The
Hockey Stick
The situation depicted above occurs frequently in
the chemical industry. Sellers very often will forecast a significant
increase in sales and earnings compared to prior years, and
buyers who see such forecasts will invariably discount the projections,
in some cases entirely.
Like the boy who cried wolf however, the seller in some cases
may be making a reasonable forecast and must convince the normally
skeptical buyer that the future is indeed as bright as it says.
The buyer must look beyond the simple numbers and understand
exactly what is behind the rosy scenario to see if there is
substance to it.
In the article that follows, we will discuss the "Hockey Stock"
from the seller’s perspective and the buyer’s perspective.
The Hockey Stick
From the Seller’s Perspective
Credibility – The most important factor that a seller
must keep in mind when making forecasts in the context of a
divestiture is to maintain its credibility. If a seller makes
forecasts which are not based on a good faith assessment of
the future, not only will potential buyers quickly see through
this but it will affect these potential buyers’ overall impression
of the credibility of the seller on other matters in the negotiation.
Anticipate Buyer’s Reaction – Regardless of whether seller’s
forecasts are realistic or not, the almost universal reaction
of buyers when seeing these types of projections is deep skepticism.
As a consequence, the seller should be prepared to explain in
detail what is behind the projections. The seller should also
be prepared to receive offers that include a portion of the
purchase price payable after the closing based on the achievement
of results that are consistent with seller’s projections.
Remember
- If a sale takes some time to accomplish, past projections
will be compared to actual results to see if they have been
achieved. It is not uncommon to see a somewhat stale offering
memorandum on a business which contained rosy forecasts
which were not achieved.
- Your managers who have to defend the forecasts during
the divestiture process may soon become employees of the
buyer. If forecasts made during an effort to sell a business
are unduly optimistic, this may be disclosed to the buyer
by key managers before they become employees of the buyer
after a closing.
From The Buyer’s Perspective
Remain Skeptical, But Keep An Open Mind – Since the
majority of hockey sticks are not realistic, the types of
reactions depicted on the front of this newsletter are usually
justified. Nevertheless, there are some situations when a
hockey stick may have a basis in reality and therefore it
pays to keep an open mind when a seller forecasts a much-improved
future.
Get The Detail – If a seller is intent on seeking a
price that is based at least in part on the future projections
it has made, a very detailed understanding of the basis for
their forecast is needed. Very often, such forecasts are not
backed up with solid information and a thorough due diligence
investigation in this area will uncover the real situation.
Be Creative – Earnouts and other forms of contingent
payments very often are a win-win in a deal where the seller
truly believes in its forecasts for the future. If a seller
insists on getting paid entirely at closing, based on a future
that is markedly better than the past, this is an obvious
red flag to a buyer.
Hold Managers Accountable – If a manager who is responsible
for a business that is being sold will likely be retained
by the buyer after a closing, the buyer should make it clear
to the manager that the optimistic forecasts that have been
presented will form the basis of his/her goals and objectives
as a new employee and that his/her compensation will depend
in large part on meeting those forecasts.
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