much work to be done.

This may sound less significant than the other factors I list above, but don’t underestimate it.

I actually know of some 2nd and 3rd year Analysts who were reluctant to leave for this very reason - yes, the pay and upside might be better, but not having any close friends in the workplace can make for a bad experience.

The Bottom Line

I don’t agree with those who think investment banking is only a stepping stone to working in private equity or at a hedge fund.

Doing the job only because you think those options are going to be completely different experiences is a bit absurd.  They’ll be better in some ways, but they can also be worse in some respects as well.  No one in banking ever yelled at you for not cold-calling enough companies.

If you want to work in private equity or at a hedge fund, it’s better to go there directly; if that is not possible, just do banking for a year and switch over (harder to do now with the market downturn).

But What About Venture Capital And Other Jobs?

I know someone is going to bring this up unless I discuss it here.

Venture capital and corporate development jobs can indeed offer a significantly better lifestyle than either private equity or hedge funds.

However, you will likely take a pay cut compared to what you were making as an investment banking analyst.  You could actually be as senior as a VP in banking and make less than a 3rd year Analyst!

Plus, you still have the issue of the work not being that much different and the social aspects referenced above.

Don’t get me wrong: if you want to still have a good salary and a much better lifestyle, venture capital or corporate development could be right for you.

But do recognize that, as with any other choice you make, there are tradeoffs between all these options and nothing is “the best.”

Feedback

What has your experience been with buyside jobs?  Am I off on anything here?  I’m curious to know what others think about these issues.

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