Yale School of Management

MGT 635 Introduction 1 _______________________________________________________________________

Introduction, Goals and Course Outline

DMCromwell@aol.com
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David Cromwell worked at JPMorgan & Co. for 30 years in a variety of job positions in New York and London. He retired early in 1995 and began teaching at Yale in 1996. During his years at JPMorgan, Cromwell had difficulty in holding down any given job. The Bank reassigned him to a new department almost every time he was just getting the hang of his current job. During 1966-1995, his job assignments included: Location New York New York New York New York New York London London London New York New York New York New York New York New York New York Department Credit Department Credit Department Credit Department Securities Research Corporate Research Financial Analysis Project Finance UK Banking Dept. Financial Analysis Mergers & Acquisitions Corporate Banking Training & Adult Ed. Banking Division Investment Banking JPMorgan Capital Job Function Financial Statement Analysis 1 Credit Investigations Corporate Credit Analysis Industry Securities Analyst Chemicals Credit Analyst -- Airlines & Aerospace Vice President & Unit Head -- London VP Banker Energy & Mining Projects VP & Unit Head Corporate Banking Senior Vice President -- Dept. Head Senior Vice President -- Dept. Head Group Executive UK & Industries USA SVP & Head of Corporate Training Morgan Senior Credit Officer Managing Director, Head of Research President & CEO Private Investments

Year 1966 1967 1968 1969 1970 1971 1973 1974 1978 1981 1983 1985 1986 1987 1989
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During his six years as head of JPMorgan Capital, that entity invested over $750 million in 75 companies, mainly in the USA but also in Europe, Latin America and Asia. Investments included venture capital, buyouts, turnaround situations and privatizations. Investments sold showed total gains of about $2 billion -- a return on investment (IRR) of about 32% per annum. When Cromwell arrived in late 1989, Morgan Capital reported a modest pretax profit of about $17 million. Its 1994 reported pretax profit was $625 million, about one third of JPMorgans total earnings for that year. During 1989-95, the investment portfolio grew from 50 companies worth $500 million to about 85 companies worth $3 billion. (Today, JPMorgan Partners is one of the largest private equity investors: portfolio = $30 billion.) In addition to teaching, David Cromwell remains active in the field of private equity as a private investor, an advisor to local startup companies and on the Board of Directors of several local venture companies.

War Story. Bethlehem Steel: Statement Spreading and learning to round off the small change.

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Spring 2008

Yale School of Management

MGT 635 Introduction 2 _______________________________________________________________________ Course Goals o Private equity investing is an apprenticeship business. One learns best by doing. o Successful investors require a wide variety of skills and knowledge: Ability to understand a business Industry and country knowledge Knowledge of information sources Effective research skills Ability to work with insufficient data Ability to focus on the key issues Drawing appropriate conclusions Communication & presentation skills Interpersonal and people skills Ability to organize self and others Creativity and flexible thinking Knowledge of financial markets Financial statement knowledge Ability to do financial modeling Knowledge of capital structure Knowledge of legal concepts Ability to work under pressure Negotiating and selling skills Teamwork skills, facilitation Leadership and flexibility Ability just to say, No. Sense of humor

o This course aims to provide students a chance to develop these skills and knowledge. Course Outline (See Attached Schedule Summary) The course contains both lectures and cases. Proper textbooks on the topic do not exist. 2 Actual private deals (that involved the professor) form the basis for all the cases. The first third of the course contains most of the Lectures. Lectures attempt to provide students with enough basic principles and techniques so that they can work on the cases. o Attached is a list of 27 Lectures topics. o The professor covers 15 lectures over the first five weeks of the course. Familiarity with this material enables students -- working together as teams -- to tackle complex deals. o Copies of the Lecture Notes are available in packets from the Distribution Center. The first packet is there now; the second packet will be available in about two weeks time. The Notes will enable students to spend most of their time listening to the lectures, rather than writing down what the professor says. The professor strongly recommends reading the Lecture Notes after each lecture, rather than before. o Students should buy a 3-hole binder for Lecture Notes and bring the notes to class. 3
If you find a proper textbook, please let me know. Probably because of the total lack of sentences with verbs in the passive voice, a number of former students have said that they have continued to refer to the Lecture Notes long after graduation from SOM.
2 3

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Spring 2008

Yale School of Management

MGT 635 Introduction 3 _______________________________________________________________________

Lecture Notes -- Content Summary 4

Part 1 1) Private Equity Jargon: EBITDA, pari-passu, P/E Ratio, Rule 144, vorpal blade 2) Private Equity Basics: Description, history, economics, players, risk concepts 3) Screening Deal Flow : Finding new opportunities, quick kills, the pursuit, criteria 4) Evaluation of Business Plans: Investment plays, unique strategies, secrets & lies 5) Macro Economic and Industry Analysis: Countries, industries, niches, competitors 6) Teamwork: Organization, techniques, Dos and Donts, performance evaluation 7) Financial Statement Analysis and Ratios : Definitions, key ratios, foolish traditions 8) Financial Plans: Projection models, key elements, sensitivity, standard format 9) Timing the Market: (Just say, No.) Investors folly, big egos, indexing, discipline 10) Equity Valuation: Simple math, VC jargon, IRR, tools, comparable companies Part 2 11) Custom Financial Models: Assumptions, traps, startups, getting rich and famous 12) Deal Structure: Management incentives, instruments, governance, exit alternatives 13) Writing Style for Business Proposals : Goals, standard outline, reading ease index 14) Oral Presentations: Presentation tactics, handouts, slide shows and oral deliveries 15) Evaluation of Management: Judgment art, difficulties, soft research, private eyes 16) Leveraged Buyouts: Buyout concepts, capital structure issues, credit risk analysis 17) Negotiations: Positions, interests, getting to Yes, emotion, those darn gremlins 18) Term Sheets: Investment proposals, outline of key provisions, standard examples 19) Investment Memos: Purpose, standard format, list of pro and con reasons 20) International Investing: Regions, regulations, language, culture, country & FX risks 21) Follow-On Investments: Good money after bad, down & dirty, a little poker math 22) Legal Documentation: Key issues, boilerplate, lawyers, the taxman, boring samples 23) Monitoring; Exits: Board reps, IPO, selling out, block sales, going bust gracefully 24) Common Obstacles: Insufficient research, valuation gaps and common death traps 25) Portfolio Management: Diversify, timing, rule of 20, discipline, portfolio accounting 26) Raising a Private Equity Fund: Types, finding investors, track record, key terms 27) Career Opportunities: In venture capital and the private equity investment industry

Copyright by David Cromwell. Revised January 2008.

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Spring 2008

Yale School of Management

MGT 635 Introduction 4 _______________________________________________________________________ Key Features of the Course o The professor hands out cases as we go. Major cases are rather complex and require the use of multifarious skills. Cases require knowledge and techniques students have learned in other SOM courses (or before coming to SOM.) Most of the opportunity to learn comes from working on the cases, outside of class hour s. o The cases all contain financial projection models . Via email, students will receive copies of the models in Microsoft Excel format. _______________________________________________________________________ o Investing in the equity securities of private companies typically requires many steps: Screen deal flow by reading Private Placement Memos from deal sponsors. Do macro research on economics, industry, sectors, niches and competition. Prepare and analyze financial statement projections , usually a custom model. Do equity valuation work and compare the results to similar public companies. Reach conclusions, make written and oral presentations . Negotiate the price and other terms & conditions of a deal, sign legal documents. o Except for negotiations, the first case takes each of the above steps, one step at a time. Students work in teams to learn the basics. o All the other cases require combination of all the steps. Students work in larger teams. o Major cases include early stage venture capital, leveraged buyouts and turnarounds. o The last two cases are international, cross-border investment deals. The final case is extremely complex. It requires creativity, flexible thinking and a sense of humor. o Effective teamwork is critical for the cases . Teams of 5-6 students play roles, compete or join forces with each other -- to attempt to do the deal. Teams share the heavy workload. One luckless team plays the difficult role of Management, trying to raise capital. The professor rotates the teams for each case, so that people will work with a completely different team each time , and with many members of the class. Rotation also allows the professor to balance the teams with respect to skill levels. o After each case, students receive feedback on perceived performance of both teams and individuals. Feedback includes (a) things done well and (b) things students could improve for the next time. This is how apprenticeship learning works. o The instructor will attempt to explain the key business learning points of each case. These include a variety of general business principles beyond just equity investing. There is a lot of feedback in this class.

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Spring 2008

Yale School of Management

MGT 635 Introduction 5 _______________________________________________________________________ Logistics and Other Features o This course requires a very heavy time commitment. students should allow up to 15 hour's time per week.

In addition to class time,

o Workload during the first week of the course is relatively moderate. Thereafter, the work tends to expand to fill all the available time , as major deals get underway. o Prerequisites Financial Accounting, Valuation / Corporate Finance and Options o Some working knowledge of financial statement analysis is useful, but not required. Most cases require the manipulation of detailed, company financial projections. Doing the model is not that difficult, but does require lots of practice. In addition to class lectures, optional training workshops on How to do research at SOM are available. o There is no textbook reading. o Performance on five major cases is 92% of the course grade, with 8% of the grade linked to a minor case and feedback tasks. There are no tests. No exams. Task Screening Deal Flow FSSNE HigherOne, Inc. Luck Industries, Inc. Subtotal Points 3 12 22 22 59 Major Teamwork Cases Cinemex S.A. Porco S.A. Team Reviews (5 of Them) Subtotal Points 14 22 5 41

o For the five major teamwork cases, the instructor awards half of the points based on the perceived performance of each team as a whole. Ones personal contribution to his/her teams effort -- as perceived by other members of your team -- is the other 50%. o After each case, all team members will complete a short Team Review report. This review evaluates the quality and quantity of effort contributed by each team member. Students make 3 brief comments about each of their teammates greatest strengths and 3 remarks about areas needing improvement for the next time. The professor keeps the sources of these student comments strictly confidential. The professor edits this input for detailed feedback to each person, after each case. o Judging skills, strengths and weaknesses of people is a business skill that is vital for a successful investor. If you cannot (or will not) judge performance of people, then this course is not for you.

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Yale School of Management

MGT 635 Introduction 6 _______________________________________________________________________ Logistics and Other Features (Continued)

o People who do not to do their share of the teams workload also are in the wrong class. Free Riders -- who coast along on the work of others -- get slammed by their colleagues and by the professor. Insufficient effort hurts your colleagues and limits your learning experience. Slackers end up at the very bottom of the class, or worse. The professor does give grades of less than proficient to slackers and free riders. o Quiet People -- who almost never say a word in meetings -- tend to do rather poorly. The major cases involve active discussion and debate. Talking to your colleagues is important in making a useful contribution to solving the task. If you feel you cannot or will not speak up, ever, no matter what -- then you should give this class a miss. o The professor does not permit Audit of this class , since it does not work. Much too much of the learn by doing is off-line, outside of class, in team meetings and in long negotiating sessions with other teams. o Waiting List. If you are on a waiting list to get into the course, come to class and do the homework -- until your status finally is clear. Those who turn up for class and do the work -- will receive priority when openings occur. We will keep an attendance list. (There is too much content at the front end of the course to easily catch up, later on.) o The class size limit is 36 mostly second-year students . The course will work with less than 36 people, but not with more. This large class size restricts active in-class discussions. As part compensation, there are active off-line team discussions, plus the professor has a tendency to inject side comments and feedback wherever possible. o We will set up a free Hotmail account for each student -- plus use free Microsoft Messenger and Microsoft Netmeeting software. This will allow students to chat with the professor and each other online, and to share and edit documents online. o There will be workshops for (1) How to do research -- Library, Lexis/Nexis, Bloomberg and the Internet and, if requested, on (2) How to run the Simplex model. o The professor always is looking for ways to make this class better. There will be a custom survey and an official end-course survey to collect your ideas and suggestions.

Registrar Generals Warning: This course carries a heavy workload and requires a large commitment of time. This VC Class may threaten all of your spare time and can cause serious damage to your social life.

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Spring 2008

Yale School of Management

MGT 635 Introduction 7 _______________________________________________________________________

1.

Wednesday Lectures:

JANUARY 23, 2008 Introduction, Course Goals and Outline ( See Handout) (Logistics, Heavy Workload and Other Requirements) 2. Private Equity Basics (Start, Part 1)

Assignment:
For Next Class

Read: Lecture Note 1: Private Equity Jargon

2.

Monday Lectures: Assignment:

For Next Class

JANUARY 28, 2008 2. Private Equity Basics (Continued, Part 2) 3. Screening Deal flow Screening Deal Flow
(E-mail answers before 8 AM Wednesday) Training: Macro Research (Several Dates: Optional)

3.

Wednesday Lectures: Discussion: Assignment:

JANUARY 30, 2008 4. Business Plans 5. Macro Research / Industry Analysis (Information Sources) Screening Deal Flow Read Case: Fire Security Systems of New England, Inc. FEBRUARY 4, 2008 6. Teamwork, Hints, Team Reviews FSSNE 1: Continue Macro Research

4.

Monday Lecture: Assignment:

For Next Class

5.

Wednesday Lectures: Assignment:

For Next Class

FEBRUARY 6, 2008 7. Financial Statement Analysis 8. Financial Plans & Financial Models FSSNE 2: Model -- Build High, Low and Base Cases

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Spring 2008

Yale School of Management

MGT 635 Introduction 8 _______________________________________________________________________

6.

Monday Lectures: Assignment

For Next Class

FEBRUARY 11, 2008 9. Timing the Market (Just say, No) 10. Equity Valuation Techniques FSSNE 3: Do Equity Valuation

7.

Wednesday Lecture: Discussion:

FEBRUARY 13, 2008 11. Custom Financial Models FSSNE Case Review Complete FSSNE Team Reviews (In class)

Assignment:
For Next Class

Read Case: HigherOne, Inc. (New 6-Person Teams)

8.

Monday Lecture: Breakout: Assignment:

For Next Class

FEBRUARY 18, 2008 12. Deal Structure HigherOne: Organize Team Logistics (In Class) HigherOne: Start Research, Do Financial Model

9.

Wednesday Lectures: Breakout: Assignment:

For Next Class

FEBRUARY 20, 2008 13. Writing Style for Business Proposals 14. Oral Presentations HigherOne: Team Discussions (In Class) HigherOne: Team Discussions / Make Decisions

10.

Monday Lecture: Assignment:

For Next Class

FEBRUARY 25, 2008 15. Evaluation of Management HigherOne: Prepare Presentation for Investors

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Spring 2008

Yale School of Management

MGT 635 Introduction 9 _______________________________________________________________________

11.

Wednesday Discussion: Special: Assignment:

FEBRUARY 27, 2008 Presentations to Investors HigherOne

Time: 10:00 AM-12:30 PM

Extended Class Time

Best Presentation Contest (Class Vote) Complete HigherOne Team Reviews (In Class) Read Case: Luck Industries (New Teams) MARCH 3, 2008 16. Leveraged Buyouts Luck: Team Discussions -- Logistics

12.

Monday Lecture: Assignment:

For Next Class

13.

Wednesday Discussion: Breakout: Assignment:

For Next Class

MARCH 5, 2008 HigherOne: Case Review Luck: Team Discussions (In Class) None

Midterm Exams & Spring Break: No Classes until March 24

14.

Monday Lectures: Breakout: Assignment:

For Next Class

MARCH 24, 2008 17. Negotiations 18. Terms Sheets Negotiate Deal (In Class) Luck: Team Discussions, Negotiate Deal Optional Reading: JPM Term Sheet Alternatives MARCH 26, 2008 19. Investment Memos Negotiate Deal (In Class) Luck: Prepare Presentation For Investment Committee

15.

Wednesday Lecture: Breakout: Assignment:

For Next Class

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Spring 2008

Yale School of Management

MGT 635 Introduction 10 _______________________________________________________________________

16.

Monday Discussion: Assignment:

For Next Class

March 31, 2008

Sections

Time: 10:00 AM-12:30 PM

Extended Class: 6

Investment Committee Meetings Luck Industries Luck: Negotiate Final Deal Deadline: 8 PM Tues. Night

17.

Wednesday Discussion: Assignment:

For Next Class

APRIL 2, 2008 Luck: Final Deal Description vs. Actual Results Complete Luck Team Reviews (In Class) Read Case: Cinemex (New Teams)

18.

Monday Lecture: Discussion: Assignment:

For Next Class

APRIL 7, 2008 20. International Investing Luck: Case Review Cinemex: Team Discussions

19.

Wednesday Lecture: Assignment:

For Next Class

APRIL 9, 2008 21. Follow-On Investments (Poker Math) Cinemex: Prepare Presentation For Investment Committee

20.

Monday Discussion: Assignment:

For Next Class

APRIL 14, 2008

Sections

Time: 10:00 AM-12:30 PM

Extended Class: 6

Investment Committee Meetings Cinemex Cinemex: Negotiate Final Deal Deadline: 8 PM Tuesday

21.

Wednesday Discussion: Assignment:

For Next Class

APRIL 16, 2008 Cinemex: Final Deal Description vs. Actual Deal Complete Cinemex Team Reviews (In Class) Read Case: PorcoComasas S.A. (New Teams)

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Spring 2008

Yale School of Management

MGT 635 Introduction 11 _______________________________________________________________________

22.

Monday Lectures:

APRIL 21, 2008 22. Legal Documentation 23. Monitoring Portfolio Companies, Exits

Discussion: Assignment:
For Next Class

Cinemex: Team Performance & Case Review Porco: Team Discussions

23.

Wednesday Lecture: Special: Assignment:

For Next Class

APRIL 23, 2008 24. Common Obstacles 25. Portfolio Management Try to Solve Legal Language Puzzle (In Class) Porco: Negotiate
(Search for the vorpal blade)

24.

Monday Lectures: Assignment:

For Next Class

APRIL 28, 2008 26. Raising a Private Equity Fund 27. Career Opportunities in Private Equity Porco: Prepare Presentation For Investment Committee
(Watch Out For Gremlins)

25.

Wednesday Discussion: Assignment:

For Next Class

APRIL 30, 2008

Sections

Time: 10:00 AM-12:30 PM

Extended Class: 6

Investment Committee Meetings PorcoComasas S.A. Porco: Negotiate Final Deal Deadline: 7 PM Sun.
(Cash in Solar Credits, Locate Wine Bar)

26.

Monday Discussion: Special:

May 5, 2008 Porco: Final Deal Description; Case Review Complete Porco Team Reviews (In Class) Official Course Evaluation

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Spring 2008

Yale School of Management

MGT 635 Introduction 12 _______________________________________________________________________

Final Exam Week NO EXAM

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Spring 2008