Strategies for Overcoming Common Obstacles in Manufacturing M&A Deals

Strategies for Overcoming Common Obstacles in Manufacturing M&A Deals

Strategies for Overcoming Common Obstacles in Manufacturing M&A Deals

November 18, 2024 | by Randy Rua

How to Avoid Disappointment When It's Time to Cash Out

Selling a manufacturing business comes with unique challenges that can complicate the transaction process and post-acquisition integration. Many challenges are not anticipated by buyers and sellers and often don’t reveal themselves until deep in the merger and acquisition(M&A) process. Below are some of the most common obstacles in manufacturing M&A faced by buyers and sellers. 

Unforeseen Financial Investments

One of the most common surprises for buyers is the money required to stabilize and modernize the acquired business. For instance, a manufacturing company may operate with outdated equipment or lack a robust accounting system. While the seller might have grown accustomed to these limitations, buyers, especially those backed by private equity, might see these gaps as significant risks.

The need for a cloud-based accounting system or an Enterprise Resource Planning (ERP) system may be non-negotiable for the buyer, but sellers often resist acknowledging the necessity or cost of these upgrades, leading to friction during negotiations. 

 

Key Personnel and Customer Relationships

Retaining key personnel and transitioning critical customer relationships can present obstacles. Buyers often discover that certain employees are indispensable or that the owner has cultivated strong, personal relationships with key customers. The risk of losing these employees or customers post-acquisition can significantly impact the perceived value of the business. Sellers often underestimate how these relationships are tied to their personal involvement, leading to disputes over valuation and deal terms. 

 

Seller’s Reluctance to Stay Onboard

Buyers may insist that the seller remains with the business for a transitional period—often through a three to five-year employment contract— if the buyer doesn’t have a strong management team to take over. This can clash with the seller’s motivations for selling, especially if they were hoping to retire or move on to other ventures. This misalignment can become a sticking point, as the buyer may view the seller’s continued involvement as crucial for maintaining stability, while the seller sees it as an unwanted obligation.

 

 

Working Capital Disputes

Working capital is another frequent source of conflict. Sellers often expect to be compensated for their inventory and receivables, viewing them as part of the business’s value.

For instance, a seller may focus on the company’s value based on a multiple of EBITDA, expecting the inventory value to be added to the agreed-upon purchase price. So, a company with $1 million in EBITDA might be valued at $4 million, but the seller will expect the  $3.5 million working capital tied up in inventory and receivables to result in a purchase price of $7.5 million. 

On the other hand, buyers typically believe that the purchase price should include everything necessary to run the business, including the existing inventory and receivables. This disconnect can lead to heated negotiations, especially when working capital levels are high.   

 

Financing Complications

Financing M&A transactions in the manufacturing sector presents several challenges for both buyers and sellers. Buyers often rely on bank financing, but various factors can make securing it difficult. Banks may raise concerns about the condition of equipment, the stability of cash flows, or the adequacy of financial reporting. 

Extended payment terms—sometimes stretching to 90 or 120 days—further complicate financing efforts, as they can strain cash flows, and banks are wary of these elongated terms and may be reluctant to lend against these receivables.

The fluctuating value of used equipment, often used as collateral, adds another layer of uncertainty as lower-than-anticipated valuations leave buyers with less collateral to secure loans. Rising interest rates also increase financing costs, leading to higher debt-to-EBITDA ratios, making it harder for buyers to meet sellers’ valuation expectations.  

However, it’s not all doom and gloom on the financing front. In response to these challenges, creative funding solutions have emerged, and buyers can increasingly turn to a combination of traditional bank loans and private equity partnerships to close deals. Government programs like SBA and SBIC-backed loans also provide essential support, offering reduced payment terms and enabling banks to take on more risk.

 

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Environmental and Compliance Issues

Environmental due diligence is standard practice – especially when the buyer is purchasing both the business and the property— including Phase I and II environmental assessments. These assessments involve third-party agencies that inspect the manufacturing facilities for any signs of contamination, such as improper waste disposal or oil spills on the factory floor. If issues are identified, they can lead to additional environmental research, increased costs, and potential delays in the transaction, which may cause the buyer to reconsider or even walk away from the deal. 

The liability associated with environmental compliance is also a key concern for buyers, as they could inherit significant risks if past environmental issues are not properly addressed. This often leads to intense negotiations between the buyer and seller, particularly over language in the agreement that protects the buyer from future liabilities. The safest approach is to conduct an environmental analysis to ensure that all potential risks are identified and managed before the deal is finalized. 

 

Cultural Differences

In manufacturing M&A deals, company culture can be a significant obstacle, but it’s often overlooked before the transaction. Culture issues rarely derail deals during negotiations but can cause serious friction afterward. For instance, a buyer who values constant innovation might find it difficult to integrate with a company that has a more traditional approach. This disconnect can lead to operational inefficiencies and lower morale, making it harder to achieve the hoped-for synergies of the acquisition.

Cultural assessments are recommended before closing, and buyers should ask questions and pay close attention to identifying shared values to build on.

 

Data Access for Due Diligence

Buyers often express frustration with the difficulty of gathering accurate and comprehensive data in manufacturing M&A transactions. Sellers may be hesitant to share data or only share partial information, which may lead to misunderstandings and misinterpretations.

The best way to prevent misunderstanding is to build a solid data room with well-organized and vetted information. This fosters confidence in the buyer and allows the seller’s team to identify and address potential issues before they become deal-breakers. 

 

Communication Breakdowns

Effective communication between buyers and sellers is crucial for a smooth M&A process, yet it is often where deals encounter obstacles. Emotions run high, and misunderstandings or overreactions to deal terms can lead to a breakdown in negotiations. For example, if a buyer suggests redesigning a product post-acquisition, the seller may interpret this as a critique of their work, potentially derailing the deal.

Having a neutral third party facilitate communication can help keep discussions focused on facts and market realities rather than allowing emotions to disrupt the process. 

 

Pre-Sale Preparation

A common reason for failed M&A transactions is inadequate preparation on the part of the seller before going to market. A thorough pre-sale due diligence review involves collecting data and anticipating and addressing questions and concerns that potential buyers will have. Sellers who skimp on this process will likely face multiple failed attempts before successfully closing a deal.  

These failed attempts not only incur legal and accounting costs but can also distract from the business’s day-to-day operations, potentially lowering its value. Conducting a thorough pre-sale due diligence process can help mitigate these risks and ensure a smoother transaction.

 

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These challenges underscore the importance of having experienced advisors involved in the M&A process. In the end, manufacturing M&A deals are often a delicate balance between the buyer’s need for stability and growth and the seller’s desire to exit on favorable terms.  

Advisors can help buyers and sellers navigate these complexities, align their expectations, and ensure that the deal structure addresses potential risks. Whether aligning on valuation, addressing operational gaps, or ensuring compliance with environmental regulations, the expertise of seasoned professionals can be the key to a successful transaction.

Contact us to learn more about the services we offer to buyers and sellers.  

Book a meeting with one of our advisors for a confidential discussion about how NuVescor can help you prepare for your M&A transaction. 

Why Growing Through M&A is the New Normal in Manufacturing

Why Growing Through M&A is the New Normal in Manufacturing

Why Growing Through M&A is the New Normal in Manufacturing

November 15, 2024 | by Randy Rua

office planning M&A

In the modern manufacturing industry, growth through mergers and acquisitions (M&A) has shifted from a strategic option to a leading pathway for expansion. With the increasing market complexity, labor shortages, and rapid technological advancements, M&A has become essential for companies that want to stay competitive and thrive. For many, it’s a faster, more efficient way to reach their goals compared to the often slower and riskier route of organic growth.

 

The Changing Landscape: More Companies Ready to Sell

One of the largest shifts we’ve seen in manufacturing over the last few years is the sheer number of acquisition-ready businesses now available. Many of today’s manufacturing companies are led by owners from the Baby Boomer generation who are ready to exit but lack successors. This creates a “buyer’s market” in the sector, where manufacturers can strategically acquire companies to enhance capabilities, expand geographically, or secure skilled talent—advantages that were far more challenging to achieve a decade ago.

The limited pool of individual buyers interested in owning and operating manufacturing businesses further increases acquisition opportunities for companies actively seeking growth.

 

The Manufacturing Segments Leading M&A Activity

While M&A activity is rising across the board, certain sectors are leading the charge. Industries like plastic injection molding and metal fabrication are prime targets. These sectors have a high number of small to mid-sized businesses, many of which are family-owned and without a clear succession plan.  For buyers, this presents a unique opportunity to acquire well-run companies with strong foundations.

Automation is another hot area for M&A, but for a different reason. Building automation capabilities from scratch is tough and requires specialized expertise. Instead of trying to recruit and develop that talent internally, companies are finding it easier to acquire automation businesses that are already equipped with skilled teams and technical know-how. This approach isn’t just faster; it’s often more cost-effective, providing instant access to capabilities that would otherwise take years to develop.

 

Why Companies Opt for M&A over Organic Growth

The motivations behind manufacturing M&A vary, but they often come down to three key areas: capacity, geographic reach, and technology. Each of these factors addresses a need that organic growth can’t meet as quickly or efficiently.

For example, a manufacturer looking to serve customers in a new region can benefit from acquiring a local company rather than building a facility from the ground up. Not only does this save on setup time, but it also provides immediate access to the local workforce and customer base. Similarly, companies looking to enhance their technology can bypass the R&D phase by acquiring a business that’s already at the forefront of innovation.

There’s also the challenge of today’s labor market. Skilled labor is in short supply, and even though more people are re-entering the workforce, finding the right talent remains difficult. Acquisitions provide an advantage here, too. When you buy a company, you’re acquiring not just its equipment or customer relationships but also its team—a team that’s already trained, experienced, and ready to contribute.

 

M&A Offers a Faster Path to Scale

One of the main advantages of M&A is speed. Growing your business by 10-20% organically could take years, but with the right acquisition, that same growth can be achieved in a matter of months. For manufacturing companies, where timing and efficiency are essential, this difference is substantial. You’re not just expanding capacity—you’re gaining the ability to hit the ground running with minimal lag.

Of course, doubling the size of your business through acquisition brings its own set of challenges. Large integrations take time, and the process needs to be handled carefully to ensure that the merged entity functions smoothly. But when you’re targeting an acquisition that adds 10-20% in volume, the integration can often be done quickly, providing a significant boost to your top line and capabilities in a short timeframe.

 

Advice for Manufacturing Owners Exploring M&A

As the economy remains stagnant or even declines, the companies that lean into M&A will be the ones that continue to grow and adapt. M&A allows businesses to achieve growth that isn’t feasible through organic means in a low-growth environment. And as the talent pool for traditional business ownership shrinks, it’s becoming even more difficult for owners looking to exit to sell to individual buyers. This dynamic creates more opportunities for strategic acquisitions by companies that are ready to grow.

Whether it’s gaining access to a new market, acquiring technical expertise, or scaling up quickly, M&A offers manufacturers a powerful tool for navigating today’s challenges and positioning for tomorrow’s opportunities. At NuVescor, we’re here to help manufacturers take that next step strategically, with the experience and insight to make it successful.

Featured on Automation.com: From Shop Floor to Boardroom: How Automation is Transforming Manufacturing Deals

Featured on Automation.com: From Shop Floor to Boardroom: How Automation is Transforming Manufacturing Deals

Featured on Automation.com: From Shop Floor to Boardroom: How Automation is Transforming Manufacturing Deals

September 9, 2024

perfect time to sell-min

As Featured on Automation.com: This article by Randy Rua was recently published as a featured article on Automation.com, a leading online publisher of automation-related content.

Article Summary

In today’s competitive environment, manufacturing companies are facing mounting challenges, including supply chain disruptions, rising operational costs, labor shortages, and geopolitical instability. To combat these issues, many are turning to automation technologies like robotics, AI, and machine learning. This shift is not only transforming operations but also reshaping the M&A landscape. Companies with advanced automation capabilities are becoming more valuable, attracting potential buyers and investors.

Automation is driving efficiencies in maintenance, material handling, and real-time monitoring, improving scalability and “future-proofing” businesses. In addition, M&A processes themselves are being streamlined through automation, from deal sourcing to strategy development. As automation continues to evolve, it will be a key factor in driving manufacturing M&A activity through 2025.

 

Read the full article here

 

About the Author: Randy Rua is the president of NuVescor, a leading provider of mergers and acquisitions services for manufacturers in Michigan and beyond. For more information, contact Randy at rrua@nuvescor.com.

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Understanding Buyer Priorities: The 8 Financial Metrics That Drive Manufacturing Business Valuations

Understanding Buyer Priorities: The 8 Financial Metrics That Drive Manufacturing Business Valuations

Understanding Buyer Priorities: The 8 Financial Metrics That Drive Manufacturing Business Valuations

September 5, 2024

Understanding Buyer Priorities: The 8 Financial Metrics That Drive Manufacturing Business Valuations

We’re currently seeing a consolidation trend in the manufacturing sector as buyers try to grow their market share and improve their bottom lines. Given this trend, now may be the right time for manufacturing business owners to think about selling their companies. However, selling a manufacturing business means finding the right buyer and maximizing the value, both of which require a good grasp of the key financial metrics that influence buyer decisions.

1. EBITDA

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is typically the first metric buyers consider when evaluating a manufacturing business. By excluding the costs of depreciation and amortization, taxes, and debt payment from the company’s earnings, EBITDA is a way to show how much cash profit the firm generates. Acting as a rough proxy for cash flow, EBITDA shows buyers the cash available for them to pay themselves, buy new equipment, reinvest in the company and help generate cash that provides working capital for growth.

 

2. Gross Margin

Buyers use your gross margin to assess how efficiently your company produces goods. It can be hard to interpret gross margin in the manufacturing sector because of different reporting methods, so buyers will dig into the details to evaluate the costs and profitability of producing every component. A healthy gross margin is seen as a sign that your business can maintain current operations and potentially increase profitability as it scales.

 

3. Overhead Costs and Break-even Analysis

Buyers are also keen to understand overhead costs and your company’s break-even point—how many sales you need to make and at what margin to at least cover your costs. Considering these details helps a potential buyer understand how susceptible your business is to sales fluctuations. A comprehensive break-even analysis can help buyers assess the risk and figure out how much of a sales drop your company can withstand before it starts losing money.

 

4. Sales Trends and Customer Concentration

Buyers analyze historical sales data to identify patterns and potential risks. They pay particular attention to customer concentration—how much of your revenue depends on a small number of customers. If a significant portion of your sales, say 30%, comes from one or two customers, losing them could significantly impact the stability of your business. If your customer base is less concentrated, that lowers the risk, making it more appealing to buyers.

 

5. Revenue trends

Buyers will average revenue over time to get a picture of the health of the business, rather than just looking at a snapshot in time. The key here is that growth is good but that not all growth is equally appealing. Potential buyers are looking for steady growth of, say, 10-15% year on year over a period of time. That kind of growth is attractive because it shows consistency and indicates that the team knows how to grow the business in a sustainable way. On the other hand, rapid “hockey stick” growth can be concerning for some buyers. If they see, for instance, 30% growth, they may worry about how sustainable the growth is or even if they are buying at the peak before a potential downturn.

A downward trend in revenue is obviously more of a warning sign for potential buyers, who will want to take a closer look into the reasons behind it.

 

6. Debt to EBITDA Ratio

The debt to EBITDA ratio is a metric that is fundamental to how the deal will be structured. Buyers use this ratio to determine how long it might take to pay off debt and how much debt your company can support based on its earnings. A high debt-to-EBITDA ratio might indicate your business is over-leveraged, potentially reducing its attractiveness. On the other hand, a lower ratio suggests that your company is financially robust and capable of servicing its debt while still providing a good return on investment.

 

7. Working Capital

Working capital is typically defined as current assets minus current liabilities and represents the amount of capital that your company needs to maintain ongoing operations. If your business ties up a significant amount of capital in inventory or accounts receivable, it may raise concerns about cash flow management.

Take, for example, a proposed sale price of $4 million for a manufacturing company that procures a large quantity of raw materials from China. To optimize costs, the company purchases these materials in bulk, resulting in high inventory levels. The company serves large customers with extended payment terms, leading to substantial accounts receivable (AR). In this scenario, the business has approximately $2.5 million in receivables, $1.8 million in inventory, and minimal accounts payable, resulting in working capital of around $3.5 million. However, given relatively modest sales figures of around $5 million, buyers might be concerned about the amount of capital that is tied up in inventory and receivables relative to sales. The worry is whether the buyer will have to keep that ratio the same as sales grow, potentially impacting future liquidity.

Buyers also expect working capital to be included in the sale price of the business so the company can continue to operate smoothly post-acquisition. In this case, with the suggested $4 million purchase price, the buyer would be paying just for working capital, leaving little for goodwill or other assets. With this kind of example, it’s easy to see how managing working capital efficiently is essential to maximizing the value of your sale.

 

8. Profit Margins and Sustainability

Buyers typically look for profit margins in the 10-15% range because that indicates there’s a healthy balance between pricing and cost management. On the other hand, margins below 10% can raise concerns about potential issues with pricing strategy or cost control. If margins dip closer to 5%, buyers may still consider the business, but they will likely offer both a lower valuation and require a solid plan to improve margins.

Profit margins that are too high can also be concerning to buyers. For instance, margins in the 30-50% range might initially seem appealing but raise questions about sustainability. Will an attempt to scale increase infrastructure costs or drive up other expenses that erode the margins? Buyers will want to carefully evaluate whether high margins are the result of a robust business model or artificial inflation caused by unsustainable practices.

Each of these metrics conveys information about the financial health, profitability, and potential for future growth of your business. Understanding and optimizing these metrics can make your company more attractive to buyers.

 

Why Now Might Be the Right Time to Sell

While there is no way to predict what the future holds, Private Equity and strategic buyers are active right now, and demand is strong for quality manufacturing businesses. However, whether the time is right to sell your business depends on more than just macroeconomic conditions and buyer demand.

At NuVescor, we know that the decision to sell isn’t simply a business transaction – it’s about securing your financial future, maintaining your hard-earned reputation, and ensuring the continued growth of what you’ve built. You want a buyer who doesn’t just see the financial value of your business, but who also shares your vision, appreciates your values, and is committed to upholding your legacy.

The manufacturing M&A experts at NuVescor can help you assess whether now is a good time to sell your manufacturing business, based on your unique goals and situation. We follow a proven process designed to help you make this complex decision and move forward with confidence.

Learn more about our sell-side services.

If you’re ready to take the next step, book a meeting or contact us to discuss how we can help you maximize the value and find the right buyer.

 

 

 

 

 

 

M&A in 2024 and Beyond: Cautious Optimism in Industrial Manufacturing

M&A in 2024 and Beyond: Cautious Optimism in Industrial Manufacturing

M&A in 2024 and Beyond: Cautious Optimism in Industrial Manufacturing

August 27, 2024

M&A in 2024 and Beyond: Cautious Optimism

Characterizing the mergers & acquisitions (M&A) climate over the past several years as “mercurial” is indeed an understatement.

While our company’s purpose is to provide strategic M&A guidance and counsel to companies in the industrial manufacturing (IM) sector, for any executive – no matter what business she or he is involved in – it is important that we keep our collective eyes on the entire M&A landscape, as all our industries are inextricably intertwined.

So, before we can look forward, we need to step back and revisit recent M&A history. Two thousand and nineteen was a solid year, which was then followed up a significant drop-off in 2020 – driven by the pandemic. M&A activity increased to record numbers the following year, but such factors as an everchanging regulatory environment in many sectors, a turbulent geopolitical state-of-affairs and tenuous global economic conditions – including rising interest rates – saw M&A activity decline in both 2022 and 2023. 

In fact, 2023 global M&A activity dropped 16 percent from a year earlier, to $3.1 trillion, while in the U.S., from an S&P 500 market value perspective, transaction activity plummeted to its lowest levels in two decades1.

Further, in the auto manufacturing sector – an industry in which our firm is entrenched – deal volume in 2023 was down about 30%, while deal value dropped sharply – about 22% compared to 2022.2

One would think that based on these numbers if there is a light at the end of the tunnel – it is that of an oncoming train.

But we do not think that is the case.

While 2023 was a down year in total, momentum did pick up through the second half of the year, with the final three months the most active. Further, the first five months of 2024 have been strong ones for M&A activity. Through May 31, the overall deal value totaled $535 billion, up nearly 30% from the $412 billion in the same period a year ago.3 And while there will always be potential roadblocks, the mood in the M&A market is one of at least cautious optimism.

M&A 2024 and Beyond: Activity Drivers

Profitability continues to – and will always be – top-of-mind for executives. As their companies continue to navigate the headwinds of high inflation and interest rates, along with structurally high input costs, including, but not limited to, labor costs, they are challenged with seeking fiscally appropriate opportunities.

However, with the understanding of potential rate cuts and future policy changes, these challenges will turn into opportunities. As companies continue to pursue both transformative and strategic ambitions, we should see an overall rise in M&A activity.

Among other signs of increased M&A through the balance of 2024 and beyond:

  • Whether as buyers or sellers, financial sponsor activity could accelerate in 2024. With pressure to return Distribution to Paid-in-Capital, we are looking at sponsors in all sectors and disciplines to monetize
  • Due in large part to inflation and interest rates, valuations have begun to return from their high levels
  • Companies will continue to focus on their core businesses and more secure supply chains
  • The tremendous increase of artificial intelligence (AI)-driven M&A through all sectors and disciplines

Turning to Industrial Manufacturing

As with many other industries, the first 120 days of this year saw an uptick in IM (industry manufacturing) M&A value over the same period in 2023. From my perspective, we can attribute these to several factors, most notably improved executive confidence and profitability growth. These two factors, among others, helped propel the increase in larger deals and activity.

Here are some other factors we think will shape IM M&A activity:

  • The pandemic-driven supply chain issues that severely hampered all industries – primarily manufacturing – are dwindling. Competitively priced raw materials are now more readily available, thus helping to stabilize or even reverse – declining margins.
  • AI, arguably one of the most significant technological advances since Henry Ford created the assembly line, will not only help manufacturers become more competitive, but also more appealing to potential buyers
  • There remain significant amounts of capital among private equity (PE) groups to deploy across the IM landscape
  • Ongoing geopolitical instability continues to have manufacturers look closely at nearshoring, reshoring or onshoring operations, which, in turn, will increase valuations and offset price- and cost-driven outsourcing.
  • Thanks to legislative efforts such as the Inflation Reduction Act, as well as millions in leftover loan proceeds from the Paycheck Protection Program (PPP), a substantial number of strategic acquirers have the cash to fund the suitable deal

Additionally, we expect easing monetary policies and a clearer picture of policy direction after the November elections should foster an increase in transaction activity at least in into 2025, in what is shaping to be a dynamic M&A playing field.

About the Author

Randy Rua is president of NuVescor, a leading provider of mergers and acquisitions services for manufacturers in Michigan and beyond. He can be reached at rrua@nuvescor.com.

Learn more about our services that help owners sell their manufacturing business and complete a successful transaction. Or book a call with one of our manufacturing M&A specialists. 

1 McKinsey: Top M&A trends in 2024: Blueprint for success in the next wave of deals, February 2024

2 PwC: Automotive: US Deals 2024 midyear outlook, June 2024

3 PwC: US Deals 2024 midyear outlook, June 2024