Part 6: Projections Under Pressure ‑ Were These Numbers Built for the Business or Built for the Courtroom?
Projections are one of the most heavily scrutinized elements of any damages analysis.
A damages analysis often requires asking a hypothetical question: “What would have happened if the alleged harm had never occurred? “
Answering that question almost always involves a “but-for” analysis, an estimate of what the business would have earned, grown, or achieved in a world where the damaging event did not take place. And that is where things get complicated.
Not All Projections Are Created Equal
The first thing a damages expert asks themselves when evaluating but-for projections is a simple but important question: Were these prepared in the ordinary course of business, or were they prepared for litigation?
Projections created before anyone knew there was going to be a lawsuit carry a very different weight than those prepared after the dispute arose. The latter reflects what someone wants a damages expert to assume, or the court to believe, usually not what the business can “prove” that they actually believed before the dispute arose. But even among projections prepared before litigation, the intended audience and the success of realizing historical projections matter.
Projections prepared for potential investors are, by definition, going to skew optimistic. Businesses put their best foot forward when trying to raise capital. Projections prepared as part of a routine internal budgeting process tend to be more grounded and realistic. Projections shared with a bank in connection with a loan request may sit somewhere in between. Understanding who the projections were prepared for, and why, is essential to understanding how much weight they deserve in a but-for analysis.
Another valuable test is looking at the company's historical track record with its own projections. Did management consistently hit their targets? Did they routinely fall short? Were they in the habit of preparing overly optimistic projections that never quite materialized? Did the company engage the help of an accounting or financial expert to prepare its projections? If a company has a history of projecting twenty percent growth and delivering five percent, that pattern is relevant context for evaluating whether the but-for projections deserve to be taken at face value.
These distinctions matter enormously, since the quality and reliability of projections are one of the first areas opposing counsel and the opposing expert will probe.
Testing the But-For Against Historical Performance
Once we understand the origin of a projection, the next step is to test the but-for scenario against the historical financial performance of the business. If a company is projecting double-digit revenue growth in its but-for world, the question is whether that growth rate is supported by anything in the company's actual track record.
A business that has grown consistently at five percent per year does not suddenly become a twenty percent growth business in the but-for world without a compelling and supportable explanation. What changed? Was there a new contract on the short-term horizon? Let’s see the documentation of this. A new product about to launch? Let’s know more about this. An expansion into a new market that was already underway? Let's look at the customers targeted, capital deployed, and market data behind that decision. If the answer is that the growth assumption is based on hope rather than evidence, that is a problem.
But-for projections that are not anchored to historical performance or supported by specific, identifiable facts or reasonable assumptions are vulnerable. A good damages expert will identify that vulnerability before opposing counsel does.
The Role of Industry Data
Historical performance is one benchmark. Industry data is another. Even if a company's own track record supports an optimistic but-for projection, we try to look at whether that projection is consistent with what was happening in the broader industry and economic environment during the relevant period.
Consider a company that had consistently achieved ten percent revenue growth year over year. On the surface, that track record might seem to support a similar growth assumption in the but-for world. But what if two new competitors entered the market right around the time the damaging event occurred? What if the industry as a whole were softening? Historical performance does not exist in a vacuum, and a but-for projection that ignores the competitive and market landscape is one that will not hold up under scrutiny. Industry benchmarks, if available, provide an independent check on whether the assumptions are reasonable given the world in which the business was actually operating.
New Businesses Are a Special Case
Evaluating but-for projections for an established business with years of financial history is challenging enough. For a new business that has little or no operating history, the challenge is considerably greater.
When a business has not yet had the opportunity to establish a track record, the damages expert has less historical data to anchor the but-for analysis to. Projections for new businesses require particularly careful scrutiny and particularly strong support. Courts have historically been skeptical of lost profits claims for new businesses precisely because of the speculative nature of projecting but-for performance without a track record to rely on. Just because the new business projection is more susceptible to scrutiny doesn’t mean a well-constructed damages opinion will fail. We have successfully supported a multi-million dollar expert damages opinion for a start-up business to a trier of fact. We will come back to the new business versus established business distinction in more detail in Part 7.
Up next: Once we understand the financial data and have evaluated the but-for projections, the next step is selecting the right framework for measuring the damages. In Part 7, we will cover the primary damages methodologies and how a damages expert decides which one fits the case.