No risk it, no biscuit?

March 26, 2021

by a searcher from University of Denver - Daniels College of Business in Boston, MA, USA

I'm close to submitting an LOI for a B2B service firm. I've talked to some fellow searchers and CPAs, and frankly it seems like they could nitpick every deal, and due diligence themselves out of a turkey sandwich.

At what point do you eventually acknowledge every deal has some risk and go for it versus waiting on the sideline??

I'd love to hear from searchers who have actually closed an acquisition. Were there major skeletons in the closet post close? What are the deal breakers for you pre LOI and in due diligence? Any searchers with major regret in their current business?

In the words of coach Bruce Arians who won the super bowl this year, 'no risk it, no biscuit.'

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Reply by a searcher
from Massachusetts Institute of Technology in Miami Beach, FL, USA

Partially, it's the "secretary problem" (https://en.wikipedia.org/wiki/Secretary_problem). A searcher has to DD the first few interesting deals and reject them all, just to build up an understanding of the average quality of businesses. Now, I know I'll have to accept a business with some hair on it.

However, I do think there are searchers who are looking for the perfect business and a zero-risk deal. Those searchers are bound to be disappointed. I'm looking for a deal that's at least an 90% likelihood of success - say success means doubling the intrinsic value of the company in a couple years. And there's a 10% chance of failure - here, a total loss of investment. Maybe I'm unlucky in the first deal. So I save up and do another 90/10 success/failure deal a second time. Since each deal independently has a 1-in-10 chance of failure, the chance of BOTH deals failing is 1-in-100.**

You need guts to pull the trigger on a purchase but you don't need to be a gambler!

**P.S. I got this concept from Mohnish Pabrai's book The Dhando Investor. Put another way, it's "heads I win, tails I don't lose much." Here's a pretty good summary of the section on dhando and the motel-mogul Patel clan: https://www.gurufocus.com/news/862082/the-dhandho-investor-why-the-patels-owned-so-many-motels

Reply by a professional
from University of Minnesota in Minneapolis, MN, USA

I think the big difference often tends to boil down to the size of the bureaucracies involved in a deal. PE Firms or more seasoned investors just tend to favor more outside due diligence - and they are often in a better position to pay for it. Personally, I like working with the smaller operators on the other end of the spectrum that are willing to take a reasonable chance even if a stone or two remain unturned along the way. Left to their own devices, many lawyers (or other DD advisors) will redline deal docs until the cows come home (or if we're sticking with football analogies, until the Vikings win the Super Bowl....sigh). But if there's one thing we learned in 2020, it's that you can't DD all the risk away, no matter what. At some point, you have to jump.

(Note - this is all easy for me to say since I'm a third-party advisor and have little-to-no metaphorical skin in the game for most of the deals I work on, but I truly believe it is true).

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