Lessons from Buffett and Munger
I was fortunate enough to attend Berkshire Hathaway's Annual Meeting last month, otherwise known as "Woodstock for Capitalists." Berkshire's Chairman Warren Buffett and Vice Chairman Charlie Munger answered questions from shareholders and representatives from the press for nearly six hours, addressing topics ranging from the recent Sokol insider-trading scandal to Mr. Buffett's outlook on commodities prices.
In addition, both Mr. Buffett and Mr. Munger had several pieces of advice that I thought were highly relevant to the business of buying and selling companies. In particular, from their years of experience buying companies, they relayed several observations about how people make poor decisions. In the context of selling what is likely a business owner's largest asset, I thought these lessons were particularly important. I took several pages of notes, and here are the best kernels of wisdom I took away:
Always look at important capital decisions through the lens of opportunity costs. If you are making a decision to sell your company (or buy another company), what are the opportunity costs of your decision? In other words, by selling your company, what are you giving up, and is it worth less to you than what you will be getting from the sale?
Too often we see clients caught up in the prospect of having a bank account full of cash after a sale, but they gloss over the significant intangible benefits they receive from owning a business. In addition, although much more risky than a diversified stock and bond portfolio, their business is almost always their best investment when measured purely in terms of return on capital.
As a result, life after a sale can be a lot different from what they envisioned. That said, timing is a non-monetary factor that should be considered. Having a diversified portfolio can provide enhanced peace of mind and security, which in a business owner's later years may be more important than making incremental return on investment.
My view is that business owners don't sell their companies for money, they sell to change their lives in some way. As a result, it is critical to thoroughly evaluate the many non-monetary considerations at play before initiating a sale process. Be disciplined and deliberate in assessing the opportunity costs of your decisions, and you will make much better decisions.
The role of hubris in poor decision making. Business owners are typically independent thinkers, and are often justifiably proud of what they have accomplished in their businesses. There is nothing inherently wrong about being proud until it interferes with objective decision making.
Business owners sometimes have a hard time looking at their business through the lens of a potential buyer or investor. For example, because they manage the risks of their business day-to-day and are deeply familiar with what these risks mean, they often underestimate the risks in their business, particularly in comparison to an outsider who has little or no knowledge of these risks (studies show most people tend to overestimate the level of risk with respect to something they don't understand).
As a result of underestimating the level of risk in their business, business owners often overestimate the value of their business, which can get in the way of making a good decision when it comes to taking on new capital or selling their company. In other words, they may pass on a truly great deal that otherwise would satisfy their financial and other objectives simply because they overestimate the value of their business.
We have seen this move too many times to recount - the business owner passes on a solid deal only to suffer the adverse consequences of those risks they previously discounted, setting their retirement or other plans back by several years. The old adage is true - "Pigs get fed, hogs get slaughtered." Focus on an objective assessment of risk in your business, and you will make better decisions when it comes to transactions.
Don't make decisions in anger. The deal process is emotional. I tell my clients that "Every deal dies three times before closing." The high stakes of a deal compounded by the up-and-down nature of negotiations can unearth very strong emotions, which if not held in check can cloud good judgment.
As Charlie Munger said, "You can always tell a man to go to hell tomorrow if you think it is such a good idea." In other words, be aware of the role of emotions in making poor decisions, and have the discipline to give yourself time to allow those emotions to mitigate in the context of making important decisions during the course of negotiating a deal.
For business owners, emotional ups and downs can be particularly acute - their business almost always means more to them than just a financial return. Indeed, their business is often a critical part of their life, and as a result, their emotional reactions to the notion that "their baby is not so pretty" can cause them to unwittingly make poor decisions.
When you are upset, your ability to exercise good judgment declines precipitously Be on the lookout for extreme emotional highs and lows, and sleep on a decision before you ruin a deal for the wrong reasons.
Look for Part II next month.
Chris Younger is Managing Director of CapitalValue Advisors, LLC (www.capitalvalue.net). Chris has over 20 years of experience in structuring deals and managing businesses, sales and operations. He was the co-founder and president of a 4,200-employee telecommunications company, has purchased and sold over 30 business as a principal and investor, and has been an advisor to hundreds of companies. Additionally, he is the co-author with David Tolson of the book Harvest: The Definitive Guide To Selling Your Company, available on Amazon. He can be contacted at firstname.lastname@example.org.