How Unrealistic Financial Projections Impact the Sale Negotiation Process

by Eric Bosveld, B&A Corporate Advisors

July 30, 2020

Those of us working in M&A have all seen the proverbial “hockey stick” projections presented by an overly optimistic seller trying to generate interest in their business.  Usually, it is accompanied by some vague explanations with a year-over-year growth target of “insert inflated figure here”.  Buyers typically view a seller’s financial projections with a degree of skepticism, and most will build out complex valuation models to determine a reasonable price they can afford to pay, based on their own assumptions.  In this blog article, we attempt to make the case for why you should be careful about how you present your expected growth potential and financial projections to build rapport and credibility with a potential buyer, and thereby enhance your position in the negotiation process.

The reality is that the best predictor of future performance is past performance.  Your negotiating position is enhanced if you can demonstrate that when we did “this”, the outcome was “that.”  For example, if you can demonstrate that your recruitment, onboarding/training, compensation, and management of new salespeople can typically generate increased sales from “x” to “y” over a specified time period, then it follows that if you repeat this process, you could make a reasonable prediction that is credible.  Other examples abound, such as marketing and advertising spending, capital expenditures, acquisitions, new product introductions, etc.  All are most credible when you can demonstrate a track record on execution.

Including projections based on a strategy that you have little experience in executing, is likely to be discounted to a large degree by a buyer.  These are more likely to be considered ideas than true projections.  While ideas are helpful in creating optimism on what may be possible for a new owner, any tie-in to the financial projections should be layered in and presented more as speculative potential, rather than true projections.  It’s important to separate what is doable based on track record and what is possible based on new ideas, wherever possible.

One area that is often missed is the inclusion of the additional working capital, additional expenses, and/or other investments that will be required to execute the plan.  Details missed on the expense side simply weaken the seller’s credibility and negotiating position.

The best approach is to have a robust business plan incorporated into your core business processes, well in advance of a potential sale or exit.  This may mean taking the management team and perhaps even a cross-section of key employees off-site to develop, review, and revise your plan.  Of course, incorporating KPIs (key performance indicators) to measure and track your progress toward your strategic goals will be helpful when negotiating with a buyer.  The most important aspect is to be able to demonstrate to a buyer that you “plan the work and then work the plan.”

You never get a second chance to make a first impression! The same principle applies to a potential buyer.  When sharing financial projections with a prospective buyer, it is important to get the negotiations off to a good start by having credible financial projections.  In fact, some would argue that no projections are better than those that are vague or even worse, unobtainable and/or unrealistic.