In a perfect world, the connection between a company’s past, present and future performance would align logically, and valuations would follow. In reality, fast-growing or volatile businesses rarely fit this profile. The sellers of these businesses often want their sale valuations to be based on projected future performance … before there is any guarantee that the improved results are actually going to happen. This is not “having your cake and eating it, too.” It is asking buyers to pay for a cake that hasn’t finished baking. While sellers believe projections should drive value, buyers view them as hypotheses that must be proven.
The good news is that businesses can be sold off of projected financials that are materially stronger than the historical results. The keys are to:
Not lose credibility by being overly optimistic. My golf handicap is 14; my best round ever was an 80. Yet if I assemble my best score ever on each hole at my club, the total would be a round of 58. Yes, I have proven myself capable of carding that score “if everything goes just right.” This is the way many sellers project future performance. “If we book all the possible new orders, have spot-on production, don’t lose any key people, don’t have any supplier problems and catch myriad other breaks, we could hit sales of X and EBITDA of Y.” (With X and Y almost always being record figures.) The problem is that there is not one chance in 100 that all these projected events will simultaneously occur. If such projected results are presented, the seller will lose credibility, especially when the more realistic results unfold. Much better to offer more realistic projections, even if they are on the optimistic side.
Persuasively support the rationale for the improved results. Most buyers will consider optimistic projections if they are supported with data. This can be in the form of
- Booked backlog.
- A robust pipeline of prospective customers.
- Demonstrated end market growth.
- Proven new products creating a stir in their industry.
- Expanded production capabilities to turn the backlog into profitable sales.
The specifics of a given company’s circumstances will determine what support can be presented; this is when the seller’s investment banker should work creatively with the seller to “make the case.”
Deciding when to go to market is important to making projections stick. If a company’s March trade show is expected to generate major orders, then go to market in April — likewise if new products are being introduced that could generate new sales. The fewer “leaps of faith” that buyers have to make, the better the chances that the seller’s projections will be accepted.
Buyers often propose making part of the price contingent on the projections proving out. This is another hazard of a seller projecting too optimistically.
The fewer assumptions buyers must make, the more likely they are to accept a seller’s projections. The simple question sellers should ask when preparing projections is, “Would I believe these projections if I were the buyer?” If the answer is not “Yes,” then it is time to rethink the projections. ●
Mark A. Filippell is a M&A professional
