Is the past comparable to the future? Thoughts about how to validate a company’s growth
Most due diligence assignments cover this topic: corroborate a company’s business plan. The validation can be done from a commercial or financial perspective. For the latter, the validation of future growth is quantitatively driven. For example: is there an explanation for these figures? How do they tie back to historical financials? Yet, there is no guarantee that growth will come as modeled.
Today, I am sharing my thoughts about a company’s growth. It’s no recipe or guide on how to approach an engagement, it is rather a collection of thoughts to keep in mind.
1) Top-line vs. bottom-line
It is important to differentiate between top-line and bottom-line growth. And everything that happens between top and bottom. Fixed costs can grow at a lower stage compared to revenue and to their fixed nature. Revenue can grow at a slower rate compared to EBIT(DA). For example, if the drivers are internal efficiency improvements. That way, the company increases its EBIT(DA) by reducing its costs. So, determining which growth rates to use for which line items is already an important first step.
2) Historical data
How many years are we looking at? In a due diligence, the last three to five years are analyzed. Is this enough to make meaningful statements about a company’s future growth? It depends on the company, the industry and the business model. Taking into account the availability of data is also important.
3) Life cycle consideration
own creation by the author
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This chart shows the different stages. And it also shows that growth depends on the company’s current stage. It is important that we understand the company’s stage. And also, to which extent this will change within the next years. For example, growth rates will likely decline for early and growth firms. But they will be stable for mature firms and negative for firms in the decline.
4) Industry matters
Each industry has its own drivers. Cyclical industries follow a “high growth — low growth” pattern, ups and downs. Project-based businesses (construction, consulting firms, automotive suppliers) often follow the order book. The order book is the pipeline with future projects. It provides good visibility of how the company will do in the next year.
Key aspects
Final thoughts
When it comes to estimating growth, there is no right or wrong, it all depends on the assumptions made. In this article, I shared some thoughts about a company’s growth rate. I hope these help you in your next discussion about a company’s business plan.
Hi, I am Jan, I share insights about financial due diligence procedures. If you find this helpful and would love to receive more content like this, follow me here on LinkedIn.
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Very interesting thanks for sharing. I also like to bring an “outside view” as Chris Bradley would say. When a business expects to grow 5x faster than the industry I ask on which competitive advantage this optimistic projection is based (I usually get bnank states or even sometimes a "we don't believe in competitive advantage in ou indusrtry ??) . McKinsey & Company has shown that it is extremely rare to grow the top line much by market share gains only because it requires an outstanding competitive advantage. Of course you have to take into account the base effect (you can grow by 100% by moving from 1 customer to 2, so this is easier to apply to non start-up/scale-up firms). Still it's a sanity check.
Private Equity / M&A / Funding / Vegan / Business Development / Non-Profit
3 年Thanks Jan! Very important things to think about. As always, great work!
Partner | M&A Transaction Services at Deloitte
3 年Key points, Jan! One of the core problems is that most top line projections show a “hockey stick” pattern. This means that we can’t necessarily use the past as a guide to the future. It’s also important to not forget about the “cost of growth”. How much marketing expenses, capital expenditures etc. are required to achieve growth aspirations? What share of growth can’t be financed internally anymore? Jan Mozer