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Scenario Modeling Framework

How to define scenarios, assign probabilities, and document boundaries for decision-grade analysis that boards and counterparties can rely upon.

When decisions involve significant uncertainty—M&A transactions, strategic investments, litigation outcomes—single-point valuations provide false precision. Decision-makers need to understand how value changes under different assumptions. That's where scenario modeling becomes essential.

When Scenario Analysis Is Required

Scenario analysis is most valuable when:

• Binary events could materially affect value (FDA approval, contract renewal, litigation outcome)
• Negotiation support requires understanding value under counterparty assumptions
• Strategic decisions depend on assumptions about market conditions or execution
• Early-stage companies face multiple potential paths with different outcomes

The Three-Scenario Foundation

Most decision contexts are well-served by three scenarios:

Base Case

The most likely outcome given current information. This is typically management's working plan, adjusted for optimism bias where appropriate.

• Represents the probability-weighted expected path
• Should be defensible as "more likely than not"
• Forms the anchor for sensitivity analysis

Upside Case

A success scenario where key assumptions break favorably. Not the best possible outcome, but a realistic "things go right" scenario.

• Typically represents 15-25th percentile outcome
• Key assumptions should be articulated explicitly
• Useful for understanding optionality value

Downside Case

A stress scenario where key assumptions disappoint. Again, not worst-case, but realistic underperformance.

• Typically represents 75-85th percentile outcome
• Should identify which assumptions drive the downside
• Critical for risk assessment and stress testing

Assigning Probabilities

Probability assignment is where most scenario analysis fails. Common mistakes:

• Equal weighting (33%/33%/33%) — Suggests no view on relative likelihood
• Hidden anchoring — Probabilities that don't reflect actual beliefs
• Precision theater — Probabilities like 37.5% that imply false accuracy

A Defensible Approach

Probability assignment should be:

Defining Scenario Boundaries

Each scenario requires explicit boundaries—what's assumed to be true in that scenario. A well-defined scenario specifies:

Element	Example: Base Case
Revenue trajectory	20% CAGR through 2027, moderating to 12% thereafter
Margin profile	EBITDA margins expand from 15% to 22% by 2028
Key event	Product launch in Q3 2025 with 70% probability
Exit assumption	M&A transaction in 2028-2029 at 8x forward EBITDA
Capital needs	No additional equity raises required

Presentation for Decision-Makers

Decision-grade scenario analysis presents results in formats that support action:

Range of Outcomes

Show the value range across scenarios, not just the probability-weighted average. Decision-makers need to know the distribution, not just the mean.

Breakeven Analysis

At what probability does the decision flip? If the investment is positive under base case but negative under downside, what probability assignment makes the decision marginal?

Key Driver Isolation

Which assumptions drive the most variance between scenarios? Focus discussion on the factors that matter most.

Documentation Standards

Every scenario analysis should include:

• Scenario Definition Summary — One-paragraph description of each scenario's assumptions
• Value Output Table — Value under each scenario with probability weights
• Probability Rationale — Brief statement supporting each weight assignment
• Key Assumption Schedule — Table comparing key inputs across scenarios
• Sensitivity Matrix — Probability-weighted value at alternative weightings