Analysis Paralysis
June 29, 2022 | Issue #69
Big Deal Small Business: Analysis Paralysis
June 29, 2022 | Issue #69
The newsletter readership is growing faster than ever, even as my pace of writing slows. If you’re new here and forgot that you signed up over the past month, I am a former private equity investor turned self-funded SMB searcher turned SMB owner-operator. I acquired a home services business earlier this year and this newsletter chronicles that experience.
In private equity (or in SMB acquisitions), the core job of the mid-level professional is to uncover problems with prospective acquisitions.
The lead partner generally sets the tone on investment thesis & deal negotiating. The junior on the team handles the basic financial modeling and internal investment memo work. The mid-level person (Senior Associate, VP, Principal or MD, depending on the firm) is the one in charge of running all the diligence workstreams.
This process was described to me as trying to turn over as many stones as possible before we sign on the dotted line.
Time kills deals - it’s cliché but true. Once a partner has established an investment thesis AND has selected a company to express that thesis AND has gotten that business under LOI / exclusivity, the sprint is on.
As the transaction workstreams progress (legal, insurance, documentation, financing, etc.), the mid-level professional is frantically turning over every stone to make sure there’s not an unpleasant surprise hiding somewhere.
The list of potential issues is basically unlimited: product warranty liabilities, delayed capex, weird sales mix trends, labor dynamics, hidden pension liabilities, etc.
As a result, due diligence is a continuous process that just ultimately…ends…once the deal is ready to sign.
We cut the data every way we can think of to try and uncover an issue. For junior folks, it can be frustrating work that feels like spinning wheels for the sake of being busy.
But it’s all in service of making one binary decision - that’s the crux of PE & SMB acquisitions. You make one BIG binary decision: buy the company or not. A bad buy is worse than no action.
As a result, as long as you’re clear on the big picture items early on, then you may as well have the junior/mid-level team sprint at every possible potential problem to make sure you didn’t miss anything.
SMB operations are different. You make very few big binary decisions. Instead, you’re making hundreds of small decisions that hopefully compound in big ways.
Do I buy truck type A or truck type B for my fleet vehicle?
Do I use CRM A or CRM B?
Do I give this angry customer a discount or not?
Do I give this employee a raise or not?
Should I spend my time today running errand X or working on problem Y?
It’s a million micro problems that roll up into the mystical “operator” job.
Unlike in PE or SMB acquisitions, doing analysis until the final moment is not a viable strategy.
Similar to PE or SMB acquisitions, time is still of the essence. But now it’s MY time that is valuable, not DEAL time.
My time, if applied well, allows me to make more decisions each day. It allows me to apply more actions on the business each day if I can make each decision faster (but similarly effectively).
So - nonstop due diligence and analysis does not work. Coming from a PE background, I find myself spinning my wheels sometimes trying to chop up a decision from every possible analytical or qualitative angle.
I’m realizing that to be a strong operator, I need to develop my gut sense and rely on a mental risk framework. Each decision is not existential for the business; the potential downside is usually far more manageable than the decision to buy a bad business.
Also, most decisions don’t have a binary decision - there are nuanced answers. I’m learning to push decisions forward toward low downside / high upside branches on the decision tree.
Think about sitting down at a poker table. In PE/SMB acquisitions, you only get to play one hand all the way to the river card, and when you do, you have to go all-in. In that scenario, you’ll choose to sit and wait for the right hand, and then only bet all the way to the river if the perfect set up presents itself.
SMB operations feel more like sitting at a blackjack table with $5 minimums. Most hands have an optimal play of some sort, but nothing is guaranteed and you’re guessing at what the dealer has anyway. Losing a hand is annoying, but doesn’t kill you. You may even lose a few in a row, and it’s okay.
Sitting there thinking long & hard over what to do with each hand won’t improve your outcomes that much. You just play your hands based on the odds and make sure you double down when you see a good set up.
Anyway, this post become a bit of a ramble but I hope you can see what I’m getting at. I’m working on quickening my decision-making abilities, while also keeping a radar up for the “big one” where there is real potential upside.
Hope you’re all doing well in your respective searches, businesses, or investments - as always, I’d love to hear your thoughts, so just hit reply to this email or find me on Twitter.
I’m still having fun, learning a lot, and haven’t broken the business yet!
Thanks,
Guesswork Investing