🧭 Dojo Compass
Module: Entrepreneurship, Market Execution and Scaling
Focus Area: Entrepreneurship and Scaling
Key Issue
Andina Industrial Technologies was a 140-person industrial services company headquartered in Latin America.
The company had developed a strong position in a specialized industrial market and had grown substantially over the previous five years.
Its founders believed that the company was entering an important new phase.
The business had established a strong domestic customer base and was beginning to expand into two neighboring countries. Management believed that its existing customer relationships, technical capabilities and operating platform could support significant growth without a proportional increase in its cost base.
The founders therefore wanted to raise a substantial amount of new equity capital to accelerate expansion.
An international private investment fund, Northbridge Capital, became interested in the company.
The investor and management agreed on the fundamental attractiveness of the business.
They disagreed, however, about its future cash flows.
Northbridge’s investment team prepared a discounted cash flow valuation.
Its base case assumed that EBITDA would grow from approximately $12 million to $18 million over five years, with substantial investment required to support international expansion.
The founders believed the company’s EBITDA could reach approximately $24 million over the same period.
The difference was not simply a disagreement about arithmetic.
The parties had fundamentally different views about risk.
The founders had spent years building the company and had considerable confidence in their ability to execute the expansion.
Northbridge was investing from another market and had less direct knowledge of the local operating environment, customers and management team. It was concerned about:
- the volatility of the company’s historical cash flows;
- currency fluctuations;
- the execution risk associated with international expansion;
- the concentration of several important customers;
- higher financing costs in the company’s market; and
- the possibility that the founders’ growth projections were too optimistic.
The founders, meanwhile, believed that Northbridge was applying too substantial a risk discount to future cash flows.
The initial valuation discussion therefore became predictable.
The founders argued:
“The company is worth $120 million based on the cash flows we expect to generate.”
Northbridge responded:
“We cannot justify paying $120 million today for cash flows that may not materialize.”
The parties were approximately $20 million apart in their valuation expectations.
Neither side was willing to simply concede.
The transaction appeared likely to fail.
Rather than attempting to determine which party had the “correct” forecast, the advisers proposed a different question:
“Can we structure the investment so that Northbridge receives protection against the downside it sees, while the founders retain meaningful participation in the upside they believe they can create?”
The parties decided to use risk sharing to bridge the DCF valuation gap.
Facts
Andina had several characteristics that made the valuation disagreement particularly important.
Strong Historical Business
The company had grown revenue from approximately $45 million to $72 million over five years.
EBITDA had increased from approximately $7 million to $12 million.
Its customer relationships were strong, and approximately 80% of its major customers had been with the company for more than three years.
Significant Growth Opportunity
Management had identified opportunities in two neighboring markets.
The founders believed that the existing business could provide a platform for international expansion without requiring the company to build an entirely new operating model.
Their five-year plan projected:
- continued domestic growth;
- expansion into two neighboring markets;
- increased utilization of existing technical infrastructure;
- additional recurring customer contracts; and
- EBITDA growth to approximately $24 million.
Investor Risk Concerns
Northbridge’s DCF model was more conservative.
It assumed slower growth, higher working-capital requirements and a higher discount rate.
The investor’s model produced an equity valuation of approximately $95 million.
Management’s model produced an equity valuation of approximately $120 million.
The difference was therefore approximately $25 million.
Importantly, neither party disputed the historical financial information.
The disagreement was concentrated almost entirely in the assumptions about the future.
Different Information and Risk Perspectives
The founders had detailed knowledge of the company’s customers, employees and operations.
Northbridge had extensive experience investing internationally but did not have the same local operating knowledge.
Each therefore possessed information that the other did not fully share.
The parties also had different risk exposures.
The founders already owned the company and expected to remain involved.
Northbridge would be committing a substantial amount of new capital at a valuation that depended heavily on future growth.
The valuation dispute was therefore really a risk-allocation dispute disguised as a valuation dispute.
Solution
Rather than forcing the parties to agree on a single DCF forecast, they designed a transaction with two economic layers:
Lower valuation today + greater founder participation in future distributable profits if the business performs.
1. Agree on a More Conservative Upfront Valuation
The parties ultimately agreed to an equity valuation of $100 million.
This was below the founders’ $120 million valuation but above Northbridge’s initial $95 million valuation.
Northbridge invested $30 million for 30% of the company.
The founders therefore accepted a lower upfront valuation than they believed the company deserved.
This gave Northbridge a measure of protection against the risk it had identified.
But the founders did not simply give up the $20 million of potential value.
Instead, they negotiated a mechanism through which they could participate in a greater share of future economic performance.
2. Create a Performance-Based Profit Participation Mechanism
The parties agreed that, after the investment, distributable profits would normally be allocated according to their respective ownership interests.
Thus, absent the performance mechanism:
- Northbridge would receive 30%;
- the founder shareholders would receive 70%.
However, the founders would receive an additional profit participation if the company achieved specified performance targets.
The mechanism was based on cumulative EBITDA and cash generation rather than a single year’s revenue.
The parties agreed on three performance levels.
| Performance Level | Agreed Measure | Additional Founder Participation |
|---|---|---|
| Base | EBITDA reaches $18M by Year 5 | None |
| Strong | EBITDA reaches $21M and agreed cash-conversion threshold | +10% of distributable profits |
| Exceptional | EBITDA reaches $24M and agreed cash-conversion threshold | +20% of distributable profits |
The additional participation would apply for a defined period and would be subject to agreed definitions of distributable profits, capital expenditure, debt service and other relevant items.
The structure therefore created a direct economic relationship between performance and the ultimate return to the founders.
3. Make the Targets Reflect the Actual Investment Thesis
The parties deliberately avoided using a simple revenue target.
Revenue could increase without creating sufficient economic value.
For example, management could expand aggressively into a new market while generating weak margins and consuming substantial working capital.
The parties therefore selected measures that reflected the actual investment thesis:
- EBITDA;
- cash conversion;
- agreed capital expenditure requirements; and
- maintenance of specified financial conditions.
This meant the founders would receive enhanced participation only if the company created real economic value, rather than simply increasing its top-line revenue.
4. Protect the Investor From Artificial Performance
Northbridge was concerned that management could potentially accelerate short-term results in ways that damaged long-term value.
The agreement therefore established rules concerning:
- accounting policies;
- extraordinary items;
- acquisitions and disposals;
- related-party transactions;
- changes in depreciation policies;
- major capital expenditures;
- debt-funded distributions;
- calculation of distributable profits; and
- treatment of transactions outside the ordinary course of business.
The objective was not to prevent management from making legitimate business decisions.
It was to ensure that the performance mechanism measured the underlying economic performance of the business rather than accounting or transaction engineering.
5. Align the Mechanism With Management Control
The founders remained actively involved in the business.
This made a performance-based mechanism more appropriate because management would continue to have substantial influence over the factors driving performance.
At the same time, Northbridge received board representation and agreed governance rights.
The parties therefore acknowledged that performance would be influenced by decisions made by both sides.
The documentation established a governance framework designed to prevent either party from deliberately manipulating performance to maximize or minimize the contingent economic benefit.
6. Create a Shared View of the Future
The transaction also changed the relationship between the investor and founders.
Under the original negotiation, each party was effectively trying to prove that its DCF was correct.
Under the new structure, the parties could acknowledge that both forecasts contained uncertainty.
Northbridge was effectively saying:
“We are willing to invest, but we do not want to pay the full value of your optimistic forecast today.”
The founders were saying:
“We are willing to accept a lower valuation today, but if our forecast proves correct, we want to participate in the value we create.”
The final agreement allowed both statements to be true.
Outcome
The transaction closed at the $100 million agreed valuation.
Northbridge received 30% of the company for its $30 million investment.
The founders accepted that they had not achieved their preferred $120 million valuation at closing.
But they retained substantial economic upside through the performance-based profit participation mechanism.
During the first two years, the company performed approximately in line with Northbridge’s expectations.
EBITDA reached $15 million.
No enhanced founder participation was triggered.
By Year 4, however, the international expansion began producing stronger results than the investor’s original DCF had anticipated.
New customer contracts increased recurring revenue.
The company’s existing technical infrastructure was utilized more efficiently.
Margins improved.
By Year 5, EBITDA reached $23 million, with cash conversion also exceeding the agreed threshold.
The company therefore qualified for the strong-performance tier.
The founders received an additional 10% share of distributable profits for the agreed period.
The economics of the transaction had consequently changed substantially from the economics implied by the original $100 million valuation.
The founders had accepted less value upfront but received greater value because their optimistic assessment of future performance had largely proven correct.
Northbridge, meanwhile, had achieved an important objective.
It had not been required to pay the founders upfront for the full value of a forecast that initially appeared too uncertain.
The investor’s downside exposure was reduced at entry, while it still participated in the substantial value created by the company’s growth.
Most importantly, the structure helped the parties complete a transaction that might otherwise have failed.
The DCF models had not been reconciled.
They did not need to be.
The parties had instead created a mechanism through which actual performance could progressively determine the ultimate economic outcome.
The transaction therefore converted a disagreement about future cash flows into an agreed framework for sharing the consequences of being right—or wrong.
Key Takeaways
First, a DCF valuation is a model of the future, not a fact about the future. Two sophisticated parties can reasonably produce different valuations because they use different assumptions about growth, margins, risk and capital requirements.
Second, valuation disagreements can sometimes be solved through deal structure rather than further argument about valuation. If the parties cannot agree on the probability of future performance, they can structure the transaction so that future performance determines part of the economic outcome.
Third, a lower upfront valuation can be combined with meaningful participation in future upside. This allows the investor to receive protection against uncertainty while allowing the founder to retain value if the company’s performance validates the founder’s expectations.
Fourth, risk sharing should be connected to the source of the disagreement. In this case, the disagreement concerned future cash flows, so the mechanism was linked to EBITDA and cash generation rather than an unrelated milestone.
Fifth, performance measures should reflect economic value creation. Revenue alone may not be sufficient. EBITDA, cash conversion, capital expenditure and other measures may provide a better indication of whether the underlying investment thesis is working.
Sixth, the parties should carefully consider who controls the variables used in the mechanism. If the investor has complete control over the company’s strategy after closing, a founder’s contingent participation may become difficult to administer fairly. Governance and measurement rules therefore become essential.
Seventh, risk sharing does not mean sharing every risk equally. The objective is to identify the particular uncertainty preventing agreement and allocate its economic consequences appropriately.
Eighth, a risk-sharing mechanism can improve alignment after closing. The investor and founders no longer need to debate whose forecast was correct. Both have an economic interest in achieving strong, sustainable performance.
Ninth, simplicity matters. A mechanism that is theoretically sophisticated but impossible for the parties to calculate consistently may create more problems than it solves.
Finally, good deal structuring can transform a zero-sum valuation negotiation into a conditional economic partnership.
The central lesson is:
When buyer and seller disagree about the future, they do not always need to agree about the forecast. They may instead agree about how the economic consequences of the forecast will be shared.
In Andina’s case, the investor received greater protection by paying a lower valuation upfront.
The founders retained the opportunity to receive greater economic value if their belief in the company’s future proved correct.
The result was not a perfect valuation.
It was something more useful:
a transaction structure that allowed uncertainty to be shared rather than allowing uncertainty to kill the deal.
Case Study Note
The case studies published by Business Warrior’s Dojo are intended primarily as tools for learning, discussion, and analysis.
They may be based on real business situations, publicly available case studies, professional experiences, or entirely hypothetical scenarios. In some cases, names and identifying details have been changed to preserve confidentiality. In others, facts, circumstances, timelines, or outcomes may have been substantially modified, combined, or simplified to better illustrate particular business issues or support discussion. Some case studies are entirely fictional and have been developed solely for educational purposes.
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