One of the most difficult tasks for an owner of a software company to undertake is building credible financial projections. Most managers develop financial projections for general business planning or for raising new capital. Here, well take a look at projecting financials in the context of pursuing an exit strategy through mergers and acquisitions. When developing financial projections, it is important to capture a realistic future earning potential of the company, especially if the forecast is used for an M&A event. Most acquirers will want to structure the deal around the future operating performance of the company. Below are a few things to think about as you take on the challenge of building solid financial projections:
• Make sure your projections are realistic compared to the companys historical performance and industry metrics such as revenue growth, profit margin, and expense ratios.
• Your assumptions should be clearly defined and documented. Study your market and understand the factors that will drive your company to succeed. Also know the factors that will cause your company to fail. The basis of your projections is more important than the projections themselves as it informs the buyer about the financial opportunity and how the company intends to achieve its goals.
• Be conservative but not overly conservative; be optimistic but not overly optimistic. If you are too conservative, buyers will not see the proposed opportunity. On the other hand, if you are too aggressive and miss your targets while in the M&A process, acquirers may require price adjustments to move forward or worst kill the deal altogether. Remember, acquirers are buying the future, so tell an exciting but realistic story of the potential of the company going forward.
• Projections should be for three years so that potential buyers can easily incorporate it into their valuation model.
Forecasts are a necessary evil. The more comprehensive and detailed you are with your assumptions, the more creditability you will have with potential buyers.
A version of this article originally appeared in Soft•letter and Software Success.