Learn about value drivers for your shop in part 2 of our series: Understanding the Value of Your Shop.
In part 1, we spoke about the biggest challenge to selling your manufacturing business – you. We outlined how shop owners become a single point of failure by performing too many critical business functions. These include business development, sales, and estimating. By doing this, when business owners try to exit, they end up leaving too much of a gap in the operation.
Today, we are going to talk through some other key drivers buyers look for when determining the value of an acquisition. Each of these will play a significant role in evaluating the value of your job shop when it comes time to make a transition. It is important to start thinking about them now.
Liquidity Discount – Companies with under $10M in sales are going to get a haircut in valuation because of perceived illiquidity. This means answering the question: if I buy your business today, how hard is it going to be for me to turn around and sell it tomorrow? If the answer is hard, that means your business is not liquid.
This discount can reach up to 50% of fundamental value in some instances. If a manufacturing operation is worth 3x earnings before interest, tax depreciation and amortization (EBITDA) on paper, then it is actually worth closer to 1.5x with the liquidity discount in play.
This is a simple truth that must be understood and communicated. Some multiples take this into account. But, shop owners need to understand why a business doing $5M in sales may go for a 3x EBITDA when a $15M in sales shop may go for 6x EBITDA. This is the liquidity discount at work.
Customer Concentration – Most job shops under $5M in sales have customer concentration challenges. This occurs when a handful of customers make up a significant part of the shop’s sales. This presents significant risk to new ownership. If a key customer leaves after the new owner takes over, the business ends up in a very bad position.
One way purchasers protect themselves in this situation is through a structure called an earn-out. To decrease the risk, the original shop owner does not get paid the entire business value up front. It is only earned when the business hits forecasted future goals. This is not optimal! To address this issue now, job shops must aim to diversify their customer base.
Business Records & Continued Operations – In general, small shops have poor historical data, much of which is in non-digital form. Even tools like QuickBooks end up abused, intertwining both business and personal expenses. As a result, determining true EBITDA can be challenging.
Furthermore, past quoting and pricing information often lives in the shop owner’s head. Many people refer to this as Tribal Knowledge. This knowledge is often inaccessible to the new shop owners, which is scary when you are taking the reins.
I ran into this all the time when looking for shops to buy. I often wondered how I would take over for the owner when he left. Also, most shop owners do not want to stick around long after the sale. So ask yourself – how long do you plan on working in the business after the new owner takes over? If the answer is not long, you need to start structuring your operation in a way that it can run under new ownership.
Revenue Trend – Shops that have a downward sales/revenue trend are going to be in bad shape when it comes time to sell. This means that year after year, your revenue has decreased. This indicates a high level of risk to a buyer. It signals that the business is failing for one or more reasons. These include: lack of capital investment, owner/manager neglect or customer attrition.
When evaluating a business I would always check for continued capital expenditures. This means steady reinvestment in the business to maintain operations. If you have started to squeeze your business by not reinvesting, this will be a red flag for investors.
The big takeaway: Perceived risk reduces exit value. Anything you do that makes your business more risky for a new owner will slash the value you get in an exit.
How can Paperless Parts help?
You didn’t think you were getting away without hearing how we solve these problems, did you?
To help with these challenges and more, the Paperless Platform drives sales. More than anything else, this will help you maintain the exit value of your business. With a streamlined quote-to-cash cycle, your shop will win more work from new customers. This will reduce customer concentration risk.
Next time you have the opportunity to quote a prototype job from a company you may not be familiar with, don’t ignore it. Send over a quote and grow your customer base. When you send that quote through Paperless, it creates a record for a new owner or employee to reference.
These are just a few ways the Paperless Platform can help you exit with the true value of your business. Come learn more – sign up for a demo today.
Next week, we will give you practical tools to use in evaluating your job shops value.
— Jason Ray
Jason Ray is the Co-Founder & Chief Executive Officer at Paperless Parts. He drives the company’s product vision, while building relationships with manufactures and partners. Before Paperless, he served as an officer in the US Navy and led the implementation of additive manufacturing technology. Jason holds a BA (Trinity) and MBA (Babson).