Oftentimes the number one driver of value in a business sale is recurring revenue streams. Examples of businesses that tend to yield hire multiples, ceteris parabus, include:
- Web-based business with monthly billings
- Central Station / Home Security – again, monthly billing model
- Government Contractors – clear view on future contract revenues
Since we do so much work in the GovCon space we’ll focus there (but the following concepts are crucial regardless of business type or industry).
In many cases company’s focus on historical performance as the basis of value. But what is a buyer really buying? In GovCon, to some extent they are buying bid history and past performance. But their focus is on the future. And if you are considering going to market, one of the most important steps you can take is put together a solid, well thought out, highly supportable waterfall chart.
What is a Waterfall Chart?
Simply put, a Waterfall Chart is a forward looking matrix that attempts to quantify future revenue streams. If you’ve spent some time in the consulting world (or reading the economist), you’ve probably seen a standard waterfall chart or two. They generally show the composition or makeup of some overall value. We often see a Waterfall Chart depicting company expenses as well.
Using a Waterfall Chart for Revenue Projections
At the most basic level, a waterfall chart shows how future revenues “tail off” as contracts end. The below is a simple waterfall chart that shows our government contractors backlog.
What do you notice? Well, as a buyer the first thing you notice is that revenues are declining every year. Why on earth would you buy a company that is evaporating? If it truly were declining with now future it would most likely be a firesale. But most buyers are smart – they realize you’ll eventually bid and win new work. But failing to show them what the future looks like is a recipe for a lower government contractor valuation.
Forecast and pWin
To take your waterfall forecast to the next level, add two more sections: works that’s been awarded, and work you are bidding on. But these revenues should not be added as a 100% certainty. Afterall, you won’t win every bid right? And in GovCon world, every IDIQ will not necessarily result in awards.
As the chart below indicates, add in your revenues in the “out” years by applying your pWin.
You now have a completed Waterfall Chart that highlights what your future revenues will look like.
For a Waterfall to be an effective government contractor business valuation tool, it’s imperative to drill down on WHY you’ve selected a particular pWin on a contract-by-contract basis.
Defending Your pWin
Buyer’s naturally have a skeptical eye – afterall they are the ones parting with a check in today in order to capture future revenues. You should expect to need to defend your projections at length.
To be successful in your defense consider developing an algorithm or framework for how you develop a pWin. Items to consider:
- Is the contract scope of a particular contract in line with your company’s record of performance?
- Are you the incumbent on the contract?
- Have you done business in the past with this specific customer?
- Does this contract related to any other contracts you are currently performing on?
- If not the incumbent, are there any issues that you are aware of with the incumbent?
As you can imagine there are plenty of ways to develop a frame work, but the important part is that you think through the issues, document the issues, and indicate WHY you have indicated a particular pWin to a contract.
We most often see Waterfall Charts used in conjunction with government contractors and defense contractors. The nature of the work directly lends itself to this type of forecasting. That being said, there is no reason that you cannot apply a similar methodology to another line of business.
Once you develop a feel for developing your own Waterfall, it becomes a fantastic and powerful tool in business valuation and M&A scenarios.