Fast thinking in private equity: The role of heuristics in screening buyout opportunities

ABSTRACT

This study utilizes a multiple-case analysis to examine the decision-making processes surrounding buyout decisions of small-to-medium businesses. Qualitative data were generated from semistructured interviews at 20 private equity groups. Rather than relying on a retrospective review of prior decisions, we present decision-makers with teasers, a summary of an investment opportunity. Our results indicate that heuristics are utilized to guide selection and execution of buyout investments. We also uncover the role of affect: strong positive or negative responses to specific stimuli in the teasers. Furthermore, the use of heuristics has important implications in the sourcing of private equity for business owners.

Notes

¹ The actual teasers, developed by Corporate Finance Associates, are available from the authors. The authors did not construct the teasers; these were actual buyout opportunities. The online Appendix shows Teaser D for illustration.

² Attribute substitution is the notion that “when confronted with a difficult question people often answer an easier one instead, usually without being aware of the substitution” (Kahneman and Frederick 2002, p. 53).

³ Heuristics differ from the concept of routines; routines are viewed as recurring patterns of action or behavior (Nelson and Winter 2009), as opposed to shortcuts that simplify the evaluation of alternatives (Pingle 2006).

⁴ The teasers, representing actual buyout opportunities, were developed by Corporate Finance Associates. Teaser D is illustrated in the online version of this article at the publisher’s web site, while the others are available from the authors.

⁵ The middle market is often defined as buyout deals up to $500 million (Thomson Reuters 2015).

⁶ The coding scheme is available from the authors.

⁷ Number in parentheses represents respondent listed in Table 3.

⁸ Tallying is unexpected but described in the adaptive toolbox of fast-and-frugal heuristics (e.g., Gigerenzer 2008; Gigerenzer and Gaissmaier 2011).