As the supply chain tightens, manufacturing companies are in increased demand, especially those that have found a way to work around supply chain shortages and the global uncertainty wrought by the COVID-19 pandemic. If you’re considering folding a second or third business into your own, or investing in a new manufacturing company for the first time, asking the right questions can ensure you make the most of the deal, while minimizing risk. Ask these questions before buying a manufacturing business.
How has this company performed during COVID?
COVID put every company to the test, especially manufacturing businesses. It’s expected that some companies would see a downturn during the pandemic. Nevertheless, how the business handled the pandemic reveals much about their ability to think creatively and flexibly. Did the company find ways to protect its staff and clients? Or did it cling to the ways o the past, unable to see another way of doing things? Did it generate new business, develop new technologies, and make the most of a challenging economic environment? Or did it just keep waiting for COVID to go away, denying the reality of the situation?
What is the future of this manufacturing sector?
No matter how strong an individual company appears, it’s important to look at the larger niche in which it operates. Is the niche growing? Or are you investing in a sector that may eventually cease to exist thanks to changing technology, shifting mores, and automation?
What is the long-term strategy here?
How is this company planning to compete in a 21st century economy, and what can you do to make it even more competitive? Good investments have good strategies. Bad investments keep doing things the way they have always been done, and hope for the best. You should have a clear vision for the future of the company, and that vision should be firmly rooted in past performance and evidence-based forecasts.
Is the company financially healthy?
Sometimes it’s a good idea to buy a struggling company and then grow it into something better, but only if you have specific experience doing so and a strong plan for getting the company back on track. In most cases, these struggling companies are money pits. You need to ensure the business is financially healthy. This means taking a long hard look at financial statements, conducting due diligence, and evaluating any potential liabilities, including possible lawsuits. Look also at financial forecasts, which may help you thoughtfully assess where the company may be in a few years.
What will I do differently as owner?
Ideally, prospective owners should have a plan for what they intend to do differently—and better—to promote greater profitability and growth. If you can’t identify specific changes you intend to make in the company’s operations, then you should not expect it to grow. And if you’re not clear about the overall operational picture of the company, it’s critical to get these details before even considering making an investment.
Employee Stock Ownership Plans (ESOPs) are more than just a fad. The benefits of having a plan by which a company’s capital stock is bought by its employees or workers are very real and tangible. In fact, NuVescor is currently helping two well-established ESOP’s grow through acquisition. We are also selling one of our manufacturing clients to a well-established ESOP.
Despite the benefits of ESOPs, there are some pitfalls. While setting up an ESOP from scratch can be an attractive option, getting an ESOP off the ground does not happen overnight – and creating one within your company can occupy lots of time and resources. For companies looking to enjoy those same benefits without the high startup costs and risk, selling to an ESOP can be a better alternative.
The problem with starting an ESOP from scratch
High up-front costs – Setting up an ESOP can cost hundreds of thousands of dollars. It is also typically recommended the company has at least 50 employees and an established management team to run the business without the owner.
Owner financial risk – On top of the regular up-front costs, owners often have to provide financing or personal guarantee bank financing to fund the purchase of the business. For owners who are looking for a comfortable succession plan, this brings added risk to their efforts to step away from the business.
Major time investment – Most ESOPs don’t begin to run smoothly until several years after they have started. There’s also a major risk that getting an ESOP off the ground can become a major distraction and cause tension within the company – all while taking the focus away from core business activities.
The benefits of selling to an ESOP
Avoiding the early pitfalls – Selling to a successful ESOP has a lower barrier of entry as there is safety in the size and resources of an established ESOP when it comes to managing companies and their assets.
Step away sooner and more comfortably– If your business’s main reason for entertaining the idea of an ESOP is to set up a succession plan, selling to an ESOP provides a quicker and safer solution. If you’re selling to an established ESOP, your company will be able to start transitioning right away with a proven model rather than having to develop and troubleshoot its own. For owners who are looking to retire or move on from their businesses, this provides a quicker solution while providing confidence that the company is in good hands.
Tax savings advantages– Sellers can save on taxes when selling to an ESOP, but that’s not the only advantage. Many ESOP’s do not pay federal tax. Therefore, an ESOP-owned company is more willing to buy stock in a C Corp because they don’t need the ability to depreciate the assets from an asset sale. If done correctly, the seller can take the proceeds from selling their stock and put them into other investments deferring any tax until they sell those investments. This allows them to have some control over when they pay federal taxes and how much money they want to pay so their CPA can help them put together a tax minimization strategy.
Benefits to employees – Employees of the selling business become owners. Because of this, ESOP’s typically have better benefits and compensation for their employees than non-employee-owned companies. Most of our business owner clients would prefer to sell to their employees but this usually isn’t an option due to financing and the risks outlined above. Selling to an ESOP gives businesses the best of both worlds – employee ownership without the financial risks.
What we’ve seen at NuVescor
In our years of experience in manufacturing industry mergers and acquisitions, clients ask us to focus on ESOP buyers to provide their employees with the opportunity to be owners without having to find a way to finance the transition. The option to sell to ESOPs rather than start them from scratch also ensures sellers that the management is strong enough to operate the business without them. Meanwhile, the sellers, buyers, and employees involved in the ESOP enjoy the advantages that come with the major tax-saving opportunities.
For over a decade, NuVescor has been a leader in the Manufacturing Mergers & Acquisitions industry in Michigan. With years of experience and a proven process, our team delivers excellent results, whether you want to buy or sell a business.
If you’re looking to sell to an ESOP or if your ESOP is looking to grow through mergers and acquisitions, NuVescor can help. Click here to get in contact with us.
The economy looks great for precision machine shop owners right now. For many, the biggest challenge is keeping up with demand. That doesn’t mean growth will be perpetual. Many owners are contemplating a sale now, when values are at record highs. Some, however, think they should keep growing the business to cash in later.
Owners should know that an equity-focused approach is best in this economy. The goal is to focus on maximizing wealth after taxes at retirement. Smaller manufacturing shops are high risk because of high concentration and low liquidity. In an increasingly consolidating industry, that’s doubly true. Your equity strategy can protect you.
So what do most owners get wrong? Many mistakenly believe that growing sales mean growing equity. But company valuations are complex, and ultimately depend on the individual factors the buyer cares about.
An Equity Strategy in a Consolidating Industry
Scale and capital are the powerful ingredients in the recipe for a successful supply chain company with good margins. You must look critically at your business, assessing financial and competitive strengths, the current financial cycle, and the route to the equity goal that is right for your company. There’s more than one way to get there.
Squeezing Profits
This fragmented industry is facing massive consolidation. Roughly the bottom third of competitors are unlikely to survive. Partnerships may be necessary as advanced technologies and automation increase the pressure. New competitive technologies can give you a strong advantage. Your management team needs a strong set of skills, and the ability to scale your company up.
PE-backed regional players invest for cost efficiency and attract strong talent. If you can’t afford these investments, you can get into trouble. Simply desiring to stay in business does not necessarily mean you should.
The Role of Private Equity
PE is currently looking to precision machining. The industry is fragmented, and ripe for consolidation. This is driving higher valuations, and multiple offers even on small companies. This suggests the cycle is peaking, and that the time to sell is now, not at some imaginary date in the future when things will be even better.
Companies that hope now tot exit the industry can avoid a sale by partnering with a stronger partner or PE firm to get more funding and build strength. PE-backed firms eventually sell on a five to seven year cycle, empowering owners and managers to sell at a higher multiple down the road. This may be a better option for owners’ long-term equity strategies, especially if they’re neither well positioned to sell nor well positioned to continue growing.
Acquisitions have always been a viable strategy for manufacturing and supply chain companies to grow. In Q1 of 2021 alone, there were $36 billion dollars in deal value, compared to $17 billion in the same quarter the prior year. M&A investments are again happening, but it doesn’t mean that they’re right for everyone, nor that any specific M&A undertaking is right for your company. These four questions can help.
What is your company all about?
This is surprisingly difficult for many enterprises to answer. Before you can move forward with a deal, though, you need to know what your company’s core competencies are, what you bring to the table. Consider your corporate culture. What sets it apart and makes it unique? What might make it better? What sorts of companies would yours blend best with?
What are your goals?
Growth is not a goal unto itself. There must be a specific reason you hope to grow, and a specific direction you want the growth to go. In many cases, businesses have a number of small reasons for engaging in M&A. This can nurture indecision and uncertainty. It’s typically better to have one or two clear, compelling reasons that justify the merger. Most acquisitions cannot address multiple needs. Forcing them to try to do so is a recipe for rapid failure.
Do you have the right team?
A merger should never be a DIY undertaking. You need to identify what you don’t know, then hire experts to fill in those knowledge gaps. An acquisition should be a collaborative, team undertaking that relies heavily on the wisdom of lawyers, investment bankers, accountants, and other industry experts. Build a strong team and the other side will be less likely to take advantage of you during the negotiation process.
How do you intend to contact companies on the market?
The way you approach a potential acquisition target can color their opinion of you. Moreover, not every company available for sale is listed on the market. Some may list with brokers, but others are discreet. Still others may be willing to sell if approached with a great offer. Be prepared to undertake a structured process to search for available businesses. Working with a good broker is key here.
There’s no one size fits all strategy for assessing every potential M&A target or buyer. It’s part art, part science, and requires quite a bit of wisdom to get right. This is why it’s so critical to work with a skilled, experienced deal team who has experience in your specific niche.
While many sectors have lagged during the global COVID-19 pandemic, small and medium-sized manufacturers have made big gains—and may continue to do so. Some owners have even been met with unsolicited offers from buyers. Owners considering a sale—planned or not—must make a number of considerations. It’s critically important to understand what’s driving this increase before you move forward.
Why the Increase in Manufacturing M&A?
Banks view transactions with manufacturers favorable because they usually involve valuable inventory and equipment, making loan underwriting easier. Strong manufacturing companies also have excellent cash flow, and typically qualify for valuable tax incentives.
It’s primarily small to mid-sized manufacturers, especially in the Midwest, seeing an increase in M&A. This is thanks in large part of the ease of transitioning revenue streams.
COVID-19’s Effect on Manufacturing M&A
The current M&A trend stems from a variety of circumstances, including COVID fallout.The pandemic strained supply chains to the breaking point, and raw materials became increasingly scarce. There was a dual effect. Some companies were decimated and pushed out of the market. But manufacturers who were not shut down by COVID gained new customers and a strong competitive edge.
Buyers gained access to valuable acquisitions and more synergies to manage supply problems. The Federal Reserve has announced it intends to keep interest rates low through 2022. This cheap lending will spur another round of M&A through the end of 2022.
Key Seller Considerations
Manufacturers considering a sale or evaluating a purchase offer must evaluate whether selling now is right for them. Some strategies to make the most of every deal include:
Bring trusted advisors, including an M&A expert, an accountant, and an attorney, into the process early. They can help you asses the offer as it fits into your long-term and strategic goals.
Know how much your business is worth. Don’t guess or fantasize. You need a credible expert valuation to help you assess any offers and structure the sale to be as fair and lucrative as possible.
Get your financials in order. Get personal expenses off the books. Make sure you have at least three years of financial statements that show strong earnings and, ideally, increasing profits. Buyers will not just take your word about profitability. You need to support every claim you make with strong financial statements.
Minimize risk to the buyer. Buyers don’t want to take on a company with serious liabilities, uncertain futures, or a negative reputation. Do whatever you can to minimize risk to the buyer. Critically, this includes being upfront about any liabilities, since doing so fosters more good will and trust between seller and buyer.
Nurture a competitive bidding process. More offers equal a higher final sale price. Sellers should not accept the first offer that comes their way.
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