The Goldilocks Problem: How to get your forecasts 'just right'
Not too hold, not too cold... we share the 60% rule on how to push your growth forecasts without losing your credibility with a buyer.
The other day, I got a worried call from an entrepreneur. Let's call him Paul.
Paul has built a small but fast-growing fintech business. One of the big banks reached out, and explained that they see his company as an acquisition target.
They were quite early in the process, getting to know each other as the potential buyer considered whether to make an offer. The had a few calls. Paul shared an overview of the business, their plans and answered a few questions.
Then came the request that made him panic: "Could you send over your forecasts for the next five years please?"
Of course, as part of their early discovery about the business, any potential buyer will want to know how you (as the owner and operator) expect the business to perform in the coming years.
Paul knew the request would come. He is a top-class entrepreneur and has a clear idea of where his business is heading. He has carefully prepared budgets and forecasts for the next few years already.
So why was he concerned?
He wasn't sure how bullish to be in his forecasts.
You want your numbers to be ambitious enough to get buyers excited about future growth. Faster growth will give you a much higher price.
But if you inflate the numbers wildly, the buyer might not believe the forecasts at all. You could lose credibility, perhaps so badly that they walk away. So you would kick yourself for over-shooting the numbers. And what if they try to use those inflated numbers as the basis for an earnout?
In this article, we'll walk through the Goldilocks problem of forecasts β getting them not too hot, but not too cold. We will introduce the 60% rule and give you a structure for how to build out your forecasts for an acquisition.
The context
As part of their early discovery about the business, a potential buyer will want to know how you (as the owner and operator) expect the business to perform in the coming years. Usually three years, sometimes five.
First of all, they'll expect you to walk through a high-level summary in the initial meetings. Then you'll need to share some more data and charts in your Confidential Information Memorandum that is shared with interested parties.
Then, if the conversations move head, they will want you to share a full financial model with assumptions.
The 60% rule
How do you balance the need to show exciting growth but without over-shooting? How do you get your forecasts 'just right'?
Use the 60% rule.
You should set a forecast that you feel you have a 60% chance of achieving.
That means that it's exciting and ambitious, but also credible.
Statistically, that means that if you 10 attempts at running the business over the next few years, you'd hit your forecast 6 times and fall short 4 times.
That's easy to understand intellectually, but it's obvious a hypothetical scenario. So, practically what does a 60% forecast look like?
If things 'go to plan' β you execute well and you have good market conditions β you will hit these forecasts.
Critically, you shouldn't need to pull any miracle moves to get to these numbers.
A 'miracle move' would be somehow doubling the productivity of your sales reps, whilst also reducing your customer acquisition cost by 50%. Buyers will get really deep into these numbers and realise that your forecasts are overly ambitious, and you'll have shot yourself in the foot.
And on the flip side, if you hit a few bumps in the road (a new product launch doesn't go to plan, or your customer churn numbers go up) then you will fall short, but you would still be within a similar range.
Further reading
If you want to learn more about financial modelling, check out these two articles:
π How to build great financial forecasts for your buyer: We break down how to build out your forecasts, common pitfalls and some tips to impress your buyer.
π Behind the Bid: How buyers model their price: We explore how a buyer uses financial modelling and scenario planning to calculate what to bid, and what you can do to get a better price.