1. MIDDLENOMICS BUSINESS MODEL HAS BEEN VOIDED DUE TO A RECENT DECISION BY THE SUPREME
COURT TO NOT GRANT GENERAL BUSINESS METHOD PATENTS. IF THE BUSINESS MODEL WAS TESTED
AND SUCCESSFUL, IT WOULD BE IMMEDIATELY COPIED BY GOLDMAN SACHS, MORGAN STANLEY AND
EVERY OTHER INVESTMENT BANK. THIS BUSINESS PLAN IS FOR INFORMATIONAL PURPOSES ONLY.
2. 2
SECTION TABLE OF CONTENTS PAGE #
1 Executive Summary 3
2 Executive Summary: Venture Capital Software 4
3 Market Size 5
4 Net Margin 7
5 Market Share 7
6 Value Added 8
7 Effects on Middle Market Companies 9
8 Patent 9
9 The Process 10
10 Valuation 12
11 Patent Valuation 13
12 VCS: Ratio Valuation 14
13 VCS: DCF Valuation 15
14 Pro Forma VCS Financial Summary 17
15 Pro Forma Six Year Financial Summary 21
16 ROI, IRR & NPV 21
17 NASDAQ: Requirements for Listing 22
18 Software Market 23
19 Competitive Advantage 23
3. 3
1. Executive Summary
Middlenomics will package middle market companies too small to go public into securities. It will combine equity
in multiple middle market companies into single holding companies and conduct IPOs. The first deal is projected to
provide 44x ROI in two years (565% IRR) assuming an initial investment of 4m. Other deals are projected to provide
an average of between 3.3x ROI in two years (82% IRR) and 13.3x ROI in two years (264% IRR) depending on pricing
power. Initial pricing power could be overestimated depending on the behavior of competitors.
MARKET SIZE
The market size will depend largely on the success of the first IPO. If middle market companies are valued at a
premium when packaged together and sold to the public, the majority of middle market companies will likely use
the innovation as their preferred exit option. The total US middle market (companies with revenues between five
million and one billion) capitalization was 4.2 trillion in 2007 – the last economic census. In 2010, there were
10,700 M&A deals totaling roughly 694b. 48% of middle market companies are owned by private equity by
valuation. The global market is estimated to be between 52b and 208b depending on pricing power.
NET MARGIN First Deal Small Cap – Market Average Valuation (1x Sales)
Market Cap $ 1,000,000,000 $ 300,000,000 $ 300,000,000 $ 300,000,000
Pricing Power 20% 20% 10% 5%
Net Margin 74% 70% 64% 53%
VALUE ADDED
Traditional venture capitalists will be the Middlenomics closest substitute and best customer. Ratio and DCF are
the primary valuation models used for both private and public companies. Middle market companies generally sell
for three to five times earnings. The stock market values companies at an average of 14x earnings. Venture
capitalists discount future cash flows at a rate of 20%-80%. Stock market analysts discount future cash flows at an
average of 5%. The resulting difference in value is around 200%. Middle market companies may be able to sell
equity for about three times as much to the public then venture capitalists.
PRICING POWER
Middlenomics assumes it can take between 5% and 20% equity in holding companies. It is closest to a SPAC
(Special Purpose Acquisition Company). SPAC managers take 20% equity from public investors then purchase
private companies. Middlenomics will take 20% equity from private companies then conduct IPOs. Middle market
business brokers generally charge between 5% and 12% of the sale price, depending on the size of the business.
Underwriters charge an average 7% of IPOs. Middlenomics will attempt to take 20% in its first deal and the market
will determine the rate after that.
POSSIBLE PATENT
Middlenomics will employ a new business process. Business processes are patentable. However, a patent is not
certain due to the evolving nature of business process patent law. A provisional patent had been filed. The process
is new, nonobvious and useful, therefore satisfying the requirement for an application. A patent would not be
granted for three to five years.
4. 4
2. Executive Summary: Venture Capital Software
Middlenomics first deal will be a software company called Venture Capital Software (VCS). It will start
with a software company because software companies have the highest valuation ratios, therefore
maximizing the value of the IPO and returns to shareholders.
Within public software companies, certain size companies have better valuations than others. Large and
mid cap software companies (>2b) are too large to be realistic. Small cap (300m-2b) software companies
have better ratios than micro cap (<300m) software companies. Small cap software companies have an
average price to sales ratio of 4.0 and an average price to earnings ratio of 65.1. Micro cap software
companies have an average price to sales ratio of 1.7 and an average price to earnings ratio of 23.7. To
maximize shareholder returns, VCS will be a small cap stock.
Also important to the value of the IPO is the venture capital characteristic. Venture capitalists have had
an average 27% rate of return before fees over the past 15 years (Cambridge Associates US VC Index).
The Russell 2000 has had an average rate of return of 6.25% over the same time period. The risks
associated with middle market investing are reduced when pooling companies into funds.
The (whole) stock market average price to sales ratio is one and the average price to earnings ratio is 14.
Although software companies are valued at premiums to the market, VCS will attempt to acquire equity
in companies totaling 300m in trailing twelve months revenue to ensure it is considered a small cap
stock.
Assuming a 1b public holding company value (the lowest valuation model (DCF)) and 20% equity, the
potential returns vastly exceed the average private equity home run rate of an 81% IRR. The following
tables represent VCS ROI and IRR (pre-tax).
ROI Time 0 Year 1 Year 2 IRR Time 0 Year 1 Year 2
44 $ (4,000,000) $ - $ 177,000,000 565% $ (4,000,000) $ - $ 177,000,000
5. 5
3. Market Size
Middlenomics will service middle market (revenues between 5m and 1b) companies wishing to sell. It is
estimated that private equity owns 48% of middle market businesses by valuation.
According to data compiled by Baird and Dealogic, in 2010 there were 5,300 merger and acquisition
deals totaling 347b in the US. An additional 5,400 deals were listed as undisclosed. For the purpose of
projections, the 347b will be doubled to 694b. 2010 is the latest data available. It is safe to assume M&A
has increased in 2011. Middlenomics projects 25% (174b) of middle market companies wishing to sell
will use packaged securities. However, the actual percentage will largely depend on the success of the
initial IPO.
As of the last economic census (2007),
there were 369,122 middle market
companies. Of these, only 1,200 were
public companies. The total middle
market capitalization was 4.2 trillion.
The majority of middle market
companies had revenues of less than
100m. 174,000 companies had revenues
of between 5m and 10m. 156,000
companies had revenues of between 10m and 50m. 21,000 companies had revenues of between 50m
and 100m. The “lower middle market” can be defined as companies with less than 100m in revenues.
This segment represented over 95% of middle market companies and generally sells for 3-5x earnings.
Accurate worldwide middle market statistics do not exist. However, worldwide stock markets can be
used as a proxy. The size of the worldwide stock market is around 45t. The size of the US stock market is
about 15t. Although international stock markets are about twice the size of the US stock market,
Middlenomics market is not three times the size of the US market. The exchange rates of many
emerging economies such as India, China, and Brazil would cut into revenues and margins. However, the
economies representing the majority of worldwide stock markets such as most of Europe, Japan, and
Hong Kong are suitable for the securitization of packaged middle market companies. Conservatively
estimated, the worldwide market is twice the size of the US market.
The projected US market is 20% (projected pricing power) of 174b or 35b. Middle Market companies
generally sell for 3-5x earnings. The stock market values companies at an average of 14x earnings.
Pricing Power 5% 10% 15% 20%
US Middle Market Cos. Wanting to Sell 9b 17b 26b 35b
Worldwide Middle Market Cos. Wanting to Sell 17b 35b 52b 69b
US Market Size 26b 52b 78b 104b
Worldwide Market Size 52b 104b 156b 208b
75%
25%
Traditional M&A
Market
Therefore, the market
size projections are at a
200% premium to middle
market companies
wanting to sell.
6. 6
The competition will be investment banks and private equity firms. Both have employees capable of
packaging middle market companies into securities. Competitors do not require 13.3x ROI in two years.
They may drive down the price
to their required rate of return.
For a deal with private equity
characteristics, competitors
require about 1.5x ROI in two
years or 2%-3% equity in
packaged securities. However,
pricing power will be mostly
determined by the customer.
The customer will likely keep ROI
at 3.3+ (5% Equity).
Middle market companies will
likely select the service provider
that offers them the most
money for their equity. In other
words, they will select providers
based on their potential stock
price minus fees. A stock can
easily move five percent in a
single day. Middle market
companies will give up more
equity in exchange for a higher
stock price. This factor will likely
keep the packaged securities
cost at 5%-20% equity.
Investment banks introduced
and manage SPACs. Under the
SPAC business model,
investment banks take 20%
equity in a publically traded
fund. Competition has not
brought down the price of
SPACs.
0%
5%
10%
15%
20%
25%
Year 1 Year 2 Year 3 Year 4 Year 5
Pricing Power
20%
80%
0%
20%
40%
60%
80%
100%
Equity
SPACs
Public
SPAC Managers
208b 208b
52b 52b 52b
$-
$50,000,000,000
$100,000,000,000
$150,000,000,000
$200,000,000,000
$250,000,000,000
Year 1 Year 2 Year 3 Year 4 Year 5
Worldwide Market Size
7. 7
4. Net Margin
VCS Small Cap – Market Average Valuation (1x Sales)
Market Cap $ 1,000,000,000 $ 300,000,000 $ 300,000,000 $ 300,000,000
Pricing Power 20% 20% 10% 5%
Revenue $ 200,000,000 $ 60,000,000 $ 30,000,000 $ 15,000,000
Expenses $ 4,000,000 $ 4,000,000 $ 4,000,000 $ 4,000,000
Bonuses $ 23,000,000 $ 6,900,000 $ 3,450,000 $ 1,725,000
EBT $ 173,000,000 $ 49,100,000 $ 22,550,000 $ 9,275,000
Earnings $ 147,050,000 $ 41,735,000 $ 19,167,500 $ 7,883,750
Net Margin 74% 70% 64% 53%
All expenses are incurred prior to the recognition of any revenue. Revenue comes in one payment (the
IPO). Bonuses are incurred during the IPO and account for 11.5% or revenue. Net margins assume a 15%
capital gains tax rate. The tax rate can be decreased from 35% to 15% by keeping stock in holding
companies for one year or more.
5. Market Share
Market Size 10% Market Share 5% Market Share
Worldwide 52b 5.2b 2.6b
US 26b 2.6b 1.3b
* Figures assume 5% pricing power
2.6b
49.4b
5% Worldwide Market Share Middlenomics will have the
ability to obtain 5% market
share in year six with no
additional capital. Middlenomics
will need 4m for every two year
deal. Assuming VCS projections
are accurate; Middlenomics will
have the ability to launch 44
new deals in year three and 146
deals in year five. The 146 deals
will total 2.2b in revenue and
represent roughly 5% of the
projected market.
8. 8
6. Value Added
Venture capitalists sometimes use the DCF valuation model. They usually use discount rates of 20%-
80%.
The following table is an example of a VC DCF approach to valuing a company. The example is based on
a VC discount rate of 27% (VC average return - Cambridge Associates VC Index over Past 15 Years). The
example assumes the company will last 10 years, have year one cash flows of $10,000,000, and grow
20% per year.
NPV Year 1 Year 2 Year 3 Year 4 Year 5
$ 61,821,289 $ 10,000,000 $ 12,000,000 $ 14,400,000 $ 17,280,000 $ 20,736,000
Year 6 Year 7 Year 8 Year 9 Year 10
$ 24,883,200 $ 29,859,840 $ 35,831,808 $ 42,998,170 $ 51,597,804
The following table illustrates the DCF value of the same example using a VCS 5.15% discount rate
(discussed in section 11: VCS: DCF Valuation on page 12). The stock market average discount rate is 5%.
NPV Year 1 Year 2 Year 3 Year 4 Year 5
$ 185,004,080 $ 10,000,000 $ 12,000,000 $ 14,400,000 $ 17,280,000 $ 20,736,000
Year 6 Year 7 Year 8 Year 9 Year 10
$ 24,883,200 $ 29,859,840 $ 35,831,808 $ 42,998,170 $ 51,597,804
Middle market company owners can likely sell their equity for about 200% more to the public than a VC.
$ Difference $ 123,182,791
% Difference 199%
9. 9
7. Effects on Middle Market Companies
1) Diversify Investment
Middle market company owners will be able to diversify their investment from one
company into 20% equity in their subsidiary and equity in a holding company.
2) Gain Liquidity
The equity in holding companies will be liquid. Stockholders will be able sell shares on a
public exchange.
8. Patent
- The United States Patent and Trademark Office
Patent Must be a: Middlenomics
Process
Machine
Article of Manufacture
Composition of Matter
Patent Must be:
New
Nonobvious
Useful
Subsidiary
20%
Equity in
Holding
Company
Subsidiary
100%
A provisional patent has been filed.
The innovation has a chance to
possess a 17 year sustainable
competitive advantage with a
patent. A patent would not be
granted until year three to five.
Business process patent law is not
clear and is likely to change by the
time of the patent hearing in three
to five years. A patent valuation is
on page 13.
10. 10
9. The Process
Step Time Table Action
1 1st
– 3rd
Months File Non Provisional Patent Application
2 1st
– 3rd
Months Hire Employees
3 4th
– 15th
Months Find and Value Middle Market Companies and Distribute Equity
4 13th
– 15th
Months Hire Conglomerate Managers
5 16th
– 24th
Months Road Show
6 24th
Month Initial Public Offering
1) File Non Provisional Patent Application
A patent application will be filed before introducing the business model to the market.
2) Hire Employees
Headhunters will be hired to find Middlenomics first 17 employees.
1 Primary Underwriter
1 Founder
2 Lawyers
2 Accountants
2 Assistants
10 Analysts
The primary underwriter will manage the IPO process. If successful, the primary
underwriter will earn 10.5m+ in two years. He or she will be paid $250,000 per year and
own one percent in VCS. He or she will aid in finding and valuing middle market
companies and run the road show and IPO. The primary underwriter will have a large
impact on the value of the IPO. It is important to find an extremely qualified primary
underwriter.
Lawyers will manage the transfer of equity from middle market companies to holding
companies. Accountants will consolidate the financials. Assistants will help the founder
and primary underwriter manage the company. Analysts will find and value middle
market companies. All employees are given equity in VCS as a bonus structure.
3) Find and Value Middle Market Companies and Distribute Equity
Middle market software companies will be found in part through the Software and
Information Industry Association, which publishes monthly software funding requests.
The valuation of each company will determine its ownership in VCS. It will attempt to
acquire equity in companies with as much revenue as possible to minimize valuation
costs. However, VCS will have at least 10 subsidiaries to mitigate the risks inherent in
middle market companies.
11. 11
Under US law, a holding company must own at least 80% of its subsidiaries to qualify for
consolidated financials and avoid double taxation. Therefore, VCS will own 80% of all its
subsidiaries. The remaining 20% may remain with the original shareholders. This
ownership structure will act as an incentive for management to continue to maximize
shareholder value in each company.
4) Hire Conglomerate Mangers
VCS will be managed as a conglomerate. Conglomerate managers will be similar to
venture capital fund managers. They will let some companies fail while re-investing in
other companies growth. They will remove subsidiary managers and hire subsidiary
managers to benefit VCS shareholders. Conglomerate managers will be chosen by the
board of directors which will be made of subsidiary owners. VCS subsidiaries will fund
conglomerate managers.
5) Road Show
The road show creates interest in VCS. It involves presentations by underwriters to
potential buyers. The road show will involve 10-50 underwriters. The primary
underwriter will manage this process. He or she will network with other underwriters to
create as much interest as possible. Stock in VCS will be sold to banks and funds prior to
the IPO in order to determine the offering price. This process generally takes three to
nine months. Underwriters take an average of 7% of the IPO in commission. The primary
underwriter is already being paid by VCS. Other underwriters commissions will be paid
by VCS subsidiaries.
6) Initial Public Offering
VCS will sell shares to the public through the NASDAQ Stock Exchange. Subsidiaries
seeking capital for growth and shareholders wanting to sell their equity will sell stock
through the IPO. The NASDAQ was chosen as opposed to the NYSE because most
technology companies are listed on the NASDAQ. Because VCS will be a software
company, it is likely to be worth the most money on the NASDAQ.
12. 12
10. Valuation
Estimations of the Middlenomics value are not accurate due to an unknown market size, market share
and pricing power. 5% pricing power is used for the purpose of valuation projections.
Market Share 5% 10% 15% 20% 25% 50% 75% 100%
Market Size 52b 52b 52b 52b 52b 52b 52b 52b
Net Margin 53% 53% 53% 53% 53% 53% 53% 53%
DCF Value 55b 109b 164b 219b 273b 547b 820b 1.093t
DCF valuations assume:
* 2.5% growth rate (inflation)
* 5% discount rate
* 15% Capital Gains Tax
* The business is assumed to last in perpetuity
Patent Time Value
Pending < 3-5 Years % of Patent & Market Share in Perpetuity
Denied > 3-5 Years Dependent Upon Market Share
Approved > 3-5 Years Patent – 1.958t & Market Share in Perpetuity
109b
37b
22b
16b 12b 10b 8b
$0
$20,000,000,000
$40,000,000,000
$60,000,000,000
$80,000,000,000
$100,000,000,000
$120,000,000,000
5% 10% 15% 20% 25% 30% 35%
10% Market Share Valuation at Different Discount Rates
NPV
14. 14
12. VCS: Ratio Valuation
Because young software companies often have sporadic earnings, the price to sales ratio is the best
metric used for valuation.
Two pure public venture capital firms exist in the US (KKR & CSWC). Both measure sales as dividends
plus interest leaving a price to sales ratio unreliable. Gains on sales of companies are placed on the
income statement under other income. KKR has a price to earnings ratio (trailing twelve months) of 3.55
and CSWC has a ttm P/E of 175.73. KKR is priced at 2x book value (mostly investments). CSWC is priced
at ½ book value (mostly investments). Both invest in diverse industries. Because venture capital funds
return more than the stock market on average, a VC characteristic should increase the value of a stock.
However, there are not enough public VC firms to quantify this characteristic. Existing public VC firms
measure profitability by the buying and selling of private companies.
1.7
4.0
5.1
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Micro Cap Small Cap Mid & Large Cap
Software Price to Sales by Market Cap
23.7
46.4
37.7
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0
Micro Cap Small Cap Mid & Large Cap
Software Price to Earnings by Market Cap
VCS sales will be actual sales
by the software companies it
owns. It will have an
estimated 300m in ttm sales.
Using the average small cap
price to sales ratio, VCS will be
worth 1.2b.
Small cap software companies
have a price to earnings ratio
of 46.4 with the top four out
of 32 P/E ratios removed. All
of these ratios are over 100. If
these four companies were
left in the calculation, the
small cap software industry
has an average P/E of 65.1.
15. 15
13. VCS: DCF Valuation
NPV Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
$ 1,001,738,673 $ - $ - $ 30,000,000 $ 30,000,000 $ 30,000,000 $ 1,125,000,000
VCS will mimic a venture capital software fund by having a portfolio of middle market companies. VCs make money by buying and selling equity
in middle market companies. On average, five out of 10 of the companies will fail, 3.5 out of 10 companies will break even (sell for or earn as
much as has been invested in the companies), and 1.5 out of 10 companies will account for all the returns (home runs). VC’s have an average IRR
of 27% over the past 15 years (Cambridge Associates VC Index). Home runs (individually) produce an average ROI of 30 in an average of six years.
VCS will not sell its companies because they will be already owned by the public. However, a DCF valuation can be projected as if the companies
are experiencing exits because VC’s are often selling home runs to the public. Therefore, the public value of the home runs will equal their sale
price. Discounting sale prices yields roughly the same result as discounting future cash flows.
The following table depicts the average returns of a 300m VC fund.
Traditional VC Time 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Company 1 $ (30,000,000) $ - $ - $ - $ - $ - $ -
Company 2 $ (30,000,000) $ - $ - $ - $ - $ - $ -
Company 3 $ (30,000,000) $ - $ - $ - $ - $ - $ -
Company 4 $ (30,000,000) $ - $ - $ - $ - $ - $ -
Company 5 $ (30,000,000) $ - $ - $ - $ - $ - $ -
Company 6 $ (30,000,000) $ - $ - $ 30,000,000 $ - $ - $ -
Company 7 $ (30,000,000) $ - $ - $ - $ 30,000,000 $ - $ -
Company 8 $ (30,000,000) $ - $ - $ - $ - $ 30,000,000 $ -
Company 9 $ (30,000,000) $ - $ - $ - $ - $ - $ 225,000,000
Company 10 $ (30,000,000) $ - $ - $ - $ - $ - $ 900,000,000
Total $ (300,000,000) $ - $ - $ 30,000,000 $ 30,000,000 $ 30,000,000 $ 1,125,000,000
IRR = 27% $ (300,000,000) $ - $ - $ 30,000,000 $ 30,000,000 $ 30,000,000 $ 1,125,000,000
*The discount rate
used is discussed on
the next page.
16. 16
Stock market analysts discount cash flows at the risk free rate (2.0%) plus the risk premium (stock
market return risk premium (geometric average of stock market returns – risk free rate) x beta).
Assuming a stock market return assumption of 5% and a beta of 1.15 (the largest software beta by
market cap), VCS would be discounted at 5.15%. This gives VCS a DCF value of about 1b.
DISOUNT RATE = 5.15%
DISOUNT RATE = 2.0% (RISK FREE RATE) + (5% (STOCK MARKET PREMIUM) – 2% (RISK FREE RATE) * 1.15
(BETA)
1.12
1.09
1.15
1.04
1.06
1.08
1.10
1.12
1.14
1.16
Micro Cap Small Cap Mid & Large Cap
Software Beta by Market Cap
21. 21
15. Pro Forma Six Year Income Financial Summary
SIX YEAR FINANCIAL SUMMARY Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
# Deals 1 1 44 44 146 146
Market Share - - 1% 1% 5% 5%
Revenue $ - $ 200,000,000 $ - $ 660,000,000 $ - $ 2,190,000,000
Expenses $ 2,400,000 $ 1,600,000 $ 106,200,000 $ 70,400,000 $ 350,400,000 $ 233,600,000
Bonuses $ - $ 23,000,000 $ - $ 75,900,000 $ - $ 251,850,000
EBT $ (2,400,000) $ 175,400,000 $ (106,200,000) $ 513,700,000 $ (350,400,000) $ 1,704,550,000
Net Income (Capital Gains) $ 1,448,867,500
Net Income (Ordinary Income) $ 1,107,957,500
Cash / Assets $ 1,600,000 $ 177,000,000 $ 70,800,000 $ 584,500,000 $ 234,100,000 $ 1,938,650,000
All earnings contributed to growth Expenses of 4m per deal
Each deal takes two years 11.5% of revenue bonus structure
16. ROI, IRR & NPV
Figures assume a year six IPO. Six years is the average holding period of Angel Investor home runs. Middlenomics is priced at 14x earnings (the
stock market average). The value of the exit will depend on a patent, market size and market share.
ROI Time 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
5,071 $ (4,000,000) $ - $ - $ - $ - $ - $ 20,284,145,000
IRR Time 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
314% $ (4,000,000) $ - $ - $ - $ - $ - $ 20,284,145,000
NPV Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
$15,136,341,307 $ - $ - $ - $ - $ - $ 20,284,145,000
*Figures assume year six (capital gains) net
income
*Figures assume the IPO will sell for 14x
year six earnings
*NPV is discounted at 5%
23. 23
18. Software Market
In 2011, 24% of all US VC funds
went into software companies.
This equates to 6.7b. There were
1,004 software deals which
averaged $6.7m. Assuming
software companies accounted
for 24% of US M&A in 2010, the
US software market is between
6b (5% pricing power) and 25b
(20% pricing power).
19. Competitive Advantage
The firm that can provide middle market companies with the best stock prices will have a competitive
advantage. This will be determined by intellectual capital. The firm with the best employees will be able
to offer middle market companies the highest valuations. High valuations will lead to high percent
equity in packaged securities and greater market share.
18.2%
$0
$5,000,000,000
$10,000,000,000
$15,000,000,000
$20,000,000,000
$25,000,000,000
$30,000,000,000
$ Amount
2011 Non-Software
Companies Funded
2011 Software
Companies Funded
24%
