I wanted to write a quick note about something that’s very negatively impacted a deal I worked on recently: the seller’s forecast, which to many sellers is just another marketing tool.
It’s difficult for me to describe what this seller had as a forecast because there was so little information in it. Typically the seller provides an income statement and balance sheet in as much detail as is relevant, which in an M&A transaction is a lot. A lot of sellers, most often if they had their own sellside banker, would provide very little detail. I’m not sure how they thought that would help them. What it did was make me dig deeper into every number, often turning up things that the sellside banker probably hoped they could hide by not providing that level of detail. And I would also create harsher sensitization scenarios because I couldn’t support the assumptions I was forced to make.
The better approach for sellers is to provide lots of detail, and if there’s anything negative highlight it for the buyer before it’s uncovered. If you highlight it first, you can spin it. If the buyer finds it, you look like you were trying to hide it. And when that happened, I would always ask myself: what else are they hiding?
The second biggest mistake that sellers make is only providing a forecast that assumes a transaction closes. This is bad because when a buyer is thinking about value, they not only consider the value to them but they also consider the value to someone else. This is especially true in auction scenarios where there are multiple bidders competing. Whenever you do a valuation, you run an LBO to estimate what a private equity buyer might be willing to pay. You can’t run an LBO if the only forecast you receive assumes a strategic picks up the company, injects capital, and realizes all kinds of synergies.
A smarter seller would create a forecast that assumes the status quo. Then they would layer in a “what if” scenario for each buyer. Only in the “what if” scenario would you assume a transaction, capital injection, or synergies. If you had time, you would create a separate “what if” scenario for each buyer if there are multiple in an auction. That way you can use the “what if” scenario to help each buyer see the benefits of the acquisition. Any time a seller did that, I loved it because they were essentially doing my job for me.
With a status quo forecast, a buyer can more easily evaluate the accuracy of the forecast. Since M&A transactions take 6-9 months at minimum, with each passing month the buyer can compare the seller’s performance to the forecast. If the seller exceeds the forecast, then that makes the buyer really happy - they’re thinking upside! If the seller’s forecast is inflated because it assumes synergies, for example, the buyer instead sees underperformance. And that puts doubt in the buyer’s mind about the value of the transaction, which can very easily kill it.
To summarize, the two biggest mistakes sellers make when forecasting are providing too little information and not creating a status quo forecast. Avoid these mistakes, and you’ll have a much smoother transaction.