Outsized Expectations (#419)
Exceptional outcomes are often worth pursuing. They just should not be expected.
Over the past few years our company has been in the market for acquisitions as part of our growth strategy. Searching for acquisitions is a bit like dating, with a similar percentage of success; you might have 50 to 100 initial conversations and explore things with a handful of prospects in depth just to get to one perfect match.
One of the first things I seek out in these initial conversations is the seller’s pricing or valuation expectations. Acquisition prices, as with housing prices, tend to follow basic formulas and norms based on the industry, size of company, profitability, and other factors.
If you’ve ever bought a home—or watched enough HGTV—you know real estate agents often price a home based on the cost of similar homes in the same area. While sellers sometimes get lucky, you can’t expect $900K for a four-bedroom house in a market where four-bedroom homes of the same condition tend to go for $700K. Your realtor would tell you upfront you were being unrealistic.
In most cases of mergers and acquisitions (M&A), there is a similar pricing approach. Whatever the industry or company type, you can probably estimate a valuation range by looking at comparable deals in the same industry and similar size of business that have cleared the market, or actually sold.
Not surprisingly, many sellers have an inflated valuation of their own businesses based on exceptionally high transaction prices they’ve heard about in the rumor mill, or poor comparisons. For example, a seller in a services business that the market would value around $10 million might be expecting $50 million, because that’s what a tech business founder in one of their networking groups claims to have been offered for their company.
Over years of M&A discussions, I’ve noticed sellers with these types of unrealistic expectations usually find themselves without a transaction after investing years of time and energy in the M&A process. Surprisingly often, they are convinced their businesses deserve to have an outlier valuation and be the exception, rather than the norm.
It’s true that in any market there are extreme cases, and people who wildly overpay for homes, art, companies or anything else they don’t want to lose out on. But these extreme outcomes shouldn’t dictate your expectations—exceptions are, by definition, outliers that are rare in nature.
The fact is that in many cases, largely due to our egos or outsized ambitions, we believe we will be the exception, rather than the rule. However, what more often leads to success is working hard to put ourselves in a position to be an exception, while still anchoring expectations to the norm. Or, to copy a classic phrase—expect the norm, hope for the exception.
Amazon and Jeff Bezos are an exception. Michael Jordan is an exception. Oprah Winfrey is an exception. They have a miraculous blend of talent and drive, plus good luck and timing. They aren’t the rule, the norm or the expected outcome; they are decidedly outliers. While you can aspire to work as hard as Bezos, Jordan or Winfrey, going into business, sports or entertainment expecting to have the same outcome as them is a low probability gamble.
Expecting that you will be the exception will also set you up for a lot of disappointment. When you decide being an exception is the only outcome you will settle for, you’ll likely waste a lot of time and energy just to end up disappointed or viewed as out of touch with reality.
While people tend to let their emotions get the best of them, markets very often tend to be rational, especially over the long run.
If you have an outcome you are seeking, especially with something you are hoping to sell, don’t expect to be the outlier. Instead, talk to a number of people who have done the same and try to get a sense of the most likely outcome.
While it’s good to aspire, it’s important to understand the market and the odds.
Quote of The Week
“The secret to happiness is to lower your expectations.” - Charlie Munger
Have a great weekend!
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Great message. TY Robert. I think it’s key to notice that in our culture we are/were consistently prodded and encouraged to seek “exceptionalism” in our lives. That emphasis keeps the goal flickering deep within, despite our experiences to the contrary.
"Expecting that you will be the exception will also set you up for a lot of disappointment. When you decide being an exception is the only outcome you will settle for, you’ll likely waste a lot of time and energy just to end up disappointed or viewed as out of touch with reality. "
This statement is a great description of Burnout!
Hopefully we will be seeing more culture encouragement to
“expect the norm, hope for the exception.”
I am thinking of Caleb and Joshua who were the outstanding exceptionals among the whole of the Israelites to exit from Egypt and enter the promised land of Canan .