Don't trust the Wall St rally

Don't trust the Wall St rally

Divining future profitability of the nation's financial firms tells us stock market valuations are still too high.
By Bethany McLean, Editor at Large

Up until now, all eyes have been on the losses that are hitting the financial sector from the acronym soup of new instruments such as CDOs and SIVs. Everyone is scared, and rightly so, of the MUB (Monster Under the Bed) that might be lurking in supposedly safe havens. Still, financial stocks staged a big rally on the last trading day before the weekend, and again Monday, due to the belief that the worst is past, and that the government will step in to save the Street should that MUB pop out from under the bed.
But even once the current crisis is past, there's another issue facing the financial sector: Will it look like it used to? "I think it is important to step back and ask some broader questions about our financial system," wrote Ben Inker, the chief investment officer for quantitative equities in global developed markets at money management firm GMO, in a recent paper. "What it does, how big it should be; and what its sustainable level of profitability might be."
These questions are obviously important for financial services firms. At its recent peak stock price in December 2006, Citigroup (C, Fortune 500), for instance, sold for $53.34, or over 2 times its reported book value (and over 4 times if you exclude goodwill and intangibles) and almost 13 times its reported 2006 earnings. Do those numbers represent a baseline to which we'll return when this crisis has passed, or are they anomalies?
And the size of the financial sector may also matter for the rest of the market. In a piece last summer, credit rating agency Moody's opined that the market was safe from systemic risk in part because the $45 billion in profits reported by a group of financial firms including Citi and Merrill Lynch (MER, Fortune 500) were "considerable and significantly larger than in 1998," when those same firms reported profits of $12 billion. As the events surrounding Bear Stearns show all too clearly, the market isn't safe from systemic risk. Was Moody's wrong partly because that $45 billion isn't sustainable - or wasn't real in the first place?
One way to think about this is to look at the profits of the U.S. financial sector versus GDP. Inker did this, and the result was what he describes as a "truly striking chart." From 1947 to 1997, financial profits were stable at around 0.75% of GDP. But over the last ten years, the share of GDP represented by financial profits began to shoot higher. In the last few years - before the Street began to report massive writeoffs - financial profits represented roughly 2.25% of GDP. Inker says that it is too simplistic to say that the right number should be 0.75%. But when you think about what financial profits consisted of at the height of the boom, 2.25% seems unsustainable too.
The last decade saw the explosion of securitization - the carving up and redistributing of risk - the boom in hedge funds, and the private equity mania. It's apparent now that Wall Street can't transform a sub prime mortgage into a triple A credit, and that the redistribution of risk doesn't get rid of it. Unless (or until) we forget that simple lesson, it's hard to see the securitization game being played again. As for hedge funds, some commentators, such as Pimco's Bill Gross, predict the demise of broad swaths of them. With that goes the rich profits Wall Street has earned on prime brokerage. And fees from private equity, which at the height made up huge chunks of the Street's investment banking revenues? That won't come back roaring without cheap credit.
We are going to have to create whole new ways of securitizing and funding debt of all types, but especially mortgages and consumer credit. While I have confidence that those intrepid bankers on Wall Street will figure out something, as their future bonuses depend on it, it is going to take time to replace a system that took decades to build.
You also have to consider the massive writeoffs that the Street has taken. Thus far, Citigroup has taken $32 billion in writedowns related to the subprime crisis. Merrill Lynch's writedowns have totaled $22 billion. So were Citi's 2006 profits really the reported $21.2 billion, and were Merrill's the reported $7.5 billion? Or was some percentage of that an illusion? If Bear can be sold for $2 or $10 a share, then how solid was Bear Stearns' $84 per share in reported book value?
Thought about more broadly, if commentators are right that mortgage losses alone will total $300 billion to $500 billion, then, as Inker writes, "profits that look like they have been 2.25% of GDP in the past several years have actually been more like 1.75%, if we smooth the losses over the last 3 years and into next year as rough justice." And of course, mortgage losses are only a subset of the total losses.
Think back to what Ken Lewis, the CEO of Bank of America (BAC, Fortune 500), said last fall when his company announced its first round of writedowns: "Making money for several years, only to give most of it back in one year, is not a brilliant business model."
Inker says that the data doesn't point to any firm conclusions about what the level of financial profits should be. His best guess, though, is that a "normal" level of profits would be about half the amount that the financial sector reported in 2006.
Then, you also have to think about the multiple of those earnings that investors should be willing to pay. In a paper published in the fall of 2005, risk management gurus Leslie Rahl and Barbara Lucas of Capital Markets Risk Advisors, noted that in the past decade, a lot of things have happened that aren't supposed to happen, from the interest rate hikes of 1994 to the 1998 collapse of LTCM to the 2001 terrorist attacks. Or as the authors put it, "once-in-a-lifetime events seem to occur every few years."
If that's the case and if such events now mean that Bear Stearns (BSC, Fortune 500) can go from seemingly viable to threatening to bring down the entire financial system in the space of a week - then what sort of multiple should investors pay for Bear, or for any financial firm? Maybe investors shouldn't pay 12 times earnings, and maybe they should pay a discount to, rather than a multiple of, reported book value.
Of course, trying to guess how this will play out is just that - guessing. But if you say, for instance, that Merrill's normalized profits would be half the 2006 level, you get to about $4 billion. If you think that we should be willing to pay a smaller multiple for those earnings than we did in the past - let's be generous and say 10 times - then you get to a total market value for Merrill Lynch of $40 billion. That's still a 10% discount from today's valuation.

The Time vs. Task Dilemma: Why You Could Be Working Too Much

The Time vs. Task Dilemma: Why You Could Be Working Too MuchSkellie
One of the reasons many of us choose to start a freelance business is the option of largely escaping time-based payment. If a task only takes an hour, it takes an hour. People like us get paid the same whether we fill a day with it or not.
While freelancers who’ve made efforts to escape time-based pay get some pretty neat perks, there’s a trade-off: a heightened risk of over-work.
Unless they’re being given more work than they can feasibly do in the time, 20, or 40, or 70-hour per week workers don’t necessarily need to be more productive. For project-paid freelancers, the speed with which we can fly through tasks will dictate how financially successful we are.
And there’s the rub. There’s nobody telling us to go home at the end of the day, there’s no point beyond which our work is unpaid simply because it’s late in the evening, no time when the office lights start to go out, no pre-paid hours. We complete a task, we get paid, and we can complete most tasks at any time of the day or night, on any day of the week. It’s no surprise that many freelancers are overworked. The lure of “one more project, one more invoice” can be hard to resist.
The danger of overwork is compounded because project-paid freelancers have a habit of not keeping accurate tabs on the hours we work. If you enjoy what you do, working out exactly what to track can be a puzzle. Does feed reading count as play, or work-related research? What about answering emails — not all of which are strictly business related? The work-life divide is often a blur.
The problem
The only thing standing between 80 hour weeks is either a) a lack of projects or b) will-power. If you’re feeling overworked, you’ve probably got enough clients. The only variable left is self-control: the ability to say “I’ve worked enough today,” and stop. If you don’t yet have it, how do you get it?
The first question to answer is: do I feel overworked? It’s a gut feeling you get. Not necessarily all the time, but it will rear its head occasionally, maybe at the end of a day when you’ve worked from when you woke up until when you tumbled back into bed, or when you realize that you haven’t seen your best friend in a while. The next variable is how you react to that gut feeling. It’s all too easy to say: “But I need to be working this much right now, because of this, this and that.” In other words, if we overwork now, we can relax later. That ‘relaxed later’ is usually postponed ad-infinitum. Sound familiar?
One solution
This isn’t the only solution and I don’t claim that it will work for everyone. All I can say is that it worked for me, and my freelance routine probably isn’t much different to yours (liaise with clients, do work, invoice, get paid… eventually). Even if this solution won’t work right out of the box for you, it might be made workable with a few adaptations.
The process starts with a calculation: what’s the minimum amount you need to earn in a week in order to live? In other words, to pay rent, bills, buy food and have a little extra spending money left over — let’s say, $50. That’s not your ideal income, of course, but it’s the benchmark for your absolute Minimum Weekly Income (MWI) — the amount you must make to keep your affairs in order. You should only allow yourself to overwork in order to meet your MWI.
The next calculation is your cap: your Target Weekly Income (TWI). The formula is this: your average hourly rate multiplied by the number of hours you’re willing to work. Let’s say you’ve worked out your average hourly rate to be $30 and you want to spend 30 hours a week on paid tasks. Your TWI is $900. When working out the hours you want to work each week, I’d always suggest subtracting roughly 5 hours (or 2 hours for part-timers) to account for non-paid, work-related tasks (like managing accounts, answering email and liaising with clients). In this example, the person would be working 35 hours, and get paid for 30.
If you’re not sure of your average hourly rate, take the last month’s worth of jobs (or the last two-weeks worth if your memory is as bad as mine) and divide how much you got paid for each job by roughly how many hours the job took. Then add up the average hourly incomes for each job and divide by the total number of jobs over the time period. The result is a rough estimate of how much you earned per hour of work last month.
The purpose of the TWI is to establish a ceiling: the point where you stop working or accepting new jobs, even if you haven’t reached the maximum amount of hours you want to work in a week. Sometimes you will work less than full-time hours, but this is to balance out those weeks where you have to struggle and over-work just to meet your Minimum Weekly Income. Alternately, you can keep working past your TWI until your reach your work-cap for the week, but you should claim the time back as earned vacation time, or raise your TWI if you over-earn consistently.
To show you a working model, here’s my overwork safety net:
MWI = $300 (If I have to, I’ll exceed my work-cap to meet this minimum earn).
Work-cap = 10 hours (I’m finishing a communications degree and have a lot of other projects going on — I don’t want to do more than ten hours freelancing a week).
TWI = $500 (The weekly earn I aim for — I can stop working once I reach it even if I haven’t reached my work-cap).
Average hourly rate: $50 (I work fast, and I won’t accept jobs with a lower estimated hourly rate unless my MWI is in danger).
If you feel like you’re regularly exceeding your TWI while staying within your work-cap, it’s time to raise your TWI by increments.
As you can probably guess, this model does require some rough time-keeping but your career is still defined by income rather than hours. If we’re to be honest, we can’t avoid overworking unless we define what overwork means for us.
If you want to get started now and don’t mind sharing, you’re welcome to list your MWI, Work-cap, TWI and rough hourly rate in the comments section. I’d also be interested to hear your experiences with over-work. If you’ve conquered it, what was your strategy?

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Thanks to my buddy, Thomas. He gave me this link so that my blog can have 3 columns. :)

Link

Excel finance formula

For those who are interested in Excel financial formula.

Finance Functions

Introduction

Microsoft Excel provides a series of functions destined to perform various types of financially related operations. These functions use common factors depending on the value that is being calculated.

Many of these functions deal with investments or loan financing.

The Present Value is the current value of an investment or a loan. For a savings account, a customer could pledge to make a set amount of deposit on a bank account every month. The initial value that the customer deposits or has in the account is the Present Value. The sign of the variable, when passed to a function, depends on the position of the customer. If the customer is making deposits, this value must be negative. If the customer is receiving money (lottery installment, family inheritance, etc), this value should be positive.

The Future Value is the value the loan or investment will have when the loan is paid off or when the investment is over. For a car loan, a musical instrument loan, a financed refrigerator, a boat, etc, this is usually 0 because the company that is lending the money will not take that item back (they didn't give it to the customer in the first place, they only lend him or her some money to buy the item). This means that at the end of the loan, the item (such as a car, boat, guitar, etc) belongs to the customer and it is most likely still worth something.

As described above and in reality, the Future Value is the amount the item would be worth at the end. In most, if not all, loans, it would be 0. On the other hand, if a customer is borrowing money to buy something like a car, a boat, a piano, etc, the salesperson would ask if the customer wants to put a "down payment", which is an advance of money. Then, the salesperson or loan officer can either use that down payment as the Future Value parameter or simply subtract it from the Present Value and then apply the calculation to the difference. Therefore, you can apply some type of down payment to your functions as the Future Value.

The Number Of Periods is the number of payments that make up a full cycle of a loan or an investment.

The Interest Rate is a fixed percent value applied during the life of the loan or the investment. The rate does not change during the length of the Periods.

It is very important to understand how these two arguments are passed to a function. The period could be the number of months of a year, which is 12; but it could be another length. Suppose a customer is getting a car loan that would be financed in 5 years. This is equivalent to 5 * 12 = 60 months. In the same way, a cash loan can stretch from 0 to 18 months, a carpenter truck loan can have a life financing of 40 months, and a condominium can be financed for 15 years of 12 months plus an additional 8 months; this is equivalent to (15 * 12) + 8 = 188 months. Here is the tricky part, especially as far as Microsoft Excel deals with its finance functions. If you pass the number of Periods in terms of years, such as 5 for a car loan that stretches over 5 years, then you can pass the Rate as a percentage value, such as 8.75%. If you pass the number of Periods in terms of months, for example you can pass it as 44 for a car that is financed in 3 years and 8 months, then you must communicate this to the Rate argument by dividing the Rate by 12. In other words, a Rate of 8.75% would be passed as 8.75%/12. If the Rate was typed in a cell named B2 that displays 8.75%, you can pass it as B2/12.

For deposits made in a savings account, because their payments are made monthly, the rate is divided by the number of Periods of a year, which is 12. If an investment has an interest rate set at 14.50%, the Rate would be 14.50/12 = 1.208. Because the Rate is a percentage value, its actual value must be divided by 100 before passing it to the function. For a loan of 14.50% interest rate, this would be 14.50/12 = 1.208/100 = 0.012.

The Payment is the amount the customer will be paying. For a savings account where a customer has pledged to pay a certain amount in order to save a set (goal) amount, this would be the amount the customer would pay every month. If the customer is making payments (car loan, mortgage, deposits to a savings account, etc), this value must be negative. If the customer is receiving money (lottery installment or annuity, family inheritance, etc), this value must be positive.

The Payment Type specifies whether the payment is made at the beginning or the end of the period. For a monthly payment of an item financed like a car, a boat, a guitar, or a house this could be the end of every month.

The Future Value of an Investment

To calculate the future value of an investment, you can use the FV() function. The syntax of this function is:

FV(Rate, Periods, Payment, PresentValue, PaymentType)

Practical Learning: Calculating the Future Value

1. Start a new workbook and fill up Sheet1 as follows:


2. Save it as Business
3. Double-click Sheet1 to put its label into edit mode. Type Future Value and press Enter

4. Click cell C8 and, on the main menu, click Insert -> Function...

5. In the Paste Function dialog box, in the Function Category list, click Financial. In the Function Name list, double-click FV and move the FV window so you can see the values on the worksheet

6. Click the box to the right of Rate and, on the worksheet, click cell C5 and type /12
7. In the FV window, click the box to the right of Nper and, on the worksheet, click cell C7
8. In the FV window, click the box to the right of Pmt and type -
9. On the worksheet, click cell C6
10. In the FV window, click the box to the right of Pv and type -
11. On the worksheet, click cell C4
12. Since this is a loan, the payments are expected at the end of the month. Therefore, in the FV window, click the box to the right of Type and type 0
13. Click OK


The Number of Periods of an Investment


To calculate the number of periods of an investment or a loan, you can use the NPER() function. Its syntax is:

NPER(Rate, Payment, PresentValue, FutureValue, PaymentType);


Here is an example:




Investment or Loan Payment

The PMT() function is used to calculate the regular payment of loan or an investment. Its syntax is:

PMT(Rate, NPeriods, PresentValue, FutureValue, PaymentType)

In the following example, a customer is applying for a car loan. The cost of the car will be entered in cell C4. It will be financed at a rate entered in cell C6 for a period set in cell C7. The dealer estimates that the car will have a value of $0.00 when it is paid off.

Practical Learning: Calculating the Monthly Payments of a Loan

1. Double-click Sheet3 to put it in edit mode. Type Payments Amount and press Enter


2. Complete the worksheet as follows
3. Click cell C8 and type =PMT(
4. Click cell C6 and type /12,


5. Click cell C7 and type ,-

6. Click cell C4 and type ,

7. Click cell C5

8. Type ,0) and, on the Formula Bar, click the Enter button



9. Suppose that, during the evaluation, a customer decides that she doesn't need a brand new car anymore. Also, she thinks that a 5-year car loan is too long. Furthermore, she wants to make a $4500.00 down payment to reduce the monthly payments. On the other side of the desk, the salesperson who wants to make a juicy commission on this loan has decided to increase the interest rate. Change the new values of the worksheet as follows and see the result

10. Save the workbook

The Amount Paid As Interest During a Period

When a customer is applying for a loan, an investment company must be very interested to know how much money it would collect as interest. This allows the company to know whether the loan is worth giving. Because the interest earned is related to the interest rate, a company can play with the rate (and also the length) of the loan to get a fair (?) amount.

The IPMT() function is used to calculate the amount paid as interest on a loan during a period of the lifetime of a loan or an investment. It is important to understand what this function calculates. Suppose a customer is applying for a car loan and the salesperson decides (or agrees with the customer) that the loan will be spread over 5 years (5 years * 12 months each = 60 months). The salesperson then applies a certain interest rate.

The IPMT() function can help you calculate the amount of interest that the lending institution would earn during a certain period. In essence, you can use it to know how much money the company would earn in the 3rd year, or in the 4th year, or in the 1st year. Based on this, this function has an argument called Period, which specifies the year you want to find out the interest earned in.

The syntax of the IPMT() function is:

IPMT(Rate, Period, NPeriods, PresentValue, FutureValue, PaymentType)

The Rate argument is a fixed percent value applied during the life of the loan.

The PresentValue is the current value of the loan or investment. It could be the marked value of the car, the current mortgage value of a house, or the cash amount that a bank is lending.

The FutureValue is the value the loan or investment will have when the loan is paid off.

The NPeriods is the number of periods that occur during the lifetime of the loan. For example, if a car is financed in 5 years, this value would be (5 years * 12 months each =) 60 months. When passing this argument, you must remember to pass the right amount.

The Period argument represents the payment period. For example, it could be 3 to represent the 3rd year of a 5 year loan. In this case, the IPMT() function would calculate the interest earned in the 3rd year only.

The PaymentType specifies whether the periodic (such as monthly) payment of the loan is made at the beginning (1) or at the end (1) of the period.

The FutureValue and the PaymentType arguments are not required.

Practical Learning: Calculating the Monthly Payments of a Loan

1. To add a new worksheet, on the main menu, click Insert -> Worksheet

2. Double-click the new Sheet1 tab to put it in edit mode. Type Periodic Interest Earned and press Enter

3. Move the new worksheet to be the most right
4. Complete the worksheet as follows

5. Click cell C9 and type =IPMT(

6. Click cell C5 and type /12,
7. Click cell C6 and type ,
8. Click cell C7 and type ,-
9. Click cell C4 and type ,
10. Click cell C8 and type ,
11. Type ,0) and, on the Formula Bar, click the Enter button
12. Save the workbook

The Amount Paid as Principal

While the IPMT() function calculates the amount paid as interest for a period of a loan or an investment, the PPMT() function calculates the actual amount that applies to the balance of the loan. This is referred to as the principal. Its syntax is:

PPMT(Rate, Period, NPeriods, PresentValue, FutureValue, PaymentType)

The arguments are the same as described in the previous sections.

Practical Learning: Evaluating the Amount Paid As Principal

1. Change the Periodic Interest Earned worksheet as follows

2. Click cell C10 and type =PPMT(

3. Click cell C5 and type /12,

4. Click cell C6 and type ,

5. Click cell C7 and type ,-

6. Click cell C4 and type ,

7. Click cell C8 and type ,

8. Type ,0) and, on the Formula Bar, click the Enter button

9. Save the workbook

The Present Value of a Loan or an Investment

The PV() function calculates the total amount that a future investment is worth currently. Its syntax is:

PV(Rate, NPeriods, Payment, FutureValue, PaymentType)

The arguments are the same as described earlier.

The Interest Rate

Suppose a customer comes to a car dealer and wants to buy a car. The salesperson would first present the available cars to the customer so the customer can decide what car he likes. After this process and during the evaluation, the sales person may tell the customer that the monthly payments would be $384.48. The customer may then say, "Wooooh, I can't afford that, man". Then the salesperson would ask, "What type of monthly payment suits you". From now on, both would continue the discussion. Since the salesperson still wants to make some money but without losing the customer because of a high monthly payment, the salesperson would need to find a reasonable rate that can accommodate an affordable monthly payment for the customer.

The RATE() function is used to calculate the interest applied on a loan or an investment. Its syntax is:

RATE(NPeriods, Payment, PresentValue, FutureValue, PaymentType, Guess)

All of the arguments are the same as described for the other functions, except for the Guess. This argument allows you to give some type of guess for a rate. This argument is not required. If you omit it, its value is assumed to be 10.

Practical Learning: Calculating the Interest Rate

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Interest Rate and press Enter
3. Move the new worksheet to be the most right
4. Change the Interest Rate worksheet as follows

5. Click cell C8 and type =-RATE(
6. Click cell C7 and type ,
7. Click cell C6 and type ,-
8. Click cell C4 and type ,
9. Click cell C5 and type ,0)*12 and, on the Formula Bar, click the Enter button
10. To use the ABS() function, change the function in cell C14 to =ABS(RATE(C7,C6,-C4, C5, 0)*12) and press Enter
11. Save the workbook

The Internal Rate of Return

The IRR() function is used to calculate an internal rate of return based on a series of investments. Its syntax is:

IRR(Values, Guess)

The Values argument is a series (also called an array or a collection) of cash amounts that a customer has made on an investment. For example, a customer could make monthly deposits in a savings or credit union account. Another customer could be running a business and receiving different amounts of money as the business is flowing (or losing money). The cash flows don't have to be the same at different intervals but they should (or must) occur at regular intervals such as weekly (amount cut from a paycheck), bi-weekly (401k directly cut from paycheck), monthly (regular investment), or yearly (income).

The Values argument must be passed as a collection of values, such as a range of selected cells, and not an amount. Otherwise you would receive an error.

The Guess parameter is an estimate interest rate of return of the investment.

Practical Learning: Calculating the Internal Rate of Return

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Internal Rate of Return and press Enter
3. Move the new worksheet to be the most right
4. Change the worksheet as follows

5. Click cell D12 and type =IRR(
6. Select cells D4:D10 and, on the Formula Bar, click the Enter button
7. In cell D11, type 12 and click cell D12
8. In the Formula Bar, change the function to =IRR(D4:D10, D11) and press Enter (you shouldn't need any significant difference unless you change the range of cells such as D4:D8)
9. Save the workbook

The Net Present Value

The NPV() function uses a series of cash flows to calculate the present value of an investment. Its syntax is:

NPV(Rate, Value1, Value2, ...)

The Rate parameter is the rate of discount during one period of the investment.

As the NPV() function doesn't take a fixed number of arguments, you can add a series of values as Value1, Value2, etc. These are regularly made payments for each period involved. Because this function uses a series of payments, any payment made in the past should have a positive value (because it was made already). Any future payment should have a negative value (because it has not been made yet).

Practical Learning: Calculating the Net Present Value

1. To add a new worksheet, on the main menu, click Insert -> Worksheet

2. Double-click the new Sheet1 tab to put it in edit mode. Type Net Present Value and press Enter

3. Move the new worksheet to be the most right

4. Change the worksheet as follows

5. Click cell C14 and type =-NPV(

6. Click cell C13 and type ,

7. Select cells C4:C12 and, on the Formula Bar, click the Enter button

8. To use the ABS() function, change the function in cell C14 to =ABS(NPV(C13,C4:C12)) and press Enter

9. Save the workbook

How to create Gannt chart

In the event that you do not have MS Project, there is this person who is able to create Gannt chart from Excel! See the tricks below!

Buyout

By: Paul B. Brown (http://www.inc.com/magazine/20010601/22698.html)

Valuations are down, investment capital is abundant, and skilled, seasoned managers are scarce. There's never been a better time to buy the business you work for.
Suppose, for a minute, that Rick Rickertsen is right.

Sure, he has an agenda. He's a partner at a private-equity investment firm, and he makes his money by keeping a steady flow of deals coming his way. Every management buyout Rickertsen's firm invests in yields up to 1% of the sale price up front plus an ongoing management fee that can top $150,000 a year. In addition, the firm earns an expected annualized return of 30% to 35% on its stake in the business when the company eventually gets resold three to five years down the line. So Rickertsen wants deal flow. Heck, he readily admits that's one of the reasons he wrote Buyout: The Insider's Guide to Buying Your Own Company, recently published by Amacom. He'd probably be happy if you were to read the book and give his firm a call. (Rickertsen is chief operating officer of Thayer Capital Partners, in Washington, D.C.) So when it comes to whether or not managers buy their companies, he's far from neutral.
Still, Rickertsen's self-interest doesn't prevent him from being a good guide to the buyout marketplace. He certainly has the credentials: Stanford University undergrad, Harvard Business School, and a stint at Morgan Stanley. And he has the experience. He's led more than 50 management buyouts. Plus, he's even spent some time with early-stage venture-capital firms and has been chairman of several companies in Thayer Capital's portfolio. He's looked at deals from all kinds of perspectives.

So suppose Rickertsen is right. Suppose there really never has been a better time to buy the company you work for. Should you do it?
Rickertsen certainly thinks the timing's right. Here's why.

There is a huge amount of money available to help you finance your purchase. Spurred by the stellar returns of early buyout firms, the money people on Wall Street have been rushing for much of the past decade to create buyout funds. Back in 1989 there were half a dozen buyout funds that had $1 billion or more to invest. A decade later there were nearly 40, says Rickertsen. He estimates that today there are about 500 buyout firms with a total of $150 billion to invest. The main goal in life of these firms is to back management teams that want to do buyouts. And when you figure that banks will lend at least $2 for every $1 of equity that is put into a deal, that means there is nearly $300 billion out there waiting for you . (For a step-by-step look at how the buyout process works, see "Buyouts by the Numbers," below.) Not even the Nasdaq crash has hurt the pot, since the two main consequences of the decline have tended to cancel each other out. Yes, the big institutions that put money into buyout funds may have less to invest because of damaged portfolios, but the reduced investment appeal of publicly traded companies has prompted those same institutions to consider investing their resources elsewhere -- which is to say, possibly on you.

If you buy the company you work for, there are inherent advantages.
The message Rickertsen wants you to take away from all this: it has never been easier to find money for this type of deal.

Investors need you. While money isn't a problem, Rickertsen contends that finding management talent is. There are just not enough senior managers to run all the companies that could be funded by private-equity deals. Thus, the laws of supply and demand come to the fore. Before management-buyout (MBO) funds became all the rage, managers who were involved in the buyout of the company they worked for might have ended up with a 10% equity interest in the business. Today 17% is the norm, and the figure can go as high as 22%, depending on how much work you're willing to do up front before the deal is done. So, says Rickertsen, from the perspective of the would-be management team, the deals are as good as they've ever been.

Prices are falling. The Nasdaq's troubles and the looming recession may not have diminished the money available for buyout deals, but they have slashed the prices people are willing to pay for businesses. You, the salaried manager, may be willing to overpay for the chance to run your own company, but the buyout firms are not. Paying less makes it easier for them to generate the returns they require. Every deal is different, but Rickertsen says that this general observation is true: before the slowdown, companies were selling at 7 to 7.5 times cash flow. Today they're going for multiples of 6 to 6.5.

The upshot of all those factors is that it's a terrific time to buy. Lower prices mean that not only will buyers have to pay less, but they won't have to borrow as much. If Rickertsen's valuation numbers are right, the amount of debt needed to finance a buyout is about 20% less than it was a year ago.

Of course, there are the inherent advantages you bring to the table if you're buying the company you already work for. You know the business, so there is no learning curve. Better, you know what fat can be chopped with a minimum amount of pain. In an in-house deal, secrecy is more assured. The owner may not want it known that he or she is shopping the company, and selling to managers makes it less likely that the news will slip out. And, finally, you can do the deal in less time than an outsider could -- four months would not be out of the question.
So the case for buying is compelling. But so are the potential problems -- for both you and the company you are acquiring.

Let's start with you. Despite what the money people will tell you, you will have to jump through a significant number of hoops before you will be able to get the funding you need. The buyout firm will examine your track record to see if you and the deal you want to do are a good fit. You'll have to have profit-and-loss responsibility, a tangible record of success, and a decade of experience before someone from the buyout firm will be willing to return your call.
Equally important, buyers can't overreach. "If you had been running a $20- million company before, you shouldn't look at anything larger than $40 million," says Rickertsen. "Anything smaller is always going to be fine." And buyers need industry experience. If you've been running a finance division, you aren't going to be able to buy a retailer, unless you bring in someone with significant retail experience as part of the deal.

If you're not talking turkey after three meetings, give up. You only have a tire kicker.
Of course, if you're buying the company you work for, you probably already have the right experience. And if everything works out, you'll likely end up with a 10% to 20% interest in the deal, consisting of stock or stock options that usually vest over four years.
The question, of course, is, Will that equity be worth anything to you? The company you're about to lead is taking on potentially crushing debt. And you're trading your current boss for another one -- the buyout firm that provided you with the money. And if you think your current boss is tough, you haven't met an unhappy equity partner.

Many managers have never had to meet with a board of directors, Rickertsen says. When they participate in an MBO, they have to get used to board meetings -- and to the fact that there won't be a lot of room for error. "If you miss your plan by 20% for two consecutive quarters, we are going to have some very hard discussions," Rickertsen says with classic understatement. You serve at the behest of the board, he explains. "They normally can fire you anytime."
And, of course, the buyout firm controls the board. "At the end of the day, it's all about the numbers," Rickertsen says. "The buyout guys like me are fiduciaries; we're pension-fund fiduciaries investing for sophisticated institutions, and we've got a job to do on behalf of those institutions. We need to do the best we can with their money."
Rickertsen says firms like his are willing to work with you when things are bad. But you need to know going in where their loyalties lie.

OK, but a 10% or 20% interest in your current company is a lot more than you have now. And you're used to pressure, right?

When the company is the boss's baby If you still think you're the kind of manager who's ready for an MBO, then consider the last variable: who's doing the selling. Things get a little different when the owner is a founder, Rickertsen says. To explore those differences in depth, we talked to Rickertsen specifically about what happens when a company's creator sells the business to his own managers.

Inc.: How different is it doing an MBO when the seller is a founder?
Rickertsen: Very. If you're a potential buyer, you need to recognize that the boss holds all the cards. So you've got to be very careful. At best, as soon as there's a whiff of disloyalty, you've put yourself into a penalty box that you may not be able to get out of. At worst, you'll get fired the moment the boss learns something is up. That's the risk of trying to bring it up.

Inc.: So if I'm a potential buyer, what do I do?
Rickertsen: You have two options. The first, which may or may not work, is to plant the seed early. You tell the entrepreneur casually that if he or she is ever thinking of selling, you would be interested in buying. That way the owner won't be shocked later on. In the interim, you make yourself as important as possible. That way you increase your leverage over time.

Inc.: How does an owner react to the planting of a seed?
Rickertsen: An owner might say something like "Well, I'm not a seller now. Let's just keep building the business." But sometimes the response is: "At this point in my career, I don't want to sell, and if you want to get on the team, get on the team. If you don't want to be on the team, get off the team. I just can't have a buyout clouding our strategy."

Inc.: Is there a way around that?
Rickertsen: Yes. You don't make the approach yourself. You find a buyout firm to make the call to see if the owner wants to sell. Owners get calls like that all the time. That way it's much easier. There's no question about your loyalty, because the owner doesn't know -- or isn't sure -- it's coming from you.

Inc.: Is there any way of telling how an owner might react when that call comes from "out of the blue"?
Rickertsen: Sort of. Owners are always in one of three places: They're not sellers under any circumstance right now; that's where most of them are. Or they're tire kickers. They'll talk to everybody who wants to buy their company, but they still really are not sellers. They just like taking meetings and getting a handle on what the business is worth. There are lots of tire kickers. And then there are real sellers. One of the most interesting things about being a buyout person is figuring out who is a tire kicker and who's serious, because you can waste colossal man-years on tire kickers.

Inc.: Is there a tip-off?
Rickertsen: If you're not talking real turkey after three meetings, give up. You have to give them that long for a couple of reasons. First, you almost never talk money right away, and second, for founders, the company is their baby. It's their whole life. It is never easy for them to sell, even if you offer them a screamingly high price. So you're never going to get very far until the third meeting. But if after the third meeting they're not ready to show you their financials, you only have a tire kicker.

Inc.: OK, suppose he's a serious seller, and he learns that the management team -- his management team -- is the potential buyer. How does everyone deal with the inherent conflicts, especially about valuation and about how the company will be run during the negotiations?
Rickertsen: Let's take the owner's position first. There are a lot of potential problems. Not only does he probably want the highest price while the buyers want to pay the lowest, but the buyers -- his managers -- are in a position to truly hurt the company. They can harm the business if they don't stay. They can sabotage relationships. There have been situations where the manager-buyers intentionally didn't perform as well, in order to get the price down. So you as the manager have an obligation to your employer to behave well.
I think the two best ways to mitigate those conflicts are: Number one, just put them on the table. Talk about them. The second way is for the seller to bring in a professional to make sure the sale is managed fairly. Part of that means finding out if there are other potential buyers. The owner may have no intention of selling to anyone else, but it keeps the management team honest and on track. If the managers are the only potential buyers, and if they turn out to be bad actors, they may hold an owner hostage. They can threaten -- directly or otherwise -- to do all kinds of damage if their price isn't met.

That's why as a founder you hire someone to run the process for you, and you start talking to other potential buyers even if your goal is to sell to management. The move puts the management team on notice that if they get too far off the reservation, the company is going to get sold to some other strategic party and they may lose their jobs.
If you are negotiating one-on-one as the owner, the risks are too great. There's the price conflict, the employee-performance conflict, and the employee risk in general. Your risks as a founder are too great, because you're turning too much leverage over to your employees. That's why I'm a big advocate of having a real process.

Inc.: I understand the idea of bringing in other potential bidders, but how receptive are owners to turning over control of the process to someone else, especially when it comes to valuation?
Rickertsen: Not very. Some 90% of the owners in this country begin with the position "My company is the best company in the world. And despite what the comparables show, my company should sell at twice the industry norm." Entrepreneurs who live in that world -- and stay in that world -- don't ever get their companies sold. I understand their position. They built the company from scratch. It's their baby, and no parents have ever thought they had an average baby, let alone an ugly one.
If you're negotiating one-on-one as the owner, the risks are too great.

Still, the entrepreneur needs some level of objectivity, and that's where the professional comes in. If you ever do want to get your company sold, you need to acknowledge that there is a market determining what companies trade for. If you don't, then you can't complain that you can't sell your company.

Inc.: What do I do as a manager-buyer if it looks as if the owner may actually sell to another company?
Rickertsen: If it's all about price, strategic buyers always win, period. They can always take out costs from a seller's income statement, which means they can show more profit, which means they can pay a higher price. In that situation, the management team is always going to lose.
Inc.: I've got no shot?
Rickertsen: You should compete with the outside buyer. You should sell the owner on what you can do for the company and what continuity will do for the company and for the employees. You should be as aggressive on price as you can. But at the end of the day, if a strategic buyer wants it, you're just not going to own it.

Inc.: Do owners want to sell to management?
Rickertsen: A lot of them are inclined to do it to preserve their legacy. They like the idea that the company will continue as is. It can be a very satisfying way to exit.

Inc.: How often do owners give the management team a break on price? Even if they want to, don't they always have family members and advisers telling them to go for the highest possible payoff?
Rickertsen: Obviously, it's the owner's call. The owner has lived with those people [the management team], and the advisers haven't. If the owner wants to do a deal at the low end of the market to sell the company to the employees, then that's a great thing for the employees. But again, the owner needs to know what the company is worth. As an owner, you hire a professional who comes in, runs the comparables, and says, "Companies like yours trade at 1.5 to 2 times revenue. And that makes your business worth between $7.5 million and $10 million."

If you wanted to sell the company to your employees for $7.5 million, that would be supportable, and it would be good for the employees.

If you go that route, you keep the continuity and all those soft feelings that we talked about before, and the company doesn't get absorbed into some massive bureaucracy. But you want to make sure your employees can get this done; don't even think about selling the company to them unless you believe they can get it done. So you help them. You introduce them to three buyout firms, and you give them a six-week lead before entertaining other offers.

That way you've created a good dynamic, because you've given your employees a proprietary shot. But they're on notice that if they screw it up and the deal doesn't get done, the company gets sold to somebody else. It creates consternation in the organization on one hand, but on the other you've given them a proprietary shot. That's fair.

Inc.: Does that happen a lot?
Rickertsen: It's one way it happens. The other is that the owner basically says: "Look, I built this business. I own all the equity. I deserve the biggest payday possible." And really, the best way to get the biggest payday is to conduct an auction.
If it goes that route, two things can happen. Option one: there is an auction, and the employees never get involved because the owner is worried about all those conflicts we talked about before. But if the founders don't let the managers bid, they almost always pay a bonus to the employees from the proceeds when the company gets sold. The number depends on the size of the company, but it usually works out to be about 5% for sales up to $20 million, a lesser percentage as the price tag goes up. By doing that, owners keep everybody on the reservation while they're going through a tough process. It's not only nice; it's smart business.

The second option is, the owner sells the business through a process but gives the employees an equal -- not a proprietary -- shot, and they run around and try to make a deal happen. In those circumstances, what I've often seen is that if the employees show up with an offer that's within 10% of the high bid, the owner will often sell them the company. If they're much more than 10% lower than the high bidder, they usually don't get it.

Inc.: One reason owners might sell to their managers at a discount is that they don't want to sell to some real or imagined enemy, right?
Rickertsen: Absolutely. But there is a flip side to that. The owner says: "I've run this business for 20 years, and I've done OK. I sell it to my employees. It does three times as well as OK. The only variable is, I'm not running the business. I don't think I want to be in that position." All parents want their children to do better than they have. And then when they do, the parents feel really uncomfortable.

It can happen. The way to protect yourself [as the owner] is to ask for "home-run warrants." You sell the company to your team, and say: "Look, I'm selling you this thing for $7.5 million. I want you to be successful. But I want a warrant that says if you guys sell it for more than $12 million, I get 15% of the proceeds [over $12 million]." That protects you on the back end.

Inc.: What happens if the management group bids and loses?
Rickertsen: They need to be prepared for that going in. You must be prepared to lose. Be gracious about it, but don't be stupid. Ask for a fee at the time of the sale. You helped build the company, and you should get something.

Inc.: How long does the whole process take?
Rickertsen: Normally, 120 to 180 days. Some deals drag on for up to a year if they're very large and complex.

Inc.: What is a common mistake that owners make during the process?
Rickertsen: There are two. First, they wait too long. Sell when things are going very well. Buyers need to believe that they can make money on the deal. A lot of owners sell after the cycle has crested, and they just hurt themselves, because the buyer knows the company is past its peak. Buyers are never dumb. And they'll see that you are trying to sell during a downturn. The result? You'll get four times cash flow, rather than the six you would have gotten a year ago when things still looked pretty good.

The second mistake is, the owner doesn't have a strong succession plan. If you're the owner, you're just going to hurt yourself, because the buyers are going to pay a lower price -- my price goes down by 30% -- to reflect the fact that your leaving represents a massive business risk.
So it's really important to think about it in advance. Be strategic. Put in a good succession plan and all the necessary systems [complete with financial reports]. And sell when there's still some money on the table, because that's when you're going to get the best price.

Inc.: If managers had a piece of the action to begin with, would management buyouts become extinct?
Rickertsen: Absolutely. If America were smarter about how it compensated its executives, you would find much less management-buyout activity. And you'd find that companies would have greater profits and would perform better.
Paul B. Brown is the author or coauthor of 10 books and editor-in-chief of DirectAdvice.com.

The Practice Formerly Known as ...
Management buyout?

If you're thinking that the process used to be described as a leveraged buyout (LBO), you're absolutely right.
Before we talk about why the name changed, let's first make sure we all agree about what we are talking about.
Here's the way Rick Rickertsen of Thayer Capital describes this type of deal: "Management buyouts (MBOs) are acquisitions of operating companies or corporate units in which the current or future senior management of the business participates as a significant equity partner in the acquisition."

As for the name change, blame Michael Milken. The term LBO has fallen from favor in an attempt to make people forget the excesses of the 1980s, when corporate raiders floated junk bonds to buy out companies -- a concept that Milken honed to perfection at Drexel Burnham Lambert -- and greedy financial types got a bad name for showing up at the aptly named Predators' Ball, where the raiders celebrated the fleecing of all they had come in contact with.

As Rickertsen writes in his book, Buyout: The Insider's Guide to Buying Your Own Company, "The term LBO is no longer used in the industry, or in polite company."
Say What?
Here are some terms that buyout firms frequently use and translations of what those terms actually mean, according to Rick Rickertsen.

What the buyout firm says
What the buyout firm means
Basically on plan
There is a revenue shortfall of 25%
Considerably ahead of plan
We hit plan in one of the last three months
Entrepreneurial CEO
The CEO is totally uncontrollable, bordering on maniacal
Ingredients are there
Given two years, we might find a workable strategy
Long selling cycle
We haven't found a customer who likes the product
Niche strategy
Small-time player
Turnaround opportunity
Lost cause
We're working closely with management
We talk to them on the phone once a month
Buyouts by the Numbers
A step-by-step primer on how a management buyout is done
There's no such thing as a typical deal, but here's how most management buyouts (MBOs) should work, according to buyout veteran Rick Rickertsen. (Note: What follows is a "straight vanilla" deal. There are infinite variations, including ESOPs -- employee stock ownership plans.)

Step 1: Be confident. "You can't have any doubts," says Rickertsen. "If you have doubts about embarking on a buyout, you just shouldn't do it." What can go wrong during Step 1? The flip side to not wanting a deal enough is wanting it too much. If, say, you're willing to pay too high a price or want to buy something that's twice as large as anything you've ever run, you won't get funding.

Step 2: Find or create an opportunity. Identify how the company can make more money. What can go wrong during Step 2? You can look too far afield. If you're working for a manufacturing company and you're thinking of buying one of the companies that sells your product, "that is going off-spec," Rickertsen says. "Retail is a different business."

Step 3: Develop a sound business plan. "You want to be aggressive," Rickertsen says. But you also have to develop a plan that's achievable and credible. If your industry is growing at 7% a year, say, and you claim that you're going to increase your sales by 30%, you're telling the world that you're planning to take market share away from other companies -- "and that is very difficult," says Rickertsen. How you structure the business plan is crucial. Rickertsen's tips:
The executive summary is key. You always suspected that if you didn't hook people on page one, you were doomed. You were right.
Research is key, too. Your description of the market needs to be better than any other summary that investors can find on their own.
Don't exaggerate. Never say you have little or no competition. Says Rickertsen: "The phrase means that either you're too dumb to recognize that you have competitors, or you believe the investor who's reading the business plan is too dumb to know better."
What can go wrong during Step 3? A buyout firm is going to hold you to your forecast. As Rickertsen puts it, "If you don't make plan, you're toast."

Step 4: Strike an agreement with the seller. In most cases, you want to avoid doing the negotiations yourself, Rickertsen says, since the process can be very emotionally charged. It's always helpful to have a "bad guy" around, like an accountant or a lawyer, who can negotiate on your behalf. As for what you offer in the deal, Rickertsen has some interesting thoughts: "You come in one dollar above insulting. Everyone has to negotiate," he says. "When I started out in the buyout business, [I figured it would go like this]: 'You want to sell me your company? Here's my deal: $7 million. If you don't want to do that, forget it.' I don't like to haggle. "What I learned is that everyone wants to negotiate. Everyone wants to win something. So you always come in lower than where you want to end up," he says. Say that a company is up for sale and the owner gets comparables indicating that it could go for anywhere between $7 million and $10 million. The investor offers between $6 million and $9 million. "I would probably come in at $6,375,000, for two reasons. One, because it's not insulting. And two, because it looks scientific," he says. What can go wrong during Step 4? The parties involved in the deal can let their emotions carry the day. For instance, the owner could hear the comparables and say something like "Hogwash. Those may be other companies, but mine is special." The potential buyers, on the other hand, sometimes become so smitten with the thought of buying the company that they're willing to pay too high a price.

Step 5: Strike a deal with an equity investor. If the deal closes, the cost of doing the MBO -- including the accounting and legal fees and the money paid to the buyout firm and banks -- usually comes to 3% to 5% of the sale price, which is added on top. That means that in a $50-million MBO you have an additional $1.5 million to $2.5 million to pay off. (If the deal falls through, the buyout firm traditionally eats most of the costs.) Plus, in a deal of that size, the buyout firm might take a $150,000-a-year management fee. What would the buyer and new CEO get? Fifteen percent of the company is the middle of the range these days, and it could come in the form of stock or stock options that usually vest over four years. Managers could get a bigger piece if they put up some of their own money. Buyout firms like Rickertsen's generally insist that they do. "It's really important for me that you have some skin in the game. It doesn't have to be a ton, but it has to be something that's meaningful to you," says Rickertsen. "Some managers can cut a check for $250,000 to $500,000. For managers who don't have a lot of liquidity, we ask them for $15,000. Some buyout firms like it to hurt. They want you to be very leveraged and very focused. We don't believe that's the right answer, because managers may be prone to taking short-term draconian actions that may impact the company longer term. But I want you to write a check, to show that you're there alongside me." What can go wrong during

Step 5? Even after writing the check, you'll have a minority interest in the company. The board, which will be handpicked by the buyout firm, will control everything, from the decision about when the company will be sold -- within three to five years -- to whether you'll keep your job. Buyers need to think of the deal they make with their equity partners as a marriage, and they need to be candid with one another up front, Rickertsen says. If your equity partners don't tell you up front what the conditions are under which they might make a management change, ask them. There probably won't be a lot of negotiating room there, but you can do some things to protect yourself. Rickertsen suggests being very specific by saying something like "If you fire me in the first year, 25% of my equity should vest." And a year's salary as severance is not out of the question. As part of such discussions, spend a lot of time on exit strategies. The buyout firm will want to be out of your business within five years, but you may not want to be. If you pick the wrong buyout firm, you can be in for a lot of unpleasant surprises. Don't shortchange this step.

Step 6: Arrange bank financing. From the buyer's viewpoint, this is the easiest part of the process. You don't do anything. The buyout firm has a list of banks it works with, and it does the deal. What can go wrong during Step 6? "There's a real credit crunch going on," Rickertsen says. "The banks have been burned in some large buyouts. They lost a lot of money in the telecom and dot-com worlds. So banks have been pulling back aggressively since about October. Today you can only borrow 2.5 to 3 times cash flow. Before the crunch, you could have gotten 4 or 4.5. That means you have to be tougher on price, and your partners need to be prepared to put in more equity."

Step 7: Complete the due diligence. What can go wrong during Step 7? Contracts with key customers that you thought were bulletproof aren't. There are expenses that haven't been accrued. You might find litigation bombshells.

Step 8: Close the deal. What can go wrong during Step 8? Says Rickertsen: "In 30% to 40% of cases, you have an 11th-hour heart attack."
Step 9: Build the company. What can go wrong during Step 9? In the venture-capital world, out of every 10 deals, "2 are screaming home runs, 3 flame out, and 5 are the walking wounded where you'll probably get your money back," Rickertsen says. "With private-equity deals, which involve later-stage companies that already have income statements and balance sheets, you probably have one to two deals that flame out. You have one that's a big home run because all of the stars lined up in a way that you could never have anticipated. And then you have six or seven moderately successful companies generating 15% to 25% returns on invested capital."

My first posting

I was on the way back today sitting in the train. Suddenly thought that how relaxing it would be going to New Zealand with my honey...

Alas, that will be for year end... Hope it will come soon!