Private equity (PE) firms are some of the most likely buyers of manufacturers. Known as “financial buyers” rather than “strategic buyers” – e.g., another industrial firm or peer looking to expand its business – these organizations leverage a combination of their own cash and debt to fund their acquisitions.
While private equity got a bad name in the 1980s during the heyday of the “leveraged buyout” or LBO market, today’s firms, especially those investing in manufacturers, look quite different. Granted, while they will still borrow 50% or more of the cost to fund many transactions, usually guaranteed against the cash flow of the business, many have truly become operators in terms of rolling up their sleeves with management to drive growth, creating operating efficiencies (often in procurement and supply chain) and driving the overall valuation of the business higher.
2019 and 2020 have been strong years for private equity. It is estimated that private equity firms are sitting on well over $1 trillion in cash, waiting to invest in their next targets. Which is why there is more interest than ever in manufacturing buyouts, even of smaller companies. Moreover, firms continue to add investible funds to their books, and are expected to add over $200 billion to their funds in North America in 2020, according to Pitchbook.
Middle market manufacturers are often ideal targets for private equity. And they are getting paid more and more for their business from these PE buyers. Manufacturing.net suggests that valuation ranges for manufacturers have risen to an average of 5.8 times EBITDA (approximately 1X revenue) for companies with $1.5-$4 million in profits. For industrial firms with $4-$8 million in EBITDA, this rises to an average of 6.2X EBITDA. And for firms over $50 million and up in EBITDA 7X, 8X or higher are possibilities.
Selling to private equity does not necessarily mean exiting the business entirely. Many owners and management will decide to stay on or maintain a smaller ownership stake in some capacity. Quite often, PE buyers will like to partner with existing management and owners, some of whom will stay on for a “second bite at the apple” by maintaining a smaller equity stake until the next transaction which is often 3-5 years down the and usually results in a significant increase in equity value for the owners.
Given the available capital in the market, 2020 may very well be the year for middle market manufacturers to consider selling to private equity. If you are interested in exploring this option, we suggest a checklist of activity to prepare for any type of process. First, understand what your business is worth. Your accounting firm can be a valuable first resource in this regard, looking at industry multiples, revenue, earnings, debt and other balance sheet considerations.
Second, if the numbers look attractive enough to consider partnering with PE, take the time to understand what the value levers will be in the business for a buyer. Will they be able to save money on purchases, reduce inventory, grow the top line? This can de-risk the deal for buyers, and drive up the valuation.
And finally, don’t forget to get solid, professional advice and go through a formal process. Avoid hiring business brokers (if you can) and find a reputable investment bank in your market, with experience, ideally, in similar transactions. They can match you with the right partners, maximize competition, structure the terms you’re most interested in (e.g., a partial exit or “recap” vs. a full exit) and drive the best possible outcomes for you.
Jason Busch and Lisa Reisman are Editors-at-Large.