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.
The Biggest Costs Affecting Manufacturing Businesses
As manufacturing businesses gear up for mergers and acquisitions (M&A), a critical task is to streamline operations by cutting unwarranted expenses without compromising on growth and profitability. Awareness of the primary cost influences can guide you in fine-tuning your company’s expenditure strategy. Here’s what you need to consider in the current climate as you prepare your business for a potential sale.
Labor Costs
It’s an extremely tight labor market, with employees increasingly able to demand more than they ever did before. While this expense varies a lot from region to region, it remains one of the highest cost drivers. As you move toward M&A, it’s important to pay fairly for labor, but also to ensure that you’re actually getting real value from the expenditure. Trim the fat by getting rid of employees who require micromanagement.
Part Complexity
Complex parts with sophisticated designs drive costs, especially if they require complicated production steps and multiple processes. Every process increases cost by increasing manual labor, set-up, and supplies. To lower costs, keep designs as simple as possible while still maintaining their functionality.
Raw Materials
The materials used in each product strongly influence price. Each plastic resin and metal alloy has its own unique properties, and owners must determine how much to spend for higher quality products. Because raw materials are traded on the international market, the cost is predictable and owners and other decision-makers can easily find commodities tables to help them determine price, thereby minimizing expenses.
Tooling
Projects that require fixed tools to be machined to make cast parts can generate additional costs. The increase in price depends on the material require to make the tools, the number of components, and their reliance on special treatments. CDC machining takes longer per fixed part than casting, but with smaller volumes it is an option to reduce project costs.
Precision
Precision is not the same as accuracy. Accuracy is a measure of how closely the feature or product matches the desired value or goal. It is measured in inches, microns, or even feet depending on the product. Precision is a measure of accuracy over time. Higher levels of precision require more work and more expense, because of the increased need to control the manufacturing environment. Companies must balance the costs of increased precision against the potential costs of imperfect products.
Volume
The volume of tools made doesn’t change the price, but the cost per finished piece will shift. The more parts made from a tool, the more the price goes down, potentially amortizing the expense. Increasing volumes also empower manufacturers to strengthen the production process, reducing waste and maximizing efficiency. It’s also possible to negotiate bulk prices for larger volumes of raw materials.
Companies considering a merger or sale should work with a manufacturing M&A advisor who can help with assessing costs, value drivers, and potential areas of improvement. Controlling costs without compromising quality is a key strategy for achieving a higher valuation and enticing more buyers to place a bid.
Relaxed credit, cash-rich balance sheets, and an improving post-pandemic economy are igniting a fire of M&A in the manufacturing sector. This is good news, since successful mergers are critical to the global economy and the bottom line of individual companies. But history has taught an important lesson: bad mergers erode value, and may actually undermine long-term success. It can be difficult to get mergers to realize the promised synergies, and integration is notoriously difficult.
While key players in deals often dismiss failed deals as outside of their control—due to chance, fate, or just plain bad luck—the reality is that the factors most likely to destroy a deal are likely well within your control.
Valuation Matters
Overvaluation is the enemy of success. Do not place unflinching trust in the valuations offered by external advisors such as investment banks. Success fees, rather than a desire to see the deal succeed, often drive these excessive valuations. You need a keen understanding of the metrics used to value your company. Don’t let your emotional reaction to a high valuation color your ability to think critically.
Get Specific About Synergies and Their Execution
Transformational deals are often little more than a CEO’s itch to do something, anything. Don’t assume a big deal is going to change everything just because you want it to. For a deal to truly offer synergistic value, you must be able to identify the specific synergies you hope to achieve. And then—this is the difficult part—devise a plan for making these synergies a reality. Integration planning must be a part of the dealmaking process—not an afterthought that only begins when the deal closes.
Open Communication
Mergers can be a time of immense anxiety for your staff, your customers, and stakeholders in the community. Lack of communication makes this anxiety worse, and gives the rumor mill time to fill in the gaps—usually with negative information that undermines the merger. As you move into the deal, develop a communication plan that offers a clear, consistent message and allays any fears. Identify a single point person for questions about the deal, and empower this person to speak empathetically and with specifics.
Knowing What You Don’t Know
Decisions about M&A are among the most important you will ever make. Unfortunately, these are also the decisions that most corporate leaders have very little experience handling. Your board, too, has probably only worked on one or two deals. This is dangerous because it’s easy to overestimate your knowledge and make risky decisions without even realizing you’re doing so. The right deal team can help fill in knowledge gaps, alert you to pivotal moments in the decision-making process, and ensure you end up with a deal you’re happy with. Don’t go it alone. DIY deals are often more costly, and are always more likely to fail.
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