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10 best practices for assessing manufacturing M&A opportunities

Oct 23, 2022

M&A activity in the manufacturing sector is at a 10-year high, and it isn’t likely to slow down anytime soon.

The favorable tax code, unspent Paycheck Protection Program funds, and a wave of retirements among baby boomer and even Gen X business owners have created an unprecedented opportunity to expand through acquisition. Savvy manufacturers are using this environment to increase their customer base, add new capabilities, gain entry into fast-growing sectors and even accelerate digital transformation. In the process, they’re adding millions to their EBITDA faster than organic growth could ever achieve.

But before you acquire a manufacturing business, you need to first make sure you’re not buying someone else’s problems — or compounding your own.

Steering clear of risky endeavors

When sizing up an M&A deal, never make assumptions. This is common sense and the reason why you conduct due diligence. However, there is an emotional component to every deal that can cloud levelheadedness, especially when speed is of the essence.

Taking an honest and unbiased assessment of both the financial numbers and nonfinancial fit is critical. With that in mind, here are 10 best practices for assessing M&A deals that will position you for a better return.

1. Build a due diligence team before you start exploring deals

Successful deals don’t just happen; they require meticulous planning and execution. So before you start scouting out opportunities, build a due diligence team.

At a minimum, include your accounting firm, attorney, and insurance and benefits providers. Lean on your team to provide an impartial assessment of your readiness to grow and of the strengths and risks of potential acquisitions. This is not an area to skimp on. Thorough due diligence will save you time, money and heartburn by ensuring you are informed and protected.

2. Define what you want to achieve

Most buyers recognize that M&A deals need to support long-term growth plans. Yet it’s easy to lose sight of this when M&A activity is hot or an exciting opportunity pops up. Whatever your growth and expansion plan calls for, build a strategy to achieve it and let that guide your pursuit. If you can’t answer why you want to acquire a business, then the business likely doesn’t align with your strategy.

3. Assess the workforce

Manufacturers across the board are having a tough time filling the floor. Acquiring a business could create an opportunity to add capabilities along with a built-in workforce. But that only works if the seller isn’t stretched for talent. And finding talent isn’t your only concern. You also need to ensure the seller’s employees can pass a background check. Otherwise, you could be staring down potential legal problems in addition to a labor shortage.

4. Evaluate growth potential

Has the seller been in a growth mode, or have they been serving the same customers for the past 20 years? Stagnant growth doesn’t necessarily indicate a lack of potential. But long-term clients may be eyeing retirements themselves. If the seller has been running on autopilot for years, you’ll need to quickly and cost-effectively build up your customer base to cushion against drift. Likewise, if the seller has been operating with a growth mindset, make sure you have the capabilities and resources to support that trajectory.

5. Dig deep behind the numbers

The COVID-19 pandemic has added a lot of static to profit and loss statements. Are current margins and profits sustainable, or are they based on temporary consumer demand or stimulus? We have seen sellers attempt to pass off PPP funds as profits to command a higher selling price for their business. You need to separate the real numbers from the noise to avoid making a decision based on transitory profits. In the current inflationary environment, beware of growing inventory. Is it due to quantity build or rising costs?

6. Consider the payback period

Henry Kravis, co-founder of KKR & Co., Inc., once said, “Don’t congratulate us when we buy a company, congratulate us when we sell it. Because any fool can overpay and buy a company, as long as money will last to buy it.” Think of the acquisition as something to monetize rather than something you’ll keep forever. This will put your expected return into perspective. There’s a direct correlation between how much you pay over EBITDA and how long it will take you to realize a return. If that payback period is too high, then it’s time to re-evaluate the deal.

7. Determine whether it’s a good cultural fit

Shared values are important, but there’s more to determining cultural fit. You need to take a hard look at what the seller does that you don’t — and vice versa. How do they market their services — or do they? How do they interact with their top customers, and are you prepared to treat them the same way? How digitally mature are their operations? What nontraditional perks do they offer employees? Do they have a management team and a governance structure in place, or does the owner run everything by fiat?

You can’t fit a square peg into a round hole. If you are not a good cultural fit, consider other M&A opportunities.

8. Set the terms for working capital early

Working capital is one of the top sources of angst in a deal. Naturally, sellers and buyers look at working capital differently. This is further complicated when the seller doesn’t have proper inventory cost or WIP reporting. As a buyer, you need to clearly define expectations for working capital and have an out-clause built into the deal if the seller doesn’t come through.

9. Appoint a project manager for integration

Integration goes hand in hand with cultural fit, and it’s where buyers most frequently stumble. Integrations don’t just happen; they take time and resources. How well you integrate an acquisition will determine the success of the deal. One of the best ways to ensure your investment pays off is to hire or appoint a project manager to focus on integration starting with the moment you decide to buy the business.

10. Do some diligence on yourself

Do you have a good handle on your own operations? Is your shop floor running at capacity? Or are hidden bottlenecks and snags hindering productivity? Are you ready to buy, or would you be better served by investing in a build strategy?

Conducting up-front diligence will help you prepare for questions that sellers, investors and funding sources may ask of you. But it’s also a good exercise to ensure your operations are running in top order before you take on another company.

The strategies you need to grow your manufacturing operations

M&A deals are fraught with risk. Good due diligence will protect your interests. Working with a partner that can help you interpret what the findings mean to your future is invaluable.

At Wipfli, our manufacturing and M&A transaction advisory service specialists offer decades of expertise with assessing opportunities and navigating the M&A process. We bring together the insights and capabilities our clients need to make informed decisions. Contact us when you’re ready to expand, and we’ll help you explore the best, most cost-effective and sustainable paths to growth.

Next up, we’ll dive into opportunities for improving margins so you can reinvest in growth. Don’t miss out on that and our other thought-provoking articles just for manufacturing leaders. Sign up using the form on the righthand side of this page to receive articles and our manufacturing newsletter directly in your inbox.

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Author(s)

Michael L. Vaccarella, CPA, CGMA, CM&AA
Partner – Private Equity and Transaction Advisory Services
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