How do you deal with data gaps and uncertainties in the target company's financial projections?

In my decades of experience in corporate development, I've found that using a blended approach to valuation—combining DCF, market multiples, and precedent transactions—provides the most robust assessment. This not only mitigates the risk of relying on a single flawed metric but also allows us to triangulate a fair value that aligns with market realities and historical deal trends.

Using multiple valuation methods to address data gaps and uncertainties is indeed a prudent strategy during the assessment of a target company in mergers and acquisitions (M&A). Each valuation method offers unique insights and helps mitigate the risks associated with relying on a single approach.

Regardless of the accuracy of their financial projections, they should have audited financial statements. Many startups don’t want to go to this expense but it’s definitely an investment that will increase the multiple used to determine the amount a buyer will pay for your company. That said, projections should include an explanation clearly spelled for every single revenue. A projection is an estimate, often based on assumptions but the basis for the assumptions should be transparent and easy to validate.

The best way to bridge data gaps is to get to source data and source person. Most times, the gap arises due to transmission of data from the source to the recipient. Ex. The business development may give a certain level of sales, provided they are given certain resources, but the finance team may just take the sales number without budgeting for the marketing investment required in full. This creates a disconnect when final level discussion takes place between Principals and abnormal observations are detected.

In my experience, a crucial step in due diligence is to scrutinize the target's income statement, removing one-time gains or losses to reveal the true earnings power of the business. This normalized view is essential for an accurate valuation, as it allows us to assess the sustainability of the target's profitability and project future cash flows with greater confidence.

Adjusting for the quality of earnings is a crucial step in accurately valuing a target company, especially when dealing with data gaps and uncertainties during mergers and acquisitions (M&A). A thorough analysis of the quality of earnings helps ensure that the earnings figures presented in financial statements truly reflect the company’s operational performance and are sustainable over the long term.

Mindset can significantly impact the outcome. A founder-run private business might not have felt the need for meticulous reporting beyond statutory requirements. Management might be feeling overwhelmed or on the back foot when faced with long DD info request lists. The acquiring team would do well to avoid undertaking an interrogation or drawing any hasty conclusions about intentions. It’s more constructive to establish a position of trust and take a collaborative approach: Working together to confirm reality. The M&A team should brief advisors and in-house teams to ensure consistency. This exercise can be a blessing in disguise as an opportunity to assess the management team. Are they able to demonstrate rigour when required?

Throughout my career, I've seen how applying discounts or premiums can significantly impact the final valuation. It's crucial to meticulously analyze factors such as the target's market position, growth prospects, and potential synergies with the acquiring company to ensure the adjustments reflect a fair and realistic picture of the deal's value.

Applying appropriate discounts or premiums to a target company's valuation is an essential technique for addressing data gaps and uncertainties during the M&A process. These adjustments allow for a more nuanced assessment of a company's value by accounting for specific risks, opportunities, and unique characteristics of the business being evaluated.

Incorporating reasonable and substantiated assumptions into any investment valuation is imperative, particularly with less liquid or proportionately large stakes. Subjectivity and critical assumptions should consider all available tangible points of reference (DCF, comparable transactions) while maintaining a comfortable discount.

From my experience, scenario analysis is an invaluable tool to assess the target's potential under different market conditions. In one deal, we modeled three scenarios (best, base, and worst case) to evaluate a tech company's valuation. This revealed a potential 30% swing in the company's value, highlighting the importance of stress-testing assumptions and pricing in the deal's inherent risks.

Conducting scenario analysis is an effective way to address data gaps and uncertainties when valuing a target company in the context of mergers and acquisitions (M&A). By creating various scenarios based on different assumptions about future performance, cash flows, and market conditions, you can gain insights into the potential range of outcomes and better assess the risks and opportunities associated with the deal.

Validating your due diligence valuation with external sources is an essential strategy for addressing data gaps and uncertainties during mergers and acquisitions (M&A). Engaging independent appraisers, industry experts, or market participants can enhance the credibility of your valuation and provide valuable insights that strengthen your decision-making process.

Throughout my career, I've found that tapping into external expertise is crucial. In one instance, engaging an industry veteran revealed a hidden regulatory risk that the target company hadn't disclosed, prompting us to adjust our valuation and negotiate a fairer price. This saved us from a costly mistake.

Valuation is an art. Utilizing various mechanisms is essential, as well as sensitizing the inputs and outcomes. And seeking fresh, external opinions is also essential to keep the valuation free of bias. In the end, there is likely no correct single valuation - only at a point in time.