Column: The Contract Waterfall

      One of the most important financial and organizational tools a government contractor can have is the Contract Waterfall.

      A waterfall sets forth all of the details of a federal government contractor's signed contracts and new business pipeline, estimating the revenue and gross margins for each contract over the next three to five years.

      A waterfall is the market industry standard to measure a federal contractor's performance, value and future business potential.

Components of the Contract Waterfall

      The Contract Waterfall has four basic components: Backlog, Recompetes, Identified opportunities or "pipeline" and unidentified opportunities. It breaks down like this:

• Backlog - Includes all active contracts in the company’s projections, including funded and unfunded backlog;
• Recompetes - Includes a projection of new business expected to be awarded resulting from re-competition of active contracts;
• Identified Pipeline - Includes anticipated new business awards in the bid and proposal pipeline, including follow-ons and new contracts; and
• Unidentified Pipeline: Also a part of the company’s pipeline, a small portion of this section may be included in a company’s projections but given relatively low revenue visibility and valued as potential upside.

Qualitative factors

      Qualitative factors of the Contract Waterfall can be just as important as quantitative factors:

• What type of contract is it? Prime contracts are more valuable than subcontracts. Free & open competition contracts are worth more than set aside contracts. The type of contract--sole source, IDIQ, Firm Fixed Price or Time & Materials--is important as it may indicate how easy it might be to lose the work in the future.
• Who is the customer and at what agency? Is it an agency that sticks with a good vendor or is it constantly seeking a low-priced, cut-throat provider?
• Is the award for a requirement that will continue years into the future, or is it for a special project that goes away after the deliverable is complete?
• What type of work are you performing? Is it high-value work for which your company has unique qualifications, or a commonly available service available from a large group of hungry competitors?

Pipeline projections

      Likewise, the identified and unidentified pipeline or "projections" in your waterfall have factors that will determine their quality and viability. Unfunded out-year options for ongoing work are considered unfunded backlog. Task orders, not IDIQ ceilings, are considered backlog. Sole source awards are valued higher than multiple award IDIQs.

      When building your pipeline into your waterfall, base it on carefully considered assumptions. While this is more art than science – you should carefully consider each opportunity and assign a win percentage to each task order or contract your company is bidding on. Making overly optimistic estimates devalues your pipeline; you should not be basing on the milestone gate method.

Utilizing a Contract Waterfall

      What does a Contract Waterfall do for business owners and managers?

      A waterfall gives owners and managers visibility to make operating decisions such as budgeting and incentives for employees. Externally, it is essential in dealing with banks, investors and potential buyers.

      When considering buying a competitor or selling your business, the waterfall is the most important document that is analyzed by all parties. It can have a significant impact on the price you are paying for a company or that you receive from a buyer. A well-done waterfall that gives organized, detailed information and clear visibility into both revenue and business opportunities will give the business a premium on their business value.

How to display a Contract Waterfall

      The best way to present this information is on a spreadsheet that can be adjusted according to performance and win probability. The waterfall should include separate sections or worksheets for each of the four basis components:

• Backlog
• Recompetes
• Identified Pipeline
• Unidentified Pipeline

      For each of these components, the spreadsheet will list the basic facts for each opportunity: the Agency, contract number, type of contract (IDIQ, FFP, CPFF or T&M), the prime or subcontractor, base period start date, base period end date, options available at the start, length of each option period, number of options remaining, total funded value, and total value received to date.

      Next comes the hard part: valuing the anticipated revenue from each opportunity. This can be estimated rather well for contracts already won, such as those in the Backlog. For Recompetes and the Identified Pipeline, a common approach is to assign a Probability of Win.

      Probabilities generally would be higher for Recompetes than for bids your company has never won. In the Identified Pipeline, Probability of Win might be higher for Set-asides than for Full & Open awards. Probability of Win would be higher for opportunities where you own a unique niche due to proprietary technology. Probability of Win might be lower if this is a Recompete and your 8(a) status is expiring or your past performance has been challenged.

      Please contact me for a full waterfall template and guidance on how build one for your company.

Michael Clark is managing director of Pierce Capital Partners, a privately-held investment banking firm. Clark may be reached at mjc@piercefinancial.net.

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Column: The Contract Waterfall

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