Gongol.com Archives: October 2021
Nobody with any sense would accuse Warren Buffett of being a novice deal-maker. Having transacted scores of buyouts placing existing firms under the Berkshire Hathaway umbrella, Buffett knows what goes into a contract to buy or sell. And even having conducted dozens and dozens of transactions in the years since, Buffett still openly regards his 1983 purchase of the Nebraska Furniture Mart as one of his favorites. It was a $55 million deal conducted in just a page and a quarter of type. ■ Buffett praised the deal when it was new, writing: "I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I'd rather wrestle grizzlies than compete with Mrs. B [Rose Blumkin, the company founder] and her progeny." The year following, he praised the deal again: "Our evaluation of the integrity of Mrs. B and her family was demonstrated when we purchased 90% of the business: NFM had never had an audit and we did not request one; we did not take an inventory nor verify the receivables; we did not check property titles. We gave Mrs. B a check for $55 million and she gave us her word." In his 2013 letter, he returned to the sale, saying "Mrs. B simply told me what was what, and her word was good enough for me". And in his 2020 letter, he returned to extol the simplicity of the deal once again. ■ Not everyone is going to make deals with savvy immigrants who overcome great odds (like arriving in America unable to speak English) with square dealing. But it is wise not to overlook the centrality of mutual trust in the Buffett/Blumkin deal. Hundreds of pages of contract language would have enriched the attorneys writing them, but they would not have altered the basic squareness of the deal. ■ No contract can account for every contingency, nor should it. Unfortunately, disproportionate bargaining power rears its ugly head as "standard" contracts grow longer, larger companies impose payment terms that favor them at the expense of smaller suppliers, and loser-pays arbitration raises the stakes in any dispute (usually to the benefit of the party with the deeper pockets). ■ When people grow anxious about inflation (which is, after all, simply paying a higher nominal price for the same outputs), what almost always goes overlooked is the hidden "inflation" of deadweight in contracts. For a while, parties can grin and bear it through a few new adverse contract terms here and there. But before long, contract inflation -- that is, deals that take more and more pages to document before any real business takes place -- starts to impose real costs. Either someone must spend time, energy, and expertise to review contracts in-house, or they must pay someone on the outside to perform a review. And with each new adverse term, someone within the agreement chain needs to account for new risks by pricing them in somewhere. ■ These problems point to the absolute centrality of having two things. One is a clear, equitable, and understandable legal system for conducting business. If it takes too long to work out disputes in the courts, then people will seek to work out the disputes in contract language instead -- effectively front-loading all of the hassles of a court case into the initial contract negotiation. (This is wildly inefficient.) ■ The other is a widespread agreement to earn, keep, and abide by good reputations. Warren Buffett liked Rose Blumkin's reputation, so he was able to make a $55 million deal in fewer than 1,000 words -- that's $55,000 per word of contract language, anchored almost entirely on a mutual trust resulting from earned reputations on both sides of the deal. ■ So, while people are worrying about headline inflation -- and whether it's structural or transitory -- we really ought not to miss the consequences of contractual inflation, too. Those consequences take a while to trickle down through the economy, but they are quite surely real.