Quick answer: Scenario analysis for a sale builds a base case, an upside case and a downside case from one model. The base case is management’s best estimate if known plans proceed. The other two change named events in volume, price, cost and timing, and every assumption carries a label for its basis. Buyers and lenders use the downside to test whether the business can service debt and to decide how much of the price to put at risk.
Key points
- The base case is the case the owner is prepared to be held to, not the most optimistic one, because it is the version buyers compare with their own.
- Cases differ by a short list of named events that move volume, price, cost and timing, while history, accounting policies and the model’s structure stay identical.
- A downside case is a plausible stress with a name, such as a customer cutting orders at renewal, and not a worst case or a flat percentage taken off every line.
- Lenders and buyers commonly read the downside first, because it shows whether debt can be serviced and how much of the price should depend on results.
What the base, upside and downside cases each answer
The base case is management’s best estimate of what happens if existing contracts run their course, planned actions are carried out and nothing unusual occurs. It is the case the owner will be held to in diligence, so it is built from what the business has done and what is already in motion. A base case stretched toward a target gets rewritten by every buyer, and the stretch costs credibility on the numbers that were sound. The guide to management case versus buyer case shows what buyers do to it.
The upside case collects events that go better than planned, such as a new program starting early or a price increase holding with more customers. It records what the owner believes the business can do without asking a buyer to pay for it in cash at closing, which makes it the natural source of earnout targets. The downside case collects events that go worse, and lenders commonly size debt against it.
A scenario differs from a sensitivity. A sensitivity moves one driver and holds the rest, which ranks the drivers by importance. A scenario moves several drivers together because the events behind them are connected, as when the customer who cuts volume at renewal also resists a price increase. Buyers use both, and a seller needs the sensitivities first to decide which scenarios are worth building.
The four levers that separate the cases
Cases should differ by a short list of named events, each expressed through four levers. Everything else, including history, accounting policies, one-time items and the structure of the model, stays identical across cases, so the only differences a reader sees are the ones the owner chose to make.
| Lever | What moves | A named event that moves it | Where the evidence sits |
|---|---|---|---|
| Volume | Units, hours billed, customers retained | A large customer reduces orders at renewal | Order history and contract terms |
| Price | List price, discounts, product mix | A price increase is accepted by some customers and refused by others | Invoices before and after earlier increases |
| Cost | Materials, wages, freight, supplier terms | A supplier contract expires and reprices | Supplier agreements and quotes |
| Timing | Start dates, ramp speed, launch dates | A new program begins late | Customer correspondence and the ramp of earlier programs |
Timing is the lever most often left unstated. A program that starts late changes the year’s earnings without changing where the business ends up, and a lender testing debt service cares about the year. A case that moves timing should show it on its own line, as the example below does.
A scenario table worked through
The example uses one invented model. The second table shows what each event is worth.
Illustrative example: One model, three input columns
A manufacturer earned $3,000,000 of EBITDA last year on 1,000,000 units at a net price of $20.00, with variable cost of $13.00 a unit and fixed costs of $4,000,000. A new distributor program has a full-year rate of 100,000 units. In the downside, an existing customer halves its orders, a loss of 50,000 units, and the program slips out of the year. In the base case the program starts mid-year. In the upside it starts on the first day. Annual debt service is a placeholder of $1,000,000.
| Last year | Downside | Base | Upside | |
|---|---|---|---|---|
| Existing-customer units | 1,000,000 | 950,000 | 1,000,000 | 1,000,000 |
| New program units | 0 | 0 | 50,000 | 100,000 |
| Net price per unit | $20.00 | $20.00 | $20.40 | $20.60 |
| Variable cost per unit | $13.00 | $13.60 | $13.20 | $13.20 |
| Fixed costs | $4,000,000 | $4,100,000 | $4,100,000 | $4,200,000 |
| Revenue | $20,000,000 | $19,000,000 | $21,420,000 | $22,660,000 |
| EBITDA | $3,000,000 | $1,980,000 | $3,460,000 | $3,940,000 |
| EBITDA margin | 15.0% | 10.4% | 16.2% | 17.4% |
| EBITDA divided by debt service | n/a | 1.98x | 3.46x | 3.94x |
The bridge below values each event. Volume events are valued at the base margin of $7.20 a unit ($20.40 less $13.20), and price and cost effects are measured on each case’s own units.
| Event | Base to downside | Base to upside |
|---|---|---|
| Existing customer cuts orders | (360,000) | 0 |
| Program start moves | (360,000) | 360,000 |
| Net price realized | (380,000) | 220,000 |
| Variable cost per unit | (380,000) | 0 |
| Fixed costs | 0 | (100,000) |
| Change in EBITDA | (1,480,000) | 480,000 |
The downside sits $1,480,000 below the base and the upside $480,000 above it. The asymmetry comes from fixed costs, which do not fall when volume does, and from price and cost events that touch every unit sold. If a buyer pays an invented 6.0 times earnings, the upside’s extra $480,000 is $2,880,000 of price, which is the amount a buyer unwilling to pay at closing might offer as an earnout. Lenders define coverage in their own terms, often after capital spending and taxes, so a real test differs from the simple division shown. All numbers are invented for illustration and are not benchmarks.
Labeling every assumption
Each assumption carries a label for its basis, so a reader can see how much of a case rests on proof.
| Label | Meaning | Support a buyer expects |
|---|---|---|
| Contracted | A signed agreement or purchase order covers it | The contract, including term and cancellation rights |
| Run-rate | It continues at the level of recent months | Monthly results for the recent past |
| Planned and funded | Management has decided and budgeted, but results are not yet in | Approved budget, supplier quotes, hiring plan |
| Requires a win | It depends on business not yet won | Pipeline records and win history |
| Outside management’s control | A customer, supplier or other party decides | Written statements from that party |
Five rules keep the cases honest.
- Name each case by its story. “The second-largest customer halves orders at renewal and the new program slips to next year” can be defended. “Pessimistic” cannot.
- List every difference from the base on one page. A reader who finds changes the page does not list will assume they are accidents.
- Keep management’s response separate. Show the downside before cost actions, then list the actions and their value on their own line, so the reader sees both the exposure and the cushion.
- Change inputs, not structure. One model with three input columns can be audited, and three separate spreadsheets cannot. The driver-based forecasting guide explains how to build that model.
- Date and version each case and tie the base case to the numbers in the CIM.
How buyers and lenders use the downside case
- Lenders. A lender commonly tests whether the business can pay interest and scheduled principal in the downside. The distance between base and downside therefore helps set how much debt the company can carry, and that in turn sets how much cash a buyer can pay at closing. The guide to financing an acquisition covers the debt side.
- Buyer approval. A financial buyer must show its own investment committee and lender what happens if the business underperforms. A seller whose downside is specific and credible gives the buyer’s deal team something to use. Without one, the buyer writes its own.
- Valuation. A buyer that prices a forecast through discounted cash flow, described in the valuation methods guide, applies a rate that reflects risk. A narrow gap between base and downside supports a lower rate, and a wide gap supports the reverse.
- Structure. Base earnings are what a buyer pays for in cash at closing. The distance from base to upside is often covered by an earnout. The distance from base to downside pushes a buyer toward a lower multiple, or toward deferring more of the price in a seller note or rollover equity, as the guide to rollover equity and seller notes explains.
How many cases are enough
A base, an upside and a downside case are the working answer. The base case carries the argument, the downside serves financing and structure, and the upside serves earnout design. A case earns a place only when it changes a decision, whether on price, structure or financing. Two cases that would lead to the same decision are one case.
A fourth case belongs only where a single yes-or-no event splits the outcome, such as the renewal of the largest contract. Model the event as a switch inside each case, not as a case of its own, so the reader can see the business with the event and without it.
Which cases go in front of buyers is a judgment call. Many sellers present the base case in the confidential information memorandum and management presentation, keep the other two ready for the questions that follow, and give a lender the downside when it asks. Probabilities assigned by the seller are best left out, because a buyer reads any probability a seller writes down as an opening position. The wider build is laid out in the guide to building financial projections for a business sale.
Frequently asked questions
What is the difference between scenario analysis and sensitivity analysis?
Sensitivity analysis changes one input at a time and holds the rest constant, which ranks the inputs by their effect on earnings. Scenario analysis changes several inputs together to describe a coherent story, such as a customer reducing orders while also resisting a price increase. Buyers use both: sensitivities find the drivers that matter and scenarios show what happens when they move together.
What is a base case in a financial projection?
The base case is management’s best estimate of results if existing contracts run, planned actions are carried out and nothing unusual happens. It is not the most optimistic version. In a sale it is the case the seller must be ready to defend line by line, and it is the one buyers compare against their own.
How many scenarios should a sale projection include?
A base, an upside and a downside case are enough for most sales. A case earns a place only if it would change the price, the structure or the financing. A yes-or-no event such as a contract renewal is better handled as a switch inside the cases than as extra scenarios.
Should a seller show buyers the downside case?
It is a judgment call. Many sellers put only the base case in the CIM and keep the other cases ready for questions. A lender commonly asks for a downside, and one built from the same model as the base looks more credible than a hurried version. A seller should decide how a downside will be used before handing it over.
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Related guides
- Management Case vs Buyer Case: How Buyers Adjust Your Projections: How a buyer turns a management case into its own case: the adjustments it makes, a reconciliation of the gap, and how sellers defend assumptions with evidence.
- Driver-Based Forecasting for a Business Sale: Build a Model Buyers Can Test: Driver-based forecasting builds a sale projection from units, price, utilization and retention. See driver trees for a manufacturer and a services firm.
- Business Valuation Methods: Income, Market and Asset Approaches: The income, market and asset approaches to valuing a private company, the methods inside each, when each fits and how valuers reconcile the results.
- Financing a Business Acquisition: Equity, Bank Debt, Seller Notes and SBA Loans: How buyers fund an acquisition: equity, senior debt, SBA-guaranteed loans, seller notes, mezzanine and rollover equity, with a sources and uses example.
- Earnouts Explained: How Contingent Consideration Works in a Sale: An earnout ties part of the purchase price to future results. Learn how earnouts are structured, why buyers propose them and how sellers can value the risk.
- Revenue Forecasting for a Sale: Backlog, Pipeline, Recurring and Cohort Methods: How to forecast revenue for a sale: backlog conversion, pipeline weighting, recurring revenue and churn, and cohorts, with the evidence buyers accept.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.