10 best practices for assessing manufacturing M&A opportunities
Merger and acquisition (M&A) activity in the manufacturing and industrials sector is holding steady but has the potential to outpace the highs of 2021 and likely run to the end of 2024. Potential interest rate cuts, election fear and frenzy, strong corporate balance sheets and strong capital raised in private equity will all play their part in finishing 2024 M&A strong.
Investment-minded manufacturers are using this environment to increase their customer base, add new capabilities, enter 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 must first ensure 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 comprehensive due diligence. Beware of the emotional component in every deal that can cloud levelheadedness, especially when speed is of the essence. We are seeing a push by sellers to get their deals completed before 2024 ends and the next U.S. president — and more importantly, their policies — are sworn in.
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 to position you for a better return.
1. Build your 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. And don’t forget IT and cybersecurity. Lean on your team to provide an impartial assessment of your readiness to grow and 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 helping ensure you are informed and protected.
2. Define what you want to achieve — know your why
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
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 and have proper I-9 documentation. Otherwise, you could be staring down potential legal problems in addition to a labor shortage.
4. Evaluate growth potential
Has the seller been in 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 retirement 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 current inflationary environment has put a dent in not only family budgets but corporate budgets as well. Owners and management teams have tried to combat higher costs by charging more, adding fees and surcharges, and in some cases even deploying shrinkflation tactics, offering less for the same pricing.
You should vet these fundamental changes in the way companies drive revenue today, how they differ from historical periods and what their impact may be in the future. Don’t just look at what is currently happening on the income statement, but also at what is sitting in inventory and work-in-process that will turn higher gains or deeper losses in the future.
Net working capital trends are a tell-tale sign of business continuity. If net working capital is erratic and inconsistent, that is an indicator of less than stellar GAAP accounting discipline and poor management of the business cash conversion cycle. Keep your guard up and continue to ask questions.
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. Remember, a 5x deal estimates a five-year return on investment. Will you have synergies to shorten that payback period? Be honest with yourself.
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 gut instinct and cash in the bank?
Blaming too much on the prior owner makes finalizing deals difficult, and it definitely muddies the water during post-transaction integration with all of the employees who work for you now, versus that prior owner. Protect yourself within your purchase agreement as well as their post-closing employment agreement.
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 the framework and calculation sample exhibited in the purchase agreement so it can be replicated at closing and in the true-up period.
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 help ensure your investment pays off is to hire or appoint a project manager to focus on integration from 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 upfront 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 help ensure your operations are running in top order before you take on another company. Do not compound your current operational problems with M&A.
The strategies you need to grow your manufacturing operations
M&A deals always come with an element of risk. Good due diligence will protect your interests. Working with a partner who 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 experience in assessing opportunities and navigating the M&A process. We bring together the insights and capabilities our clients need to make informed decisions. Practical advice. Practical price.
Contact us when you’re ready to expand, and we’ll help you explore the most sustainable path to growth.
