Modeling Start

Without the runway or cameras

To effectively evaluate opportunities, I need to understand financial terms and at the least basic modeling. Having never taken a finance, accounting, or a similar course, it can seem somewhat like a foreign language. I was discussing this on a recent ride in the car with my oldest son. He asked the obvious, simple question, why do people use different names for the same concepts. Explaining that nuance is why those that go deep into specific a subject end up with new words that seem like a foreign language at first. To solve this problem, I began taking courses on the internet. Almost all of this kind of material can be learned for free if one spends the time looking and sorting through the vast array of materials. That said, it is probably quicker to pay and go through materials in order.

So far, I have gone through two free courses on the Corporate Finance Institute (CFI), and they are excellent quality. I may pay for a year of access ~$500 to take a few that are behind the paywall. I have also gone through some other materials from other sites as well. My goal here is to get familiar with the terms enough to evaluate opportunities, and to get a basic model built that I understand fully. I have no desire to become a financial analyst.

List of courses I have taken so far:

• CFI Reading Financial Statements

• CFI Excel Fundamentals - Formulas for Finance

• Multiple Expansion Easy LBO

• Multiple Expansion LBO with Model

That said, I signed up for Live Oak Bank’s office hours with Lisa Forrest, and attended both sessions to understand what the banks require. She also provided me with materials, including a basic model for a leveraged buyout. Using this model, I evaluated an online service business I had requested additional information about, which I received after I signed the NDA. Below is the model results summary.

What was is not shown in this summary is my owner compensation, which I selected for this model result to be $200K. The results here require interpretation, but as can be seen in the debt service credit ratio (DSCR) graph, Live Oak Bank requires a 1.5, and this business does not achieve that level. Even though this business is brining in considerable EBITDA, the ~4.5x EBITDA multiple for purchase price is too high. Using an 90% debt financing will make this dangerously leveraged. Moreover, the revenue has been declining, and thus if I project it will continue to decline at this rate it would be even harder to service the debt in future years. Without going into more details, I do not believe my skill set would enable this business to go from decline to incline. So, I informed the broker I was passing on this opportunity.

My experience with modeling’s usefulness goes back two decades. Most of what I was involved with modeling however was with radars and/or missiles, so not all that relevant to financial modeling. That said, here are some quotes I find relevant for modeling:

“All models are wrong, but some are useful” George E. P. Box

“ The purpose of models is not to fit the data but to sharpen the questions” Karlin Samuel

“Any mental activity is easy if it need not take reality into account” Marcel Proust