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Determining the true value of your manufacturing operation

As published in Jackson Magazine

A few important factors should play a major role in the timing and outcome of a business transition. Perhaps one of the biggest obstacles in a successful business transition is coming to a realistic, optimal value. Often times, owners think they know how much their business is worth (this may be based on what they have heard from colleagues or what they have read in recent industry publications). However, determining the value depends on many factors, some of which include: 

  • Your industry segment 
  • The recent history of performance
  • Inorganic growth strategies focused on product and service differentiation
  • The quality of the underlying business, patented and proprietary methods
  • Customer base transferability and access to new markets, customers and technology.¹

Keenly important to the price that will be paid is future earnings potential; also, whether the transition will be internal or external, and the structure and documentation of process and people all influence value². Ideally, a formal valuation with market comparisons will be completed to provide a baseline and objective value which may be used as a basis for conversation and further planning. Overvaluing or undervaluing creates issues with any form of transition.

Disagreements in the valuation of a business are the biggest deal breaker in any transition. A dispute between a buyer and seller — or the difference of opinion between family members or key employees — will stop the process cold. As an example, consider the situation when a manufacturing company has several interested buyers. The company starts the due diligence process, and things are going really well. Then, they sit across from each other at the table but they do not agree on the value of the business. Their difference must be worked out whether it’s the structure of the agreement, through less cash up front or a longer owner financed timeframe. However, this creates more risk for the seller.

Quite often, what actually happens often is that terms are not agreed upon and the deal falls through. When there’s a family transition with multiple siblings who plan to buy or inherit the business, difficulties often arise. They often have their own unique perspective on the value of the business now as well as how to determine the longer term cash flow and distributions to the exiting generation.

An objective and professional valuation provides the context for the terms of the transition with documentation and explanation of market or discounts related to structure, which helps bring all parties to the table in agreement. A professional, high-quality transition team uses this as a starting point to structure transactions in a practical, workable and tax efficient way for all parties involved.

Once a valuation is complete, how does that translate to what is happening in the marketplace? We are currently in a “seller’s market,” where the price and structure for external transactions is at a premium and the ability to leverage assets and resources for an internal transition provides options for financing over a longer timeframe at a lower cost to all interested parties. The multiples that are being offered for manufacturing and distribution companies is a 9.74x³ 4(2016) average resulting in offers that often exceed the expected price by 20 percent or more. Factors that are driving deal activity in 2017 include limited organic growth options, changes in the market business models and availability of credit and cash reserves.

Consider the two primary variables that impact the value of your manufacturing operation, risk and cash flow. The lower the risk and the stronger the cash flow the more options there are related to sales price and deal structure. By reviewing buy/sell agreements, retaining key employees, documenting processes, enhancing your customer base, risk is decreased which then affects the terms and price of a transition agreement.

The other key elements that both greatly influence and build value (and were referred to previously), are intangible assets and transferability. These assets include the talent of your team, your integrated customer base, your infrastructure related to process, people, technology and facilities, and your social capital which includes your culture and brand. The transferability of people and process, or the what, the how and the why, all promote business continuity. These are attractive to future owners and create value in all forms of transition.

Working with a team that has ample experience optimizing value, aligning prospective buyers, establishing terms that are compatible with your goals, structuring a deal that is workable and creates the least leakage in terms of tax payments should be the goal. Taking advantage of the seller’s market and having a good, supportable handle on what the manufacturing operation you have built is worth makes transition on your terms possible and hugely rewarding.

 


¹ Deals Insights, A4 2016 Update
² Manufacturing Data, Rua Associates, 2017
³ Industry Week, April 26, 2016
4 Pitchbook M&A Report, 2016 Annual

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