I highly recommend Berkshire-Hathaway's annual report for
your pleasure, amusement and education – even for those of you
who don’t enjoy reading business publications. More
specifically, I recommend chairman Warren Buffet's annual
message to shareholders.
Buffet always educates and illuminates. He doesn't offer
excuses for performance shortfalls. There is only the
Brutal Truth (see
the May '06 issue of Performance Digest for more on this
subject). This year, Buffet details his six criteria for
assessing acquisition candidates. I won’t bore you with all
six, but two of them put a smile on my face:
• Successful management in place. He says that since
the holding company brings very little management expertise to
the party, this has to be a stake in the ground.
• Simple businesses. He adds, "If there's lots of
technology, we don't understand it."
If you read his complete message (or you have in the past),
you'll be impressed by his straight talk and logic. No
convoluted explanations of lofty concepts and abstract
philosophies.
After reading this year's message, I thought about two
incidents in my past business life.
Several years ago, I considered pursuing a "roll-up" of
small financial services firms. I had procured the help of an
investment banker and spent about six months soliciting
interest from potential sellers and combing through financial
documents for many of those firms to assess the value of
each.
One firm seemed particularly promising. The principal and I
hit it off immediately. He had built a company, completely
organically, from zero to about $5 million in revenue in a
very short time. The business was no longer dependent on him
for survival or success. Because of a health situation, he
wanted to throttle back. It couldn't have been a better
scenario.
After our initial two meetings, he crafted a profile of the
business for my review. That included three years of
retrospective financial information and a two-year financial
projection – a pro forma.
For the next two weeks, I spent every free moment combing
through his financials. I concluded that his pro forma
document was really a bull sheeta document. Here's why:
His projections depicted rosy scenarios across the board.
Although his past growth had been impressive, his future
growth projections were stratospheric: almost 100% in the
following 24 months. When I questioned him, his reasoning was,
at best, flawed, and at worst, delusional.
His expense projections were similarly "optimistic." I'm
overly simplifying here, but it looked as if all of the
expenses he incurred to grow the business to its (then)
present day size would discontinue or very significantly
diminish during the following 24 months. He evaded my pointed
questions.
When all was said and done, my estimate of free cash flow
during the 24 months to follow was about half that of his
"bull sheeta" projection. Accordingly, I pegged the value of
his business to be about half of his asking price. We never
did the deal.
Did he really believe that I would succumb to his asking
price? Did he think that I wouldn't do the appropriate amount
of due diligence on his "story"? Did he believe that I would
even consider doing business with a person who would stretch
the limits of credulity with an outrageous set of numbers?
About a month after the deal died, we conducted a
post-mortem and I asked him those questions. His response:
"Rand, it's only business."
HUH?!
A year later, I was helping a $1 billion (revenue)
financial services company craft its strategy. During my first
one-on-one meeting with the CEO, I asked to review their
current document. He handed it to me with some apparent
unease. It consisted of some very lofty philosophical
statements about being "the best they could be." As I scanned
it, the president leaned over my shoulder and flipped the
pages until he arrived at the pro-forma financial document.
"This," he proclaimed, "is the meat of the document." I
inquired, politely, if I could ask him some questions about
the plan and the process that produced it. He looked at me
suspiciously, but said OK.
The bottom line: There was no evidence that they had
considered how they would achieve the numbers they projected.
So, the plan was a credenza ornament and the pro forma was
really bull sheeta.
Here are some lessons, first from the initial example:
1. Don't assume that others will do business with you on
the same (above board) basis upon which you will do business
with them. Don't become cynical; do become discerning.
2. Don't conclude, when you've learned a tough lesson, even
if it's cost you some money, that "it's only business," and
that you should adjust your future approach because some
others might cut ethical corners.
3. If you are not a "detail monger," find someone that you
trust who is. You need to explore every crevice in a potential
transaction.
4. Conduct your transactions as if the other party is your
clergyman. Be the example for others! Your reputation depends
upon your credibility.
And, from the second example:
Business plans must:
• provide the linkages necessary between lofty and
philosophical, on the one hand, and specific and quantifiable,
on the other.
• result in specific people doing specific things,
culminating in specific results, consuming specific resources,
within specific periods of time. If they don't, you are
wasting your time.
• create the focal point for an organization's reward
systems. What gets rewarded, gets done. Reward systems must
drive the achievement of planned results, not the number of
Suzie's sick days or Fred's adherence to the dress code.
• create buyer value in measurable ways.
• undermine the status quo.
• never merely extrapolate the past into the
future.
