If you own or manage a manufacturing business that has been “in the family” since its founding, you may be considering what is next for you and your company. After the disruption of the pandemic, many business owners are looking for an exit from an industry that continues to struggle with supply chain, talent management, and inflationary pressures. However, exiting from your company is not always a slam dunk – it takes proper planning and a focused strategy to achieve the greatest value and the best outcome for you and for the business you have built.
According to Pitchbook, a slowdown in merger and acquisition (M&A) activity occurred in the third quarter of 2022, but prospects still exist for companies that are the right fit. The cloud of rising inflation and interest rates, along with talk of recession, make the process of selling a business more challenging to navigate, but for buyers and sellers who are well positioned, there are available opportunities.
Generally, acquisitions can come from three sources: private equity or independent sponsor funded, strategic partner, or public offering. A privately held business that is planning an exit should decide early on in the process which strategy makes the most sense, as the preparation can vary depending on the plan. Regardless of the exit strategy, below are some of the preparations that management can undertake to ensure the best outcomes¹ in deal value and post-deal success.
- Evaluate your value – A private manufacturer hoping to attract a suitor for a potential exit should first do a thorough self-assessment. This includes assessing the capacity and capabilities of its operations, analyzing its financial results, and assessing the skills and longevity of its management team.
In assessing its current operating environment, a private company needs to understand its competitive place in its industry and identify any operational challenges. These might include excess capacity and gross margin pressure.
- Streamline processes to improve margins – The price earned on a sale transaction is generally based on a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA). As the target operating company, management’s goal is to support a higher EBITDA because that will lead to a larger cash infusion. Base EBITDA improves, the more efficiency you can create in your process, such as increased automation, and processes that reduce touch points throughout the manufacturing cycle.
Commonly, EBITDA is adjusted for expenses that are not expected to recur once the investment transaction is completed. These can include items such as above-market compensation or expenses incurred with parties related to the current owners. Management should evaluate their financial records to consider these potential add-backs and begin to develop the support for these items as they plan for the exit strategy.
- Continue to invest in automation – Manufacturers who have increased automation (especially those that have moved toward advanced manufacturing) should expect to earn a higher price relative to less advanced businesses.
- Manage working capital – Working capital is the ratio of current assets to current liabilities. This is the amount of resources a company needs to fund its business on a daily basis.
Manufacturers face the challenge of managing not only customer collections, but also inventory levels, to regulate the amount of working capital needed to sustain the business.
Most sales agreements will provide an adjustment to working capital at closing based on the difference between the actual ratio and an agreed upon value. A buyer will most likely push for a higher working capital amount. Being able to demonstrate that the business has operated on a lower ratio, such as using a trailing 12-month average, can serve to increase the amount of cash received when the deal closes.
- Implement improvements in the finance and accounting team – While you may have been able to effectively run your manufacturing business with a lean finance and accounting team and relatively simple tools, the reality is that during the due diligence process of a sale and after, more complex reporting and analysis will be needed. For a manufacturing business contemplating an exit, considerations such as product profitability, and supply chain management are key differentiators that can lead to additional value.
If you can put that infrastructure together before you go to market, you will have an advantage over your competitors who are looking at the same partners as you are. As with any such enhancement, you need to evaluate the cost/benefit to see which areas are key to enhance and which can wait.
- Enterprise Resource Planning (ERP) upgrades – One theme that came out of Citrin Cooperman’s 2022 Manufacturing and Distribution Pulse Survey is the importance of moving toward enhanced, actionable data that is needed to run manufacturing businesses in today’s environment. Whether for keeping a handle on product costs or enhancing your knowledge of customer buying patterns, information tools such as ERP systems and artificial intelligence (AI) help to create a leading-edge business, which will be more attractive to a greater number of buyers.
Manufacturing companies that are thriving after the pandemic years may be hoping to cash in with a successful exit. While the economic conditions of inflation and higher interest rates may limit the number of opportunities, companies that position themselves well should be able to meet their exit goals.
¹EBITDA Multiples: Earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples can vary depending on industry, the size of the deal, and company specific factors. In general, EBITDA multiples have been falling as interest rates and the related cost of capital have increased.
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