Manufacturing business owners are retiring in record numbers, and manufacturing companies have been among the most sought-after acquisitions for the past several years. If both of these things are true, why does the Harvard Business Review report that between 70-90% of M&A deals fail? Here are 12 deadly killers of manufacturing M&A deals:
1. Unrealistic Valuation
2. Business Decline During the Sale Process
3. Due Diligence Red Flags
4. Disagreement on Purchase Price Allocation
5. Time – Deal Fatigue
6. Loss of Trust
7. Third-Party Challenges
8. Environmental Issues
9. Weak Management Team
10. Forcing a Match
11. Different Post-Closing Transition Expectations
12. High Emotions
Let’s take a look at the 12 Deadly Killers of Manufacturing M&A Deals in more detail.
Unrealistic Valuation:
Most readers will automatically assume that I’m referring to unrealistic valuation expectations on the part of the seller. While that is clearly a problem, as a 30-year veteran selling exclusively within the manufacturing sectors, I see this more often from buyers. Often, buyers will submit offers of 3-4X of EBITDA when current market conditions for certain manufacturing sectors might be 5-12X.
In some cases, the buyer is simply trying to buy low, and in other cases, they are simply misinformed. Buyers need to consider where they are getting their information from. There is a lot of valuation information available on the web from business listing sites, which is very general in nature. An M&A professional selling exclusively within a sector, whether it’s a manufacturing company or a doctor’s office, will always have more current information as a result of having their finger on the pulse of the particular sector.
Business Decline During the Sale Process:
This is often the result of a seller taking their foot off the gas pedal after listing their business. They are relieved that they made the choice to go to market, and they’ve got one foot out the door on the approach to retirement. However, it could also simply be an unexpected event like the loss of a customer who decided to offshore or discontinue a product. Sellers should do everything in their power to maintain and increase sales during the time the business is on the market. But for issues outside the scope of their control, the M&A professional should have a heart-to-heart conversation with the seller about pausing the listing until sales return to normal or lowering the sale price if the seller wishes to exit quickly. There’s no one right answer in these situations; it’s what is right for the seller, their family, and the continuity of the company.
Due Diligence Red Flags:
Quality buyers don’t like surprises, and frankly, there shouldn’t be any. The seller and M&A professional should go to great lengths to ensure that all information provided is accurate. A quality M&A firm should have client vetting procedures to eliminate sellers who are not ready for the process or who will damage the firm’s reputation with a lack of transparency or inability to provide consistently accurate information.
To give you a sense of what “red flags” might look like, I would refer you to my recent article 10 Tips For Selling Your Manufacturing Company For Maximum Value, specifically #9 on GAAP accounting.
In another recent article, The Exponential Cost of a Bad Manufacturing Employee, I tell the story of something the seller kept hidden that cost him the deal.
Disagreement on Purchase Price Allocation:
Purchase price allocation (PPA) can be a challenging part of the deal negotiation. In an asset sale, both buyer and seller must submit IRS Form 8594. The entire purchase price must be allocated among seven asset categories. Buyers want to allocate the greatest portion of the purchase price to categories they can depreciate the quickest. Sellers want the largest allocation to categories that are taxed at a lower rate. Of course, what helps the seller hurts the buyer and vice versa.
If you’re considering selling your manufacturing company, you should speak to your CPA and financial planner before going to market so that you’re prepared. The Corporate Finance Institute is a great place to learn more.
Both buyers and sellers need to take a win/win approach to this subject, understanding that if you want the deal to close, neither side will get 100% of what they want in PPA.
Time – Deal Fatigue:
There’s an expression in the M&A world, “Time kills all deals.” Speed in responding to data requests is critical to a successful M&A deal. The M&A professional should collect a wealth of data upfront so that the seller can remain focused on their business during the listing period. However, ongoing data, like the latest completed quarter of financials, should be provided quickly during the listing period. If buyers are waiting too long for information, they’ll assume that getting information during due diligence will be a nightmare, and they’ll simply move on.
Loss of Trust:
A loss of trust can occur on both sides. If information is submitted during due diligence that contradicts what was previously provided, buyers lose trust. If a buyer submits an Asset Purchase Agreement that doesn’t mirror what was previously agreed to in the Letter of Intent for no good reason, sellers lose trust.
Both sides are gauging the other’s character, truthfulness, and business acumen at every stage. If incorrect information was previously provided, sellers should be quick to explain the error, how it was corrected, and the measures taken to ensure it won’t happen again. Buyers need to understand that retiring manufacturers want to sell to someone they can trust with their business and employees. If you’re trying to change the deal without a good reason, like the loss of a major customer, don’t be surprised if you get kicked to the curb.
Third-Party Challenges:
This is one of the hardest things to control in the M&A process because it can be the most unpredictable. Third-party challenges come in a number of forms including but not limited to:
• Landlords who don’t want to assign the lease.
• Minority shareholders who don’t want to sell.
• Taxing authorities moving too slowly to provide clearance certificates.
• Attorneys who don’t have specific M&A experience.
• Spouses who are not happy about the sale.
• Employees trying to sabotage the deal.
• The seller’s kids making an 11th-hour bid to take over the business.
Most of the above can and should be vetted out and thoroughly discussed before going to market.
Environmental Issues:
Manufacturing business owners need to be aware of the environmental clearance requirements in their states and be prepared to take the appropriate action to obtain a Phase I or beyond if required. Many sellers we speak with think this doesn’t apply to them if they are not selling real estate. In many states, the sale of the business is a “triggering event,” requiring that clearances be obtained.
In my home state of NJ, a buyer could be held liable for an environmental cleanup, regardless of whether they caused it, simply by being in the chain of tenancy, not the chain of title. Approvals can cause delays, and delays kill deals. Be aware of the environmental requirements prior to going to market.
Weak Management Team:
A weak management team will affect the price of your business, but it can also kill the deal. Buyers and acquisition lenders see risk if the business is too dependent on the seller. There should be leaders within the organization who can perform the functions of the retiring sellers.
Along the same lines, having documented standard operating procedures can help alleviate some of the risks. Sellers that have ISO or AS9100 certifications already have these SOPs in place.
Forcing a Match:
This one is most often the fault of the M&A professional trying to get to a quick closing. Just because someone has money or can be financed, it doesn’t mean they’re a good fit for the business. “Main Street” business brokers may be able to get away with this, but highly specialized manufacturing companies are a different story. A retiring owner does not want to leave his business in the hands of someone without experience.
The buyer market has been flooded in the last few years, with people using the search fund model as a financing tool to acquire their way into entrepreneurship. For more on this, see my recent article Why Manufacturers Hate the Search Fund Model. Manufacturing sellers most often want to sell to someone with industry experience.
Different Post-Closing Transition Expectations:
If you’re a financial buyer who doesn’t want to be involved in the day-to-day, find out the seller’s post-closing transition desires early. If you’re dealing with my firm, we will force the conversation to ensure we’re not wasting everyone’s time. M&A professionals need to nail this with their clients before going to market, which means sellers need to really understand what they want and clearly communicate it. This deal killer is completely avoidable with clear communication early in the process.
High Emotions:
During the M&A process, both sides will have high emotions at different stages. This is completely normal and understandable. It’s hard to get the buyer and seller interests aligned so that they still like and respect each other and can work together to ensure the continuity of the business after the closing.
In the last 30 years of selling manufacturing businesses, I’ve seen the strongest of people have complete emotional meltdowns. For sellers, this is a huge life event. They’re saying goodbye to part of their identity. It can be just as stressful for the buyers. First-time buyers are also on an emotional roller coaster. More seasoned buyers are usually not that emotional, but they are just as concerned about making a good investment. A good M&A team will help both sides understand what’s normal and customary and provide a path forward during the more difficult aspects of the sale.
Follow these tips to avoid the 12 deadly killers of manufacturing M&A deals.