When should we use management assumptions / projections in an LBO model? When shouldn’t we? (1 min)

We should use management assumptions and projections in an LBO model only if management has given us significant back-up data and rationale supporting their assumptions. For example, if management is projecting a certain range of revenue growth for each of their segments, we should find out what is underpinning that growth and their reasoning for segmenting it the way they have.

If much of the business’ topline growth is dependent on one emerging but rapidly growing sector, it’s important to perform a deep dive on that critical sector to understand the competitive landscape. We can analyze how consolidated or fragmented the segment is, and if the company’s positioning in the sector is defensible and if there is market share to be won. We can also analyze the products and speak with industry experts to get some comfort around the growth rates.

If much of the business’ topline growth is based on winning key large customers such as large national accounts, we need to perform due diligence on the sales process, such as looking at which customers the company has in its sales pipeline and what stage each discussion is at.

Similarly, if the company is planning to grow revenue through acquisitions, taking a look at the pipeline of potential M&A leads and seeing which ones have LOIs signed would be a great way to validate that.

If cost improvements are coming from enhanced technology or manufacturing processes, it’s important to understand the technical details of these initiatives and speak to industry experts to make sure that the margin improvement makes sense.