Decision-Making Processes – Deliberation Heuristics

As noted, the PEG business development officers review a significant number of proposed transactions per year. Generally they seek to cast a wide net so as to ensure that they review as many opportunities as possible. The volume can easily be 700-1000 proposals reviewed annually. The following are excerpts from the respondents regarding their approach towards the review process. The “whole idea for our model is to source broad and close on a very small number of these transactions.”(7) The business development officers “sign NDAs (Non-Disclosure Agreements) and take more information, simply because I’d rather make an informed decision than not.”(20) The process will cull the number of proposals to 150 – 250 that will receive a serious review. Generally, the PEGs look seriously at 10-15% of the proposals submitted and ultimately pursue 1-5%.

This necessitates the ability to quickly and deliberately review the teaser, applying the investment criteria of the firm, in order to determine whether to proceed. The decision-maker would quickly review the material and provide his/her initial feedback and rationale. This process only takes a few minutes.

The procedures utilized by the various PEGs differed significantly and ranged on a continuum from a very formal process to an informal review practice. Only four indicated that they follow a formal process. “We have a very formal process in place. A teaser comes in and if it meets criteria, a confidentiality agreement is executed, the Confidential Offering Memorandum (CIM) is requested.”(12) The teasers are reviewed by specific individuals responsible for this function whose deliberation on the information contained determines whether to proceed. “My boss has a weekly, sometimes several times a week, discussion about what we are looking at.”(10) “Then we talk about it at a formal Monday meeting, and we’ll go through a regimented step-by-step process of peeling back the onion skin…” (3) These PEGS have formal evaluation criteria. One fund had a list of 25 criteria on a checklist that was reviewed for each submission. If the proposed transaction scores above 65% in the process, it’s worthy of more time” and they will continue with the review. (20) Another relied on “our criteria is posted …in the limited partnership fund. We only invest in companies that have these sets of criteria.” (5)

Varying degrees of informal review processes were used by the majority of the PEGs. Comments range from business development officers stating “we just kind of know whether it’s something of interest”(17) to “I’ve been here close to eight years now and there is just not much controversy in our team in terms of whether something is going to fit or not.”(9) These views are reflected by the partner level responses such as: “We don’t have a formal investment

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deals at one point or another and we are always updating each other throughout the entire process.”(14) One respondent made the offhand comment; “to say we have a process would be an overstatement.”(16)

Evaluations of specific criteria appear to exist for every deal, but the decision-makers do not clearly state them all. This leads to a particular interest in the “rules of thumb”, heuristics, that are applied in the decision-makers’ deliberations. “We are looking for businesses with a 30% margin.”(20) Another business development officer noted that they are looking for the same key points: “we seek companies with stable histories of earnings, year in and year out. The other thing that we like is that there is someone on the inside that is capable of running it.” (9) He stated that these criteria have been established over history. In their case, he felt that there was not much controversy because they were not making investments on growth scenarios but on stability of earnings.

Another indicated, “Whoever does the first screen checks to make sure that it fits five or six different criteria that are kind of big boxes that we would check, on which there is not a lot of flexibility; maybe little bit, but not a lot.” (8) This is reinforced by the existence of very informal deal progression techniques: “if all those things continue to line up or there are no big flags, we will try to arrange a meeting.”(9) Many state that they are ‘industry agnostic’ as they review potential investments. Instead they are looking for a sustainable advantage in the industry or some other variable that will jump out at them as they review the teaser. However, the results of the respondents’ reviews of Teasers B and C where the deal was rejected would suggest that there are at least certain industries that they will not consider.

The founder of one PEG stated: “our focus is really on owner situations more than

anything else…we look to buy businesses…with management teams that are still hungry to grow the business.”(13) This PEG has three partners “and for the most part we all know what we are looking for.”(13) They seek investments in businesses that can control their own destiny or have a relevant intellectual component. Another founder put it this way: “Do we agree that there’s a way to grow this company, and do we agree that there’s an opportunity here that makes sense to go after… This is a piece of art. It’s not a science.”(5) A partner stated: “It’s not black and white but more of a guideline, so there is definitely some thinking about it.” (11)

Negative experiences affect the criteria as well. “These criteria have really been set over the last 10 to 12 years based off of what common criteria are or deals that everyone in the firm likes and even if they’re negative criteria… so if X then the deal is a pass, a clear pass. And so those, those kind of negative criteria are set because either one partner has a particular issue with something where he has gotten burned before or we as a firm…”(13)

Another business development officer noted; “Our founding partner got whacked in a mining deal so you’re not going to have any luck in a mining deal in our shop. We’ve had some automotive experience that did not go well. I think any automotive deal would have a hard time.”(10) These comments indicate that there are other decision-making biases involved in the respondents’ reviews of potential investments.

The prior acquisitions experience of these PEGs results in the improvement of the performance of their process. The PEGs use certain deliberative rules to choose particular

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opportunities. A partner reflecting on the firm’s investment criteria stated:

So, that’s our business model: we look to grow our businesses by a factor of three to five over a four to five year period… If a business does not have an

opportunity, we are probably not going to be interested… But we do look at the fundamental nature of the market, and find that the internal growth factors are really limited, and you would be required to do it through acquisitions: that is probably not going to be compelling for us. (13)

A founder added; “we’re a firm that focuses on investing in high growth businesses … we invest in three areas, business services, health care and government services. We like service

businesses because they can grow at great rates and self-fund”. (4) Another’s experience led him to believe: “We would rather go where other people are afraid to go because if you don’t have our type of background you are going to go broke bringing in the professionals to outsource that type of due diligence for you.” (18)

These findings suggest:

Proposition 1: Private Equity Groups utilize deliberative heuristics that guide selection