Why Now is a Good Time to Own a Small Manufacturing Company | Corbett Hub

HomeArticlesBuying a BusinessWhy Now is a Good Time to Own a Small Manufacturing Company

Why Now is a Good Time to Own a Small Manufacturing Company

As American companies accelerate their exits from relying on China-based sourcing and manufacturing, there are growing opportunities for small U.S. manufacturers and for those who acquire manufacturing companies.

The operating uncertainties in China stemming from the political climate, pandemic shutdown concerns, and a shrinking direct labor benefit are driving decisions to manufacture, or source, here in the U.S. Even prior to these issues, tariffs imposed on China imports and their pressure on profit margins in recent years expedited many management decisions to find long-term alternatives. In addition, new concerns of intellectual property theft provide another tailwind on decisions to secure domestic manufacturers.

The decision by major companies to shift product and component sourcing to the United States creates opportunities for the smaller manufacturing companies that supply components to a wide range of industries ranging from Defense to Medical. Examples of such companies include CNC, plastic molders, heat treatment services providers, and stamping and metal forming companies.

The Move to Domestic Manufacturers is Already Underway

The construction of new manufacturing facilities in the U.S. jumped 116% over the past year, a tremendous leap from the 10% gain on all building projects combined, according to the 2022 Dodge Construction Network via an article posted on Bloomberg

A January 2022 UBS survey of C-suite executives highlighted the breadth of the “China Exit” sentiment in this country. More than 90% of those surveyed said they either were in the process of shifting production out of China or had plans to. And about 80% said they were considering bringing some of it back to the US. 

But not all companies are willing to quickly exit China due to complex logistics chains which cannot be easily replaced or the need to preserve margins. In terms of the latter, companies may look to sourcing from other low-cost countries such as Mexico, India, and Vietnam and not to the US. 

A Gartner Survey in 2020 reported that 33% of Supply Chain Leaders either moved to manufacture out of China or were planning to do so by the end of 2023. This represents a present and ongoing opportunity for small business buyers to acquire such small manufacturers and take advantage of this growing shift. This includes investors seeking to acquire multiple similar businesses such as precision stamping and CNC companies and consolidate them into a larger more profitable entity benefiting from scale and overhead absorption.

Is a Manufacturing Business Right for You? Consider the following:

Lenders prefer manufacturing transactions
Manufacturing is often favored by lenders due to its asset composition including three classes of inventory (raw, work-in-process, and finished goods), capital manufacturing assets, and often real estate all of which can collateralize loans. These high-quality assets serving as collateral for a loan increase the attractiveness of the acquisition to lenders.

In addition, manufacturing companies often generate steady positive working capital which enhances the ability to obtain acquisition financing. It’s for this reason that SBA solutions are commonly used in manufacturing acquisitions. Most of such acquisitions are asset deals with SBA7 (a) and 504 financing.

You don’t necessarily need manufacturing experience
Buyers with relevant manufacturing experience who understand the processes, markets, and materials utilized are obvious candidates for a manufacturing company acquisition. However, smart general managers especially those with a process-based business model experience, including private equity groups, do succeed.

However, it’s important to note that individuals targeting manufacturing acquisitions often will be competing with larger strategic buyers or private equity groups seeking “bolt-on” acquisitions. In these cases, the winning bid typically comes down to cash.

How to Identify the Right Small Manufacturing Company

Despite the growing opportunity, owning a small manufacturing company is not without hurdles that must be considered and planned for well ahead of any acquisition decision. Savvy buyers should work with their broker to analyze each of the following questions to determine risk and even sale price. 

  • What is the customer concentration? This is a common problem for small manufacturers with a handful of customers often representing fifty percent or more of annual revenues. Buyers need to understand what contracts exist with customers as well as the account share with key clients to assess risk, as well as opportunities to expand that account share. 
  • What is the owner’s role? Understanding the owner’s role and importance to the ongoing success of the business is an early first-stage requirement of assessing a manufacturing acquisition. For instance, the owner’s role may be hard to replicate with just one employee and the owner’s relationship with key customers may be essential to the ongoing success of the business. 
  • Does the company have a reliable workforce? Skilled labor is currently a major issue for manufacturers in addition to a nationwide general labor shortage. Buyers must understand skill depth by position and the employee attraction and retention strategies that the company executes. 
  • What’s the status of vendor relations? Key supplier and vendor relationships need to be confirmed especially if the vendor provides a non-commodity product or service not easily be replaced. 

In addition, quality methods, instrumentation utilized, personnel, and records must be reviewed and matched with product return data as well as any margin improvement strategies. This is less of a concern for ISO-certified companies or who manufacture to DIN (European) standards.

Employee safety standards and records must also be reviewed. Local manufacturing and trade organizations offer direct labor and supervisory training and State assistance via grants and tax credits should be analyzed by prospective buyers. 

Buyers also need to confirm that key processes are documented and with offsite backup. As much as possible the “art” of any process should be in writing and possibly be captured on video. Well-managed manufacturing companies are often metric driven which helps in due diligence and competitive benchmarking. Such metrics include revenue and margin per employee, percentage of annual revenue from new products, specific equipment productivity, returned goods analysis, quote capture rates, and inventory turnover.

The Long-Term Direction

Small Business buyers should consider manufacturing company acquisitions as part of their acquisition and wealth creation strategies. Such companies have unusually good long-term prospects in an increasingly unsettled world that is driving demand for U.S. based manufactured products and services. 

The product lives of manufactured products often exceed that of other industries contributing to financial stability. However, smart manufacturers constantly innovate existing products to provide competitive products with good margins. If you choose to own a manufacturing company, consider the importance of appropriately pricing replacement parts which are a common additional high-margin income stream for supporting an installed base of customers. 

Given current macroeconomic trends, the long-term direction and upside for American manufacturers and investors are potentially brighter than that of other industries. Buyers need to carefully create and execute acquisition strategies for manufacturing with solid due diligence.

Original Source Written by Robert Flynn

Become a Hub member and start enjoying the benefits.