An entrepreneur is optimistic by nature, so too when issuing forecasts. However, realistic forecasts are crucial in business acquisitions because they form the basis for the valuation of a company and directly influence the final sales price.
They provide an estimate of a business's future performance, such as expected revenue, profit and cash flows, and largely determine the price a buyer is willing to pay. Whether it is a discounted cash flow analysis or another valuation method, the projected cash flows from the forecast always play a crucial role.
A well-founded forecast based on past results and concluded contracts for the future strengthens the seller's negotiating position by building trust and clearly communicating expectations. At the same time, a realistic forecast helps avoid surprises during the due diligence process, which furthers the sales process and increases the likelihood of a successful transaction.
An overly optimistic forecast
It is tempting to present an optimistic forecast in the expectation of realizing a higher sales price, but failing to meet the forecast has negative consequences. An overly optimistic forecast, the so-called "field hockey stick," often arouses reticence among buyers, especially if the figures cannot be properly substantiated.
Failure to meet the forecast can disrupt negotiations and lead to price adjustments. Moreover, an optimistic forecast will often result in a transaction structure with a variable subsequent payment (called earn-out). If the seller does not meet the set targets, this will result in missed payments or even post-acquisition legal disputes.
An overly cautious forecast
On the other hand, a forecast that is too conservative may result in potential buyers not being interested or the business being undervalued. Too low a forecast does not show the full growth potential of the business, which can result in less attractive bids and missed financial benefits.
This is because buyers are looking for growth companies, and with a conservative forecast, the seller may receive less than the true value of the business. This can put the seller in a weaker negotiating position, as buyers factor less future potential into the price.
Preparing a realistic forecast
A realistic forecast is based on thorough analysis and substantiated assumptions. It is important to analyze historical performance and use it as a basis, taking into account factors that have contributed to both success and setbacks.
The forecast should be consistent with broader market trends and the competitive landscape to outline a realistic growth path. Correcting for one-time effects and excluding extraordinary events help create a sound basis. External advisers can provide an objective view here and identify blind spots.
Preparing a well-founded forecast helps to correctly assess the value of the business and prevents disappointments during the acquisition process. Finding the right balance between optimism and caution is essential so that the forecast remains credible and satisfies both parties. As a result, a balanced forecast contributes to a successful transaction and building trust between buyer and seller.
