This article is a contributed piece by Brian Garfield, Managing Director of Lincoln International's global middle-market investment banking, and the views expressed are solely those of the author.

In the early stages of the pandemic, chief financial officers (CFOs) generally leaned toward conservatism in budgeting to prepare for worst-case scenarios. However, a prolonged market correction like that of 2008 did not materialize. Instead, many industries that experienced demand disruptions saw a V-shaped recovery, with business quickly returning to pre-pandemic levels and making up for earlier losses. This recovery was largely supported by the steadfast backing of private equity sponsors and lenders, as well as federal government stimulus measures.

Looking ahead, positive sentiment regarding the performance of private companies continues: in a webinar hosted by Lincoln International's Valuation and Opinions Group, 70% of attendees expected valuation multiples to rise or remain flat in 2021, despite current valuations already being at historic highs. Additionally, optimism is growing as vaccination rates increase, lockdown measures ease, and the government injects more capital into the economy.

These positive signals, combined with better-than-expected 2020 results and the localized nature of the pandemic's impact, have led CFOs in many industries to forecast double-digit EBITDA growth for 2021.

The data behind optimistic forecasts

According to Lincoln International's analysis of its database of 1,700 private companies, the average annual EBITDA growth rate is in the low-to-mid single digits. For reference, the average growth rate during the 2019 bull market was 2.5%, and in 2020 it was 5%. However, amid the ongoing pandemic, the 2021 EBITDA growth forecast is close to 10%.

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Brian Garfield
Image source: Lincoln International
 

Looking deeper across industries, we are seeing the 'rubber band effect' of the V-shaped recovery: companies are shifting from 'surviving' to 'thriving,' even in the sectors hardest hit by the pandemic. This is especially evident in the consumer and industrial sectors, the two most severely impacted.

According to Lincoln International's private company analysis, EBITDA for consumer companies fell by an average of 1.7% in 2020. Unsurprisingly, pandemic-hit food and beverage and retail sectors dragged down growth, with EBITDA declining 27.7%. But 2021 expectations show these losses being reversed, with projected revenue growth of 17.6% and EBITDA growth of 11.3%. This projected growth rate exceeds the sector's pre-pandemic trend. Private company revenue growth estimates are nearly double those projected by S&P Global Market Intelligence for its consumer products and consumer services sectors, which are primarily based on public companies.

In the industrial sector, global factories were forced to shut down at the peak of the pandemic, disrupting supply chains. Overall, according to Lincoln International's analysis, industrial sector earnings in 2020 remained stable compared to 2019. However, forecasts show a similarly steep rebound, with 2021 projected revenue growth of 10.1% and EBITDA growth of 8.3%, as the sector returns to pre-pandemic operating levels. Interestingly, these revenue estimates align closely with S&P Global Market Intelligence's expectations for several industrial sub-sectors.

In contrast, the technology sector saw surging demand, driven by the e-commerce transformation and the need for technology upgrades across all businesses. Among these, the software-as-a-service (SaaS) segment proved particularly resilient, with EBITDA growing 24.7% in 2020, and the sector is expected to maintain this growth trajectory in 2021.

Key questions in budgeting

With strong growth expected in hard-hit industries, CFOs should anticipate tough questions about achievability during budgeting. Despite the positive metrics, the pandemic is not over. The uncertainty of 2020 led to more lenient budget assessments, but this year, as companies are being valued, CFOs need to be prepared to address how budgets will be met and justify the magnitude of revenue and EBITDA growth.

Here are some questions valuation professionals will ask:

  • Has the projected revenue level ever been achieved before?
  • How much of the projected growth comes from contracted revenue?
  • Were the cost-cutting measures implemented during the pandemic temporary or permanent? Have these measures weakened the company's ability to expand and achieve future revenue targets?
  • How do the forecasts compare to industry peers?
  • When does the budget assume the economy will fully reopen? Has the current reopening status changed this outlook?

Buyers and sellers will value companies based on the achievability of forecasts, and they will apply discounts to projections that cannot be substantiated.