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Manufacturing Sector Prime Territory for M&A in 2021

Manufacturing Sector Prime Territory for M&A in 2021

A recent Institute for Supply Management Report conveyed that United States factory production and product sales are surging at the end of Q1.  The trade group’s index of factory activity, a measure that takes into account new orders for goods, production, inventory levels, and commodity prices, increased from 60.8 in February to 64.7 in March.  As a reference point, any figure above 50 indicates industry expansion.  The expansion was comprehensive in the manufacturing sector ranging from consumer to construction products.

This information is good news for anyone thinking of selling a manufacturing company, as bullish, broad based, future revenue and earnings projections in a specific industry sector when combined with general economic optimism and low interest rates for acquisition capital are foundational elements in the creation of a robust marketplace for business transactions to be completed.

This strong general, current in the mergers & acquisitions market has already created an environment where multiple offers and strong market values are being produced.  As an example from March 2021, IBA successfully facilitated “sell side” negotiations for a client where agreement was reached on a Letter of Intent for approximately $5 million where the agreed price was an $100,000 above asking and our client had the ability to select from multiple suitors, incorporating metrics like preference for successor leadership into their selection analysis. This was not the only project at IBA with multiple offers delivered to our clients in the last 30 days, as several of our presently nine deals in escrow pending sale had this market dynamic. It was also true for one of the deals that was completed by IBA at the end of Q1.

Recognizing the present, robust M&A marketplace for manufacturing sector companies, the following are four reasons why a business owner may want to bring their business to market in Q2 2021:

Taxes – The federal government is currently evaluating the long-term gain capital tax rate as a method to pay for pandemic spending and future infrastructure investment.   Historically, the tax rate has ranged between 15 – 35% during the last fifty years.  It is presently at 23.8%.  A 5% increase equates to $50,000 of additional tax burden per million dollars of goodwill value (The value paid for the reputation, market share, and economic productivity of a company by a buyer.) for the party selling the company.  This is on top of the $238,000 in taxes currently payable per $1,000,000 of intangible value gain. It is anticipated that the probable increase in this tax rate will be 5 – 10% based on legislative proposals currently being discussed in Congress.  A “best guess” is that this tax rate change will occur for the year 2022 based on historically it has taken the Senate, House, and President collaboratively seventeen months to take tax change legislation from bill to law and urgency exists to pass the legislation prior to the next election, November 2022, that could change control of one or both chambers of Congress.  Additionally, troublesome in Washington state is the advocacy from the Governor’s mansion to institute a state capital gains tax designed to target technology workers who have appreciated stock and owners of privately held companies and commercial real estate wishing to sell.  It traditionally takes IBA three to nine months to sell a business, so anyone wishing to “play it safe” and try to take their equity off the table at the present tax rate should seriously think about taking action in Q2 or potentially face the consequences of less net proceeds in 2022 than were obtainable this year if the completion date for a transaction falls into the next calendar year.

Financing – Interest rates are starting to increase from their historical low levels. Higher interest rates result in less buying power. They also can negatively impact the market value of companies or result in a need for more seller participation to finance a portion of the transaction.  As an example, if a $3 million dollar Small Business Administration (SBA) backed loan is used to buy a company using the 7(a) program.  The current annual debt service on the loan would be approximately $216,000 at 5.25% (2% above the prime rate of 3.25%) amortized over 25 years.  Incorporating a 25% debt service coverage premium to mitigate risk of default in underwriting, the ability to annually debt service about $270,000 per year would be required by most lenders to approve this loan.  An increase of 1% in the interest rate of this loan would push this debt service coverage requirement to approximately $300,000 annually or $25,000 per month.  As an historical reference, the prime interest rate was 7.50% approximately twenty years ago on April 19, 2001.  This rate would result in a 7(a) loan interest rate of 9.50% or greater and an annual debt service coverage requirement approaching $400,000 for the same $3,000,000 loan.  It is common knowledge that interest rates run through cycles of higher and lower rates. The following historical chart demonstrates that the probability of an interest rate increase this decade is much higher than seeing lower rates (United States (Fed) Prime Rate Chart).  It is prudent for both business sellers and buyers to take this into consideration in terms of timing their entry and exit from the marketplace.

On a positive front for business buyers, the SBA to encourage business activity coming out the 100 year, economic event caused by the COVID-19 pandemic is currently offering programs where up to $9000 of monthly interest & principle payments on 7(a) loans are being waived during the first six months of a business acquisition financed with this product (https://www.sba.gov/sites/default/files/2021-01/Procedural%20Notice%205000-20079%207a%20and%20504%20Section%201112%20Payment%20Extension-508.pdf).  This program is anticipated to terminate in 2021 after being extended once.  It provides a rare opportunity for a business buyer to receive a discount on the purchase price of a company without needing to negotiate it from the seller.

Industry 4.0 – As an active member of CAMPS (The Center for Advanced Manufacturing Puget Sound) and a leading M&A facilitation firm in the manufacturing and technology sectors, IBA has been closely following the integration of technology & manufacturing that started before the pandemic and increased in implementation during the last year.  One motivation for sale articulated by our clients is a desire to avoid the time, energy, and capital investment necessary to evolve processes from what has historically worked to what is necessary to effectively compete in the future.  This recognition is a demonstration of mature, experienced management, as failure to implement change correctly can be more detrimental than not doing anything at all.  If change is inevitable in your business model whether it is 3, 5, or 10 years on the horizon and it is not your desire to manage that evolution, then we would welcome the opportunity to help transition the business while it is firing on all cylinders and exhibiting maximum profitable.  Excellent information and resources related to Industry 4.0 for the manufacturing sector can be found through engagement with CAMPS (Industry 4.0 | CAMPS (camps-us.com)).  If you would like a warm introduction to the organization’s executive management team, we would welcome the opportunity to connect you.

Retirement – Father time stops for no one.  There is a time in life to play, learn, work, and then play again.  The pandemic has demonstrated how quickly the dynamics of everyday life can change.  If you are in the process of recognizing that you have things you want to do, places you want to see, and people you want spend time with without the responsibilities of entrepreneurship, then we would welcome the opportunity to start the conversation about how to implement an exit strategy employing best practices in an environment of confidentiality designed to achieve the best possible value in the marketplace for what you have built as a business owner.  IBA is unique in the business brokerage industry in that 100% of our fees are payable upon performance at completion of a sale. We charge no administrative fees or retainers to share our knowledge and experience with entrepreneurs considering a sale of their privately held companies and family businesses.  We simply would like to audition for the job of business broker on your team whether a sale is targeted in 2021, 2022, or 2025.   We are also happy to help you build your succession planning team with introductions to the “best of the best” in the estate planning, wealth advisory, legal, and accounting professions in the Pacific Northwest.

For many Baby Boomer demographic entrepreneurs a read of their tea leaves says that a sale of their business is on the horizon.  The reasons to ponder that life changing decision are even more vibrant for business owners with manufacturing companies.  Most decisions start with enhanced knowledge.  The manufacturing transaction team at IBA is happy to engage by telephone, email, or in person with anyone in Washington, Oregon, or Alaska who would like to learn more about the process associated with selling a privately held company or family business.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, accounting, legal, wealth advisory, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

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