While “manufacturing” could reference any type of product creation, the information presented here is based on observation of asset-heavy manufacturing company valuations in the lower mid-market (small-mid sized businesses).
Below we will briefly outline what the driving factors are for a businesses valuation and what makes the business more or less valuable.
This valuation spectrum is entirely predicated on what a businesses risk factors are, what the potential upside of the business is and what type of lifestyle will the business be able to generate for its owner.
In order to understand how companies are priced, we should start first with an understanding of how any asset is priced.
The price received for a given asset is simply the equilibrium of what a buyer is willing to pay and what a seller is going to sell. More buyers than sellers in any market drives prices up, more sellers than buyers in any market will drive prices down.
Anybody who has ever attempted to sell a business in the lower mid-market knows that there are not nearly enough able buyers in the market to buy all of the good businesses on the market.
Because sellers still need to find a way to dispose of their business, they end up taking a far lower valuation than they would if it was a larger business.
Risks to Buyers
Below are a few of the common risk factors that are assessed by buyers during the preliminary screening process where they look to see what businesses they should invest in.
- How sticky are the clients. Manufacturing is an industry that lends itself to having clientele stay with the company for several years. The lower the client churn rate, the lower the risk. All buyers love the idea of stable clientele.
- How stable is the market for the product. A lumber mill will have a much easier time drawing interest from buyers than a manufacturer of trendy purses. Commodities like wood will sell well for centuries after the trendy purse manufacturer has folded.
- High asset levels. When acquirering a business, buyers look to get the highest return possible on their money. If they have to buy both a business and its several million dollars worth of assets, rates of return go down and so does the number of interested buyers.
- How old the business is. Manufacturing is a stable industry with a lot of second and some third generation businesses on the market at any point. Legitimate buyers will want to see a long history of stable, predictable, growing free cash flow from the businesses they acquire.
- The team in place. One of the main assets every business has is its human capital. Manufacturing businesses are no different. A business with a tenured and reputable team in place that will stay on to work for the new owner de-risks the business significantly.
- The deal structure. See our blog entitled “Selling Your Manufacturing Business” to learn more about acquisition deal structures and what type of deal makes sense.
Upside to Buyers
Once a buyer has answered the above questions about a businesses risk, they must determine what the upside of the business is and balance the two factors out to come up with a price and deal terms that make sense for them. A few of many potential upsides than can appeal to buyers are:
- Neglected line of business. Some businesses simply do not change because they have never needed to. Sharp buyers can spot businesses that have opportunity to add value in an adjacent industry to it’s current one. Purchase the business and greatly expand its top and bottom line figures with some focus and investment.
- Expand marketing effort. Manufacturing lends itself to having residual clientele. Because the lifetime value of these clients is very high, it is cost effective for some manufacturers to allocate a large portion of capital to marketing in order to expand their client book.
- Bring professional expertise. The manufacturing mid-marker space is filled with successful business and wealthy founders. However, it is not filled with lawyers and Harvard MBAs. In the majority of manufacturing businesses there can be costs cut and efficiencies uncovered by bringing in a buyer who understands how to sharpen their pencils and tighten up a businesses books and operations.
What else could I do?
Selling may not be the best option for you. You may just want to wind your company down, give it to your employees or even continue to run it on a part time basis.
If you are new to the thought of refinancing to continue running your business or potentially considering selling it, read our manufacturing business financing options article.