Pro forma financials are overly optimistic.

We’re going to show how a private equity client reduced their equity check size by $6M.

How? By using customer insights to calibrate pro forma financials and build a more accurate valuation model.

Pro forma financials are like my new year resolution to read a book a week. Well-intentioned but doomed from the start.

Inflated pro formas are a real challenge for investors given how important forward-looking financials – specifically cash flow – are to M&A valuation models like the Discounted Cash Flow method which many of our clients use.

I have seen a pro forma from a company that was expecting a 100,000% increase in revenue over four years. That’s right. $1M to $1B in four years. It’s not impossible, but highly unlikely.

We all know pro forma financials tend to be exaggerated, but that doesn’t mean they aren’t grounded in some degree of reality. Historical data, market trends, business cycles, and several other variables are considered when preparing these estimates.

Unfortunately, what is often missing is direct input from the source of a company’s revenue in the first place – its customers!

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As an example, we were conducting buy-side due diligence on a target company that was expecting a 50% increase in revenue from 2020 to 2021. Our private equity client was rightfully skeptical since the target serves end markets that have been hit hard by COVID, and wanted to pressure-test these assumptions.

After conducting in-depth interviews with decision-makers at each of the target company’s top accounts, we heard a very different story:

  • The target’s top account was forecasted to increase spend by nearly 50%. After speaking with the key contact at this account, we learned there was not likely to be any material change in spend at all.
  • The second-largest account was forecasted to grow by 84%. We spoke with two decision-makers here, and while both said there would be an increase, they were only expecting about a 25% bump in spend.
  • The only bright spot was account number 6. Management was expecting a 31% drop in spend, but the customer said spend will be relatively stable. But, given the top three accounts were 60% of revenue, the impact here was negligible.

Armed with these insights, our PE client was able to calibrate forward-looking financials as well as their valuation model. This resulted in that $6M check size reduction.

When you invest in a company, you are essentially investing in customer relationships which, in turn, generate revenue, profit. While pro forma financial are grounded in data, we sometimes forget to include the most predictive data point of all – the voice of the customer.


Anthony Bahr is Managing Director of our Customer Due Diligence practice. When he's not advising private equity clients on customer risk, he guest lectures on consumer behavior and research methodologies at Cornell University, Loyola University Chicago, and the University of Pennsylvania.

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