TLDR: Math problem about optimal strategy for hiring job applicants has similar (but not same) assumptions to searching for a company. Does anyone have a set # of deals they want to seriously evaluate before pulling the trigger on an LOI?
The secretary problem (https://en.wikipedia.org/wiki/Secretary_problem) is a scenario in optimal stopping theory that derives an optimal policy for selecting a job applicant. The formulation assumes there is one position to fill, a known number of applicants (n) interviewed in random order, and that each applicant must be accepted/rejected immediately after the interview. The mathematically optimal approach is to reject the first n / e applicants (where e is approx###-###-#### and to then accept the first applicant that is better than all prior applicants. This is supposed to balance the risk of committing too early against waiting too long and missing your best chance.
Replace "applicant" with "company", and this sounds a little bit like a search fund. Assume you can seriously diligence/evaluate one business per week or 104 during a two-year search. If the secretary problem assumptions hold, you should theoretically evaluate ~38 companies before making an investment.
The secretary problem assumptions aren't exactly applicable (the company must also "accept" you, companies cannot be unambiguously ranked, LP experience can help you avoid the risk of committing too early, search can be extended, etc.).
However, does anyone have a set # of deals they plan to seriously diligence before committing to an LOI?
Secretary Problem Applied to Search Funds?
by a searcher from The University of Chicago - Booth School of Business
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We maintain partnerships with database providers that make searching more effective, efficient and affordable along with features that help searchers find deals and investors and vice versa.
It actually parallels a principle I use in locating the best deal - whether a new hire, a real estate deal or a business. It goes something like this"
"You don't know what a good deal looks like until you let one pass you by."
Or stated another way, did I regret passing on the deal afterwards? After all the excitement, momentum and emotion is gone, would I have gone back in time and done the deal? Sometimes I just decide to let a deal go because I know it's too early in my decision making process. I haven't done enough reps and built up an internal database of situations to make a decision I'm highly confident in.
If I wished I could go back in time to do the deal, I can see what qualities made it appealing and I start having a framework to think with for future deals.
Also, as Georgyi mentioned, pre-LOI you are mostly screening, not really doing due diligence on the company. Hopefully have a thorough CIM to review. However, if the seller and/or their broker/M&A Advisor found out you had seriously looked at 38 companies and were planning on looking at still many more, that would send up serious red flags, and plays into some of the concern and misconceptions that the seller's side has about searchers. The seller's side wants to limit the number of potential buyers they divulge confidential information to in order to reduce the chance of a confidentiality breach, not to mention time spent away from running the business. So, spend some serious diligence time on the industry, geography, and external factors. That way you are focused on what you are after and can limit the number of companies you actually dig into. And if you get to the LOI stage, you should definitely be ready to pull the trigger if due diligence confirms all is on the up and up.