There are three primary considerations when approaching such a transaction: how to maximize the seller’s economics, how to time the market and how to make the business financially attractive to buyers willing and able to pay the most.
This paper by Dan Mulvaney, CPA (inactive), MBA, Sunbelt Business Advisors tells you how a manufacturing business is different from other types of businesses and what you need to do to prepare to sell one.
CPAs who advise lower middle-market manufacturing companies, defined as those with revenue between $5 and $100 million, should understand how to help their clients net the most when they sell to a third party.
There are three primary considerations when approaching selling your manufacturing business for cash: how to maximize the seller’s economics, how to time the market and how to make the business financially attractive to buyers willing and able to pay the most.
Economics: net-after-tax cash:
Despite business owners’ usual focus on sale price, a seller’s most important economic metric from a financial standpoint is net after-tax (NAT) cash. NAT cash is the amount of cash the seller receives after every third party is paid, including the government, lenders, employees, merger and acquisition (M&A) advisers, etc.
Sale price is a major component of NAT cash, but so, too, are the tax allocation, transaction structure, post closing cash payments (seller financing), closing costs, excluded assets and liabilities, etc.
Timing also influences NAT cash, most notably through the economic cycle and the condition of the business at the time of sale.
Timing: sell at the peak:
Properly timing the economic cycle requires selling at the peak of the M&A market for an owner’s industry group. Since most businesses follow the general economic cycle, the best time for most to sell is during peak markets in the broad M&A marketplace.
Since 1969, economic cycles, defined as trough-to-trough, have lasted from 27 months to 129 months, with the average duration from 1990-2009 being 107 months. Broadly speaking, business cycles over the past five decades average about seven to nine years in duration. See www.nber.org/cycles.html
June 2009 is recorded as the most recent economic trough. We believe the market is at peak level today for sellers (September 2016) and has been at this level for a few years. We are now seven years into the cycle from the last trough.
Selling during a peak market is key to maximizing NAT cash. If an owner is trying to decide between selling now or in three to five years, they should think seriously about selling now. Selling during a downturn results in less buyers, less bank financing and less business profit — all of which result in less sale price and NAT cash. How to sell a manufacturing business for the most cash.
Timing: make the business financially attractive to buyers:
In order to maximize NAT cash from sale, it is important to make the business financially attractive. The more financially attractive the business, the higher the price. Buyers want stable cash fl ow and future growth — the more consistent the better.
Financially, a business is most attractive when GAAP-based revenue and profit are increasing and capital expenditures are minimized. Balance sheets with no debt are more attractive than those over-leveraged. Revenue growth, healthy gross profit percentages and growing earnings before interest, taxes, depreciation and amortization (EBITDA) percentages are all value-drivers. Properly calculating EBITDA is a fundamental that is often not part of ownership’s dashboard, and is sometimes miscalculated.
Post-closing management, diversity of customer/vendor/ product base, barriers-to-entry, market share, customer relationships, patented products, modern well-maintained equipment, etc., are qualitative attributes that also drive value in the M&A marketplace.
Many owners balk at investing in an audit or review. If the goal is to maximize NAT cash in a sale, then the value created from these reports more than justifies the cost in most cases. Strategic buyers value audited financial statements — they add credibility to the seller’s presentation of a professionally managed business being run with proper investment.
Successful manufacturers use their production processes as a competitive weapon in the marketplace. They are able to plan, execute, monitor and self-correct to maintain a profitable business while efficiently shifting with customer demand. From an accounting standpoint, buyers want to know where the money is being made — by product, customer, market and SKU (identification code). Being able to slice-and-dice sales and costing data provides valuable insights. The best information is gross profit by customer by SKU, an SKU being the most basic item sold and not commingled with other products.
The most complex part of a manufacturer’s accounting system is the cost accounting system that tracks manufacturing costs, then allocates them to product moving through the production process until shipped. Well-functioning cost accounting systems allow for accurate and timely cutoff between the P&L and the balance sheet.
The complexity of properly managing an accurate cost accounting system is high. Indicators of a sound cost accounting system include:
- Process-driven systems based on best practices, consistently applied and managed
- Concise accounting methodologies and accurate measurement of a work-in-process
- Minimal amounts of monthly variances-to-standard
- Minimal amounts of physical-to-book variances for full physicals and cycle counts
- Minimal amounts of slow-moving inventory
- Closing the monthly books quickly (when not closed quickly, the culprit is usually the cost accounting system)
Buyers value accounting systems that provide accurate, timely and easy-to-read information. Cumbersome or poorly-designed cost accounting systems are fatal flaws for some buyers and may result in a valuation discount by those still interested. Buyers value strong financial and management reporting systems that provide company decision-makers with timely and accurate information that allows for more informed decisions.
The sale process:
A properly executed sale process is the best way to maximize NAT cash.
Most business owners agree that having many customers for their products is a plus. Th is same principle applies when selling a business. Competition from multiple buyers drives price and terms for the seller.
It is tempting for a seller to accept an unsolicited offer from a strategic buyer, private equity group or other financially capable buyer. Buyers pay sophisticated people a lot of money to find off -the-market businesses to purchase. These “finders” get paid high fees because buyers know that without competition, they will purchase the business for materially less.
If the priority is to maximize NAT cash, then selling to the first buyer doesn’t make sense. There is no way to quantify the amount lost by the seller who accepts an unsolicited offer because there is nothing with which to compare.
In order to maximize NAT cash, it is best to create a milestone driven, time-based competitive marketing campaign and bidding process that targets strategic buyers. Reputable sell-side M&A advisers have the experience and infrastructure that allows them to find and negotiate with the best buyers to achieve the highest NAT cash from sale.
Competition between buyers shifts the demand curve up while the supply curve remains fixed, resulting in a higher sale price. Th is basic economic concept of competition driving economics is proven by skilled sell-side advisers daily in the M&A marketplace.
Strategic buyers create financial synergies with an acquisition and, therefore, can justify a higher price while achieving the same ROI as a financial buyer. For this reason, the marketing campaign should target strategic buyers. If strategic buyers aren’t interested in the acquisition, then financial buyers, including private equity groups, family offices and high-net worth individuals, should be pursued.
Buyers value management teams able to accurately budget and forecast revenue, expenses, assets, liabilities and cash flow. Accurate budgeting is complicated and typically results from focused repetition over a period of years. Those companies able to budget and forecast know, from a financial standpoint, their businesses intimately. This knowledge enables creation of a future plan substantiated by historical results and reasonable assumptions.
A crucial part of the M&A adviser’s marketing campaign is to articulate a simple, understandable future plan about how the new owner will grow the business and generate more profit in the future. The less simple and clear the story, the less value ascribed to the business.
A key milestone in the sale process is a buyer’s written off er in the Letter of Intent (LOI). From a seller’s standpoint, the LOI should include all material economic terms of the transaction. The instant the LOI is signed by both parties, the power shifts from the seller to the buyer and the buyer begins its due diligence investigation. This is why it is optimal to have all material economic terms defined in the LOI, because if they are not, then the buyer may use blemishes found during due diligence to negotiate undefined terms down when finalizing the definitive purchase agreement.
Once the LOI is fully executed, then a smooth due-diligence process maximizes the likelihood of closing. Due diligence and legal documents are necessary to reach closing, but these subjects are outside the scope of this article.
Maximize into the future:
Consider this your road map for advising business owners how to maximize NAT cash from sale. Timing the sale with a peak market, making the business financially attractive and engaging an experienced M&A adviser to run a competitive marketing campaign will maximize NAT cash from the sale in nearly all instances.
- Dan Mulvaney, CPA (inactive), MBA is a sell-side M&A adviser with Sunbelt Business Advisors in Minneapolis. email@example.com or 612-860-0047. Special thanks for review and comments from Jay Abdo, Dave Henderson and Tom Rosen.