Category Archives: Investing

This Is Personal

[Editor’s note: one more post rescued from the e-trash bin. I wrote this almost 3 years ago. How true it rings, even now. And still incomplete.]

For a blogger on the internet I suppose this is a good “problem” to have– I’ve received a lot of emails lately from people who follow my blog (strangers and acquaintances alike) asking me if I’ve given up blogging and noting that my last post was in November, about two months ago.

I was planning to write a little something along the lines of a response to “Where the hell have you been?” anyway, but there’s a bit more urgency now as more and more keep chiming in with sounds of confusion and dismay. Yes, I am a unique product in apparently high demand.

To start, I wanted to offer three general excuses for why in the recent past, or any other time in the distant past or future, my blogging output may have been/may be inconsistent to nonexistent:

  1. Lack of enthusiasm, inspiration or both
  2. Short-term priorities and time-use choices which interfere with contemporaneous blogging
  3. Long-term priorities, etc…

With regards to the first item, I’ll give a little bit of a background on myself that might serve to establish some contrast in illustrating the point. When I was a younger man, I blogged quite often on personal issues, sometimes two, three, four times a day (or night). I felt I had no end to my desire to share my thoughts, and an almost endless variety of subjects upon which I saw fit to opine.

I consider myself a thoughtful person (meaning full of thoughts, not necessarily beneficially so) and certainly I can’t deny being opinionated (in the sense of deriving great satisfaction from expressing my views, not simply in possessing them or strongly defending them). Combine this with a youthful experience with general alienation from my peers because I did not understand them and they didn’t understand me and I had no one to talk to out there but myself. I blogged a lot seeking release. I blogged a lot to practice thinking and reasoning. I blogged a lot because I found my former self — one week, one month, one year earlier — endlessly entertaining.

As I grew older, but not necessarily wiser or more mature, I came to realize I wasn’t as alone as I always thought I was. I found the virtue of patience and adherence to particular standards and eventually came to understand how to find and connect with the kind of people that got me (and vice versa) in the great sea of global society. I started seeing the impropriety of sharing my thoughts on everything that crossed my mind with anyone who crossed my path. I settled down a bit, too. I blogged less. In other words, as everyone else began entering the Facebook Era of 24/7 trivialization, I had finally found a pair of running shoes that fit and was in the process of hauling ass in the opposite direction.

But it is a process, not a destination, and sometimes I stumble. I can’t claim to be without flaws in my execution of this process, only that I am committed to always trying to improve it. So, if anything I’ve written here has come across as not quite sacrosanct in accordance with these principles, I make no apology.

And in conclusion, I try to police myself as best I can in this regard and that’s why many things I would publish to the blog in fact go still born. Oftentimes I experience a disconnect somewhere between the “I should write about this” thought and the “Publish” button which results in sufficient disillusionment with the value of the whole ordeal that I end up throwing my hands up in the air, shouting something along the lines of “Oh, who gives a shit? I know I don’t!” and then giving up.

I was born with a savior mentality but I’ve slowly purged myself of that. When it momentarily gets the better of me the result is usually an aborted blog post when I catch myself and realize I don’t want to live the life of a crusader and I’m not about to try to change the world with a blog post. Better just to record some observations as I have them, keep myself honest as best I can and shuffle along.

As far as short-term priorities go, my personal circumstances regarding family, friends and relationships over the Thanksgiving-New Year’s holidayfest period left me singularly unable to tend to any personal pleasures and upkeep, which included this blog. This excuse isn’t much more detailed or interesting than this fact. I let a lot of things go by the wayside with the limited free time I perceived myself to possess during this time and the blog got heaped in the pile.

The final excuse, regarding long-term priorities, is perhaps the bone with the most consequential meat on it and so if you’ve read this far I encourage you to nibble and see how you like it.

Right around the beginning of January, 2012, a personal friend whose company and judgment I value immensely sent me an e-mail encouraging me to visit the blog CS Investing. Were it anyone else, I probably would’ve taken a look, briefly, weeks later, if that. But because I respect this person I decided to take his recommendation seriously and I visited the site immediately.

The timing on this was nothing short of fortuitous. I happened to be taking a brief respite from anything resembling adulthood responsibility for a period of three weeks, visiting a friend on the other side of the country and prepared to spend most of my days busying myself with reading and web browsing and cooking. I was at a place in my life where I was nearly perfectly situated to let the message of this blog resonate within me in a profound way.

The message of CS Investing was, on the surface, taking a case study-based methodological approach to studying the principles of value investing. The tone of the site was collegial and ancient academy-like: the students gathered around the teacher to receive a lesson, but in the context of all discussing, debating and learning (versus the standard model today of authority-to-servant). The resources were vast and high quality.

But the thing that hit me the most was the attitude of individual self-improvement and growth, of which I had already been a fan. John Chew, the proprietor of the site, made it clear that one could have an intense education in business and investing without going to business school and that maybe even this choice was antithetical to the stated aims! A bold claim that people with and without MBAs seem to fall on either side of, but one which sparked my imagination regardless of the consensus surrounding it.

My best personal friend was himself engaged in an intensive experiment he called his “personal MBA in entrepreneurial farming” in which he had committed to learning what it took to create a small-scale organic, local farming enterprise from scratch. Using his efforts and organization as a model, and considering CSInvesting.org as my primary resource, I decided to commit myself to a year-long “personal MBA in investing and business analysis”. My plan was to follow the case study methodology as well as read and digest as many authoritative texts, articles, interviews, etc., as I could on the subject of value investing, financial analysis and business management in the space of a year.

This decision took me in a number of directions over the course of the year that I could not and did not predict before I made the commitment.

One result of my commitment was the making of a lot of social connections with other talented, intelligent value investors and business thinkers who I originally came across through their blogs. I’ve mentioned a number of them at various times on this blog but I’ll list some of my favorites just in case, though this list is by no means exhaustive or comprehensive:

These relationships have been invaluable in a number of ways. I have learned a lot from these people, many who have mentored me a bit at times which I always enjoy even if such relationships remain informal and ad hoc. They have inspired me in various ways, helping me to tease out ideas buried deep in my mind and psyche, or giving me entirely original motivations. Some have become partners in activism on various investment ideas while others have explored more formal business partnerships with me. All lent me encouragement and support through various crises of thought and existence, minor and major, along the way.

Warren Buffett Investment Process Commentary

[This post is incomplete, and was intended as a collection of Buffett investment process remarks along with my own commentary. It is instead a disjointed collection of Buffett investment process remarks and nothing more.]

Forecasts usually tell us more of the forecaster than of the future

There is nothing at all conservative, in my opinion, about speculating as to just how high a multiplier a greedy and capricious public will put on earnings.

our unwillingness to fix a price now for a pound of See’s candy or a yard of Berkshire cloth to be delivered in 2010 or 2020 makes us equally unwilling to buy bonds which set a price on money now for use in those years. Overall, we opt for Polonius (slightly restated): “Neither a short-term borrower nor a long-term lender be.”

the auction nature of security markets often allows finely-run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise.)

we evaluate single-year corporate performance by comparing operating earnings to shareholders’ equity with securities valued at cost.

However attractive the earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no-strings-attached cash.

Small portions of exceptionally good businesses are usually available in the securities markets at reasonable prices. But such businesses are available for purchase in their entirety only rarely, and then almost always at high prices.

For personal as well as more objective reasons, however, we generally have been able to correct such mistakes far more quickly in the case of non-controlled businesses (marketable securities) than in the case of controlled subsidiaries. Lack of control, in effect, often has turned out to be an economic plus.

Logically, a company with historic and prospective high returns on equity should retain much or all of its earnings so that shareholders can earn premium returns on enhanced capital. Conversely, low returns on corporate equity would suggest a very high dividend payout so that owners could direct capital toward more attractive areas.

Beware of “dividends” that can be paid out only if someone promises to replace the capital distributed

we regard the most important measure of retail trends to be units sold per store rather than dollar volume

Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the least.

Asset-heavy businesses generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. In such cases earnings have bounded upward in nominal dollars, and these dollars have been largely available for the acquisition of additional businesses.

During inflation, Goodwill is the gift that keeps giving. But that statement applies, naturally, only to true economic Goodwill.

The buying and selling of securities is a competitive business, and even a modest amount of added competition on either side can cost us a great deal of money

we think an all-bond portfolio carries a small but unacceptable “wipe out” risk, and we require any purchase of long-term bonds to clear a special hurdle. Only when bond purchases appear decidedly superior to other business opportunities will we engage in them. Those occasions are likely to be few and far between.

In many businesses particularly those that have high asset/profit ratios – inflation causes some or all of the reported earnings to become ersatz. The ersatz portion – let’s call these earnings “restricted” – cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas: its ability to maintain its unit volume of sales, its long-term competitive position, its financial strength. No matter how conservative its payout ratio, a company that consistently distributes restricted earnings is destined for oblivion unless equity capital is otherwise infused.

Unrestricted earnings should be retained only when there is a reasonable prospect – backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future – that for every dollar retained by the corporation, at least one dollar of market value will be created for owners

you should wish your earnings to be reinvested if they can be expected to earn high returns, and you should wish them paid to you if low returns are the likely outcome of reinvestment.

Since the long-term corporate outlook changes only infrequently, dividend patterns should change no more often. But over time distributable earnings that have been withheld by managers should earn their keep. If earnings have been unwisely retained, it is likely that managers, too, have been unwisely retained.

Only by committing available funds to much better businesses were we able to overcome these origins. (It’s been like overcoming a misspent youth.) Clearly, diversification has served us well.

You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to capital employed, an even more important point must be examined: how much additional capital was required to produce the additional earnings?

retirement announcements regularly sing the praises of CEOs who have, say, quadrupled earnings of their widget company during their reign – with no one examining whether this gain was attributable simply to many years of retained earnings and the workings of compound interest.

Many stock options in the corporate world have worked in exactly that fashion: they have gained in value simply because management retained earnings, not because it did well with the capital in its hands.

No owner has ever escaped the burden of capital costs, whereas a holder of a fixed-price option bears no capital costs at all. An owner must weigh upside potential against downside risk; an option holder has no downside

First, stock options are inevitably tied to the overall performance of a corporation. Logically, therefore, they should be awarded only to those managers with overall responsibility

owners are not well served by the sale of part of their business at a bargain price – whether the sale is to outsiders or to insiders. The obvious conclusion: options should be priced at true business value

all Berkshire managers can use their bonus money (or other funds, including borrowed money) to buy our stock in the market. Many have done just that – and some now have large holdings. By accepting both the risks and the carrying costs that go with outright purchases, these managers truly walk in the shoes of owners

Berkshire’s strong capital position – the best in the industry – should one day allow us to claim a distinct competitive advantage in the insurance market

we prefer to finance in anticipation of need rather than in reaction to it

Tight money conditions, which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side

The primary factors bearing upon this evaluation are:

1) The certainty with which the long-term economic characteristics of the business can be evaluated;

2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;

3) The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;

4) The purchase price of the business;

5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.

The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage

Thirty years ago, I bought silver because I anticipated its demonetization by the U.S. Government. Ever since, I have followed the metal’s fundamentals but not owned it. In recent years, bullion inventories have fallen materially, and last summer Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand. Inflation expectations, it should be noted, play no part in our calculation of silver’s value.

If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter.

Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag.

Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.

It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.

Notes – The Snowball, By Alice Schroeder: Part V, Chap. 43-52

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder (buy on Amazon.com). This post covers Part V: The King of Wall Street, Chap. 43-52

[These notes were never published on time. They may be incomplete as posted now.]

The modern Buffett

In Part V of the Snowball, we see Buffett’s transformation from the early, cigar butt-picking, Grahamian value-minded Buffett, through the filter of his Fisherite partner, Charlie Munger, into the mega cap conglomerator and franchise-buyer Buffett who is popularly known to investors and the public the world round.

It is in this part that we also see Buffett make one of his biggest missteps, a stumble which almost turns into a fall and which either way appears to shock and humble the maturing Buffett. It is in this era of his investing life that we see Buffett make some of his biggest rationalizations, become entangled in numerous scandals he never would’ve tolerated in his past and dive ever deeper into the world of “elephant bumping” and gross philanthropy, partly under the tutelage of his new best friend and Microsoft-founder, Bill Gates.

The lesson

Buffett made a series of poor investments but ultimately survived them all because of MoS. There will be challenges, struggles, and stress. But after the storm, comes the calm.

The keys to the fortress

From the late seventies until the late nineties, despite numerous economic and financial cycles Buffett’s fortune grew relentlessly under a seemingly unstoppable torrent of new capital:

Much of the money used for Buffett’s late seventies spending spree came from a bonanza of float from insurance and trading stamps

This “float” (negative working capital which was paid to Buffett’s companies in advance of services rendered, which he was able to invest at a profit in the meantime) was market agnostic, meaning that its volume was not much affected by the financial market booming or crashing. For example, if you owe premiums on your homeowner’s insurance, you don’t get to suspend payment on your coverage just because the Dow Jones has sold off or the economy is officially in a recession.

The growth in Buffett’s fortune, the wilting of his family

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million

Meanwhile Buffett proves he’s ever the worthless parent:

he handed the kids their Berkshire stock without stressing how important it might be to them someday, explaining compounding, or mentioning that they could borrow against the stock without selling it

Buffett had once written to a friend when his children were toddlers that he wanted to see “what the tree has produced” before deciding what to do about giving them money

(he didn’t actively parent though)

Buffett’s private equity shop

Another tool in Buffett’s investment arsenal was to purchase small private companies with dominant franchises and little need for capital reinvestment whose excess earnings could be siphoned off and used to make other investments in the public financial markets.

Continuing on with his success in acquiring the See’s Candy company, Buffett’s next private equity-style buyout involved the Nebraska Furniture Mart, run by a devoted Russian immigrant named Rose Blumkin and her family. And, much like the department store chain he once bought for a song from an emotionally-motivated seller, Buffett beat out a German group offering Rose Blumkin over $90M for her company, instead settling with Buffett on $55M for 90% of the company, quite a discount for a “fair valuation” of practically an entire business in the private market, especially considering the competing bid.

An audit of the company after purchase showed that the store was worth $85M. According to Rose Blumkin, the store earned $15M a year, meaning Buffett got it for 4x earnings. But Rose had buyers remorse and she eventually opened up a competing shop across the street from the one she had sold, waging war on the NFM until Buffett offered to buy her out for $5M, including the use of her name and her lease.

One secret to Buffett’s success in the private equity field? Personality:

“She really liked and trusted me. She would make up her mind about people and that was that.”

Buffett’s special priveleges

On hiding Rose Blumkin’s financial privacy: Buffet had no worries about getting a waiver from the SEC

Buffett got special dispensation from the SEC to not disclose his trades until the end of the year “to avoid moving markets”

The gorilla escapes its cage

Another theme of Buffett’s investing in the late 1980s and 1990s was his continual role as a “gorilla” investor who could protect potential LBO-targets from hostile takeover bids. The first of these was his $517M investment for 15% of Tom Murphy-controlled Cap Cities/ABC, a media conglomerate. Buffett left the board of the Washington Post to join the board of his latest investment.

Another white knight scenario involved Buffett’s investment in Ohio conglomerate Scott Fetzer, which Berkshire purchased for $410M.

Then Buffett got into Salomon Brothers, a Wall Street arbitrage shop that was being hunted by private equity boss Ron Perelman. Buffett bought $700M of preferred stock w/ a 9% coupon that was convertible into common stock at $38/share, for a total return potential of about 15%. It even came with a put option to return it to Salomon and get his money back.

But Buffett had stepped outside of his circle of competence:

He seemed to understand little of the details of how the business was run, and adjusting to a business that wasn’t literally made of bricks-and-mortar or run like an assembly line was not easy for him… he had made the investment in Salomon purely because of Gutfreund

Buffett’s disgusting ignorance and hypocrisy

Buffett:

I would force you to give back a huge chunk to society, so that hospitals get built and kids get educated too

Buffett decides to sell the assets of Berkshire’s textile mills– on the books for $50M, he gets $163,122 at the auction. He refused to face his workers and then had the gall to say

“The market isn’t perfect. You can’t rely on the market to give every single person a decent living.”

Buffett on John Gutfreund:

an outstanding, honorable man of integrity

Assorted quotes

Peter Kiewit, a wealthy businessman from Omaha, on reputation:

A reputation is like fine china: expensive to acquire, and easily broken… If you’re not sure if something is right or wrong, consider whether you’d want it reported in the morning paper

Buffett on Wall St:

Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway

Notes – Original Issue Discount (OID) Tax Implications, Lessons Learned (#taxes, #investing)

In the process of carrying out the KV Pharmaceuticals capital structure arbitrage trade of 2012, I got caught with my pants down a bit as I didn’t think to sell the convertible notes before they stopped trading. As a result, I missed an opportunity to lock in a capital loss for tax purposes at the time, which would’ve helped shield some of the income I made on the puts and thus made the trade as a whole more tax efficient.

Instead, I got a double-whammy of tax inefficiency for my ignorance, a chicken that finally came home to roost in tax FY2013 as the CPA assisting me with my tax preparation informed me that I ended up owing an additional sum beyond amounts withheld in prior periods due to Original Issue Discount (OID) interest income related to my defunct KV Pharmaceuticals play!

At first I was shocked and dismayed– the company went into bankruptcy and the securities were eventually removed from my account entirely earlier this year. How could I owe taxes when I never earned any cash interest and will never get back even a penny from the securities I stupidly held onto?

I talked about it with my CPA (who double-checked with his partner) and then spoke to a rep at TD Ameritrade and the matter is decisively not going to turn out in my favor. I learned that when a bond goes into default it often switches from cash interest basis to accrual interest basis in the eyes of the IRS, and like any good group of thugs they want their blood now, not later. In other words, I owe federal income tax on “accrued interest” I not only never received but never will receive. Because the securities were removed from my account in 2014 and not 2013, it looks like I accrued interest income due to me even though we clearly know right now that I’ll never get it.

Instead, I get a stepped up cost basis on the securities (in the amount equal to the accrued interest not received) so when I finally report the loss for FY2014 taxes, it’ll be a total loss of X + Y instead of just X. I get to shield additional future income with the X + Y amount but I paid real cash up front for the privilege.

If I had known better, I would’ve executed this trade such that the gains and losses all occurred in the same period in 2012. I also probably wouldn’t have gotten into a trade in the first place whose money-making mechanics I generally understood but about whose technical execution and tax implications I was grossly ignorant.

Another expensive lesson learned!

Notes – Stanford Graduate School of Business Search Fund Primer (#searchfund, #business, #investing)

Notes on “A Primer On Search Funds” produced by the Stanford Graduate School of Business

“The Search Fund”

  • Greater than 20% of search funds have not acquired a company
  • Stages of the Search Fund model:
  • Raise initial capital (2-6mos)
  • Search for acquisition (1-30mos)
  • Raise acquisition capital and close transaction (6mos)
  • Operation and value creation (4-7+ years)
  • Exit (6mos)
  • SFs target industries not subject to rapid tech change, easy to understand, fragmented geographic or product markets, growing
  • Highest quality deals are found outside broker network/open market due to lack of auction dynamics
  • Research shows that partnerships are more likely to complete an acquisition and have a successful outcome than solo searchers (71% yielded positive return, 15 of top 20 performing funds were partnerships)
  • Principals budget a salary of $80,000-120,000 per year w/ median amount raised per principal $300,000~
  • Majority of the economic benefit of SF comes through principal’s earned equity; entrepreneur/partners receive 15-30% equity stake in acquired company in three tranches
  • Investors typically receive preference over the SFer, ensuring investment is repaid, with return attached, before SFer receives equity value
  • Individual IRR from 2003-2011 median was not meaningful, heavily skewed toward 75th percentile where median was 26% in 2011; 57% of individual IRRs were not meaningful in 2011; the median fund destroyed capital in 2009 (0.5x) and 2011 (0.8x); 58% in 2011 broke even or lost money
  • Half of the funds that represent a total or partial loss were funds that did not acquire a company; biggest risk is in not acquiring a company at all
  • Median acquisition multiples: 1.1x revenues; 5.1x EBITDA
  • Median deal size, $8.5M

“Raising a Fund”

  • Search fund capital should come from investors with the ability and willingness to participate in the acquisition round of capital raising

“Search Fund Economics”

  • Search fund investors often participate at a stepped up rate of 150% of original investment in acquired company securities

“Setting Criteria and Evaluating Industries”

  • Desirable characteristics for a target industry: fragmented, growing, sizable in terms of revenues and number of companies, straightforward operations, early in industry lifecycle, high number of companies in target size range
  • Desirable characteristics for a target company: healthy and sustainable profit margins (>15% EBIT), competitive advantage, recurring revenue model, history of cash flow generation, motivated seller for non-business reasons, fits financial criteria ($10-30M in revs, >$1.5M EBITDA), multiple avenues for growth, solid middle management, available financing, reasonable valuation, realistic liquidity options in 3-6 years
  • Key challenge is “know when to take the train” lest a SF never leaves the station waiting for the perfect opportunity
  • Ideally, seller is ready to transition out of the business for retirement or personal circumstances or has something else they’d like to do professionally
  • Experience shows it is better to pay full price for a good company than a “bargain” for a bad one
  • Idea generation: SIC and NAICS codes, Yahoo! Finance, Thomson Financial industry listings, Inc. 5000 companies, public stock OTC and NASDAQ lists and even the Yellow Pages; generate a list of 75 potential industries to start
  • Target industries buoyed by a mega-trend
  • Can also target an industry in which the SFer has worked and possesses an established knowledge base and network
  • Some focus on 2-3 “super priority” industry criteria (eg, recurring revenues, ability to scale, min # of potential targets, etc.)
  • Objective is to pare down the industry target list to 5-10 most promising
  • Basic industry analysis (Porter’s five forces, etc.) is then used to narrow from 10 to 3; SFers use public equity research and annual reports for market size, growth, margin benchmarks; also Capital IQ, Hoover’s, Dun & Bradstreet and One Source
  • Industry insiders (business owners, trade association members, sales or business development professionals) and industry trade associations or affiliated ibanks and advisory firms are primary methods of research and often have general industry research or white papers available
  • Next step is to create a thesis to codify accumulated knowledge and compare opportunities across common metric set in order to make go/no-go decision
  • In order to become an industry insider, SFers typically attend tradeshows, meet with business owners, interview customers and suppliers and develop “River Guides”

“The Search”

  • Median # of months spent searching, 19
  • 54% spend less than 20 months searching, 25% spend 21-30 months, 21% spend 30+ months
  • Track acquisition targets with CRM software such as Salesforce, Zoho, Sugar CRM
  • Bring up financial criteria and valuation ranges as early as possible when speaking to potential acquisition targets to save everyone time
  • A company that is too large or too small as an acquisition target may still be worth talking to for information
  • You must immediately sound useful, credible or relevant to the owner; deep industry analysis should already have been performed at this stage
  • Tradeshows can be a critical source of dealflow
  • If a particular owner is not willing to sell, ask if he knows others who are
  • “River Guides” are typically compensated with a deal success fee, usually .5-1% of total deal size
  • Boutique investment banks, accounting firms and legal practices specializing in the industry in question are also a good source of deals
  • The business broker community itself is extremely large and fragmented; could be a good rollup target?
  • Often, brokered deals are only shown if a private equity investor with committed capital has already passed on the deal, presenting an adverse selection problem
  • Involve your financing sources (such as lenders and investors) early in the deal process to ensure their commitment and familiarity

“Evaluating Target Businesses”

  • Principles of time management: clarify goals of each stage of evaluation and structure work to meet those goals; recognize that perfect information is an unrealistic goal; keep a list of prioritized items impacting the go/no-go decision
  • Stages: first pass, valuation/LOI, comprehensive due diligence
  • It is in the best interest of the SFer to tackle core business issues personally during due diligence as it is the best way to learn the details of the business being taken over
  • Adding back the expenses of a failed product launch rewards the seller for a bad business decision; adding back growth expenses gives the seller the double benefit of capturing the growth without reflecting its true cost
  • Due diligence may also uncover deductions to EBITDA or unrealized expenses that reduce the “normalized” level of earnings (undermarket rents, inadequate insurance coverage, costs to upgrade existing systems, etc.)

“Transitioning Ownership and Management”

  • Create a detailed “Transition Services Agreement” with the seller, a legal contract where specific roles, responsibilities, defined time commitments and compensation are agreed prior to the transaction close
  • The first 100 days should be dedicated to learning the business
  • Businesses consist of people, and people need communication; great leaders are always great communicators
  • “Don’t listen to complaints about your predecessor, this can lead to a swamp and you don’t want to be mired there.”
  • The goal is to learn, not to make immediate changes
  • Outwork everyone; be the first person in and the last to leave
  • Many SFers insert themselves into the cash management process during the transition period by reviewing daily sales, invoices and receipts and signing every check/payment made by the company
  • The company’s board should be a mix of deep operational experience, specific industry or business model experience and financial expertise
  • The seeds of destruction for new senior leaders are often sown in the first 100 days