What is the virtue of a financial model?

Having been a philosophy major in college, and being a lifelong proponent of questioning the nature of things, I feel a great deal of resistance to going along with how deals are supposed to be done. Today (er, yesterday), after a seemingly interminable day of fiddling with an off-the-shelf Excel model sourced by my ever-supportive boyfriend, I found myself tapping out this email to my business partner's and my deal advisor:

We've got sort of a philosophical question. We've been working on the terminal value calculations using a model that a GSB class passed out as a template. We're a little leery of investing more into building the model because the level of detail that we could put in seems pretty astronomical (what month do stores open, what would the capex be for a 2000sq ft loc be versus a 1000sq ft, and all sorts of operating issues that aren't settled at this point and require guesswork). I guess we don't like that the accuracy of the thing depends so much on numbers that we're picking out of the air, and we are wondering if we might as well just pick the topline or bottomline number out of the air and work towards those. Sorta blunt and unnuanced, but we really like the quick calculation that you walked me through yesterday. Do you think there is any clear and present danger (so to speak) about keeping things "back-of-the-envelope" rather than doing all the modeling? Thx.


An enduring criticism I have of my business school education is that I wasn't taught how to think about a deal. I learned how to use a bunch of useful tools in analyzing aspects of a deal, but me being me, I ask: What's the virtue of having a box full of tools that I don't know when to pick up -- or put down? What's missing is the virtue of judgment: that know-how expertise that eludes all but the experienced, or what Plato called "phronesis" (practical wisdom).


So in this -- what I refer to as my business partner's and my "practicum year" -- we're learning deal judgment from a GSB friend of ours who has taken on the role of our deal advisor. His experience in banking and private equity has afforded him the opportunity to hone a fine sense of judgment about how to approach 'the deal.' Moreover, he's plainspoken, thoughtful, direct, and doesn't make us feel dumb for asking all the questions we've got. We're incredibly grateful that he's serving as our river guide.


So what's the virtue of a financial model? We don't know yet. What we do know is that, for now, it's not worth our time to guesstimate our way to an all-encompassing model computing the terminal value of a target firm. We're also not going to just pick numbers for the revenue line and the EBITDA line, as we were wont to do in our erstwhile exasperation (maybe desperation). Instead, we're going to focus on the three major categories that our deal advisor suggested in his reply:

• Average revenue per unit.  What is it now?  What should it be?
• Store level profitability. What is it now? What could it be?
• # of stores. How many today? How many new stores can/will you open?

If you build a simple model that focuses on these 3 items, and spend most of your time coming up with reasonable estimates for these, you'll be in better shape than if you spent a bunch of time building a huge valuation model.

Amen to that. What's the virtue of working with a fellow with phronesis? You get work done.

The hardest part

By now, most of my fellow grads have gone to work. My business partner and I have, too, but our days look nothing alike.

Most "day jobs" involve an eight to six (or if you're lucky, a nine to five) schedule. Be it planned or ad hoc, there is some sort of structure to the productivity within the firm, and occasional checks on how you stack up to others' expectations. There's some direction to your career too: up or out, up or stay -- there is an actual "up." In theory, it's also possible to draw the line between your day job and the rest of your life -- doing so could be as simple as putting down the Crackberry and walking slooowly away, or as complicated as managing an unforgiving workload or an overbearing boss. Most important, there's a paycheck.

Searching for the right deal means that these certainties go away. First of all, nobody knows what success will look like. Obviously success will be a deal that goes to completion, but beyond that: Will we start up a new concept from scratch? Will we become master franchisees of a foreign fried chicken joint? Will we acquire and convert (into a plausible target for resale) a rundown mid-sized donut shop chain? Will it be a small multi-unit California casual restaurant that we join and help grow into a national chain? Do we try to go the private equity route and pitch ourselves as the dynamic duo for portfolio operations in Texas? There are many roads to Damascus, as they say, and we've seriously considered each of these. There are probably others too, but we don't know which will actually get us to the destination.

The uncertainties are what make this occupation difficult. Losing the luxury of a bi-monthly direct deposit and spending down the last of my assets are symbolic of a deeper psychological inquiry into how I value myself as a business person. In this search, nobody affirms my contributions with dollars or positive reviews. I dip into an accumulated pride in my skills and judgment to keep the search engine running. The virtuous cycle of working hard and being rewarded for it has been temporarily suspended. And it's not clear when it will be reinstated, or when the search will end. It's not hard for the search to take over all my waking hours (and even those when I should be sleeping).

All the uncertainties: that's the hardest part about being a search funder.