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“Your company becomes more valuable when it is distinctive, predictable and readily transferable.”
The 7 value-determining elements of a company in the industrial sector
Anyone selling their business will soon focus on one number: EBITDA. That is understandable, as it usually forms the starting point for a valuation. However, two companies with comparable profitability often achieve materially different outcomes in a sale process. The difference almost always lies in the underlying quality or risk profile of the business.
What makes a successful transaction in the manufacturing industry?
The value of a manufacturing company is often reduced to a multiple of its earnings. However, this view is too limited. Buyers do not only look at what your company earns today, but above all at how certain those earnings will still be tomorrow and under which conditions they can grow. Cash flows are the best indicator of this. Factors such as the quality, predictability and transferability of the business translate into a multiple and therefore influence enterprise value.
In the industrial sector, this distinction is sharper than in many other sectors. Capital intensity, technological developments and dependency on people mean that valuation is strongly determined by a number of specific factors. Our sector team advises on dozens of transactions in the industrial sector each year. Based on this experience, we have identified the key elements that make the difference and determine whether you end up at the lower or upper end of the valuation range.
Joost Streefkerk
Sector specialist Industry
1. Products: complexity protects margins
An important starting point is the type of product you manufacture. Does the company produce technically complex products or products that must meet high quality standards and certifications? If so, this is more attractive to buyers. Your company is better able to differentiate itself from competitors and is less easily replaceable. This often results in stronger margins and a higher valuation.
Buyers also often face the classic make-or-buy question: should we invest in capacity, machinery and knowledge ourselves in order to produce these products in-house, or is it more efficient to acquire a company that has already mastered this? Particularly in specialised manufacturing, an acquisition can be attractive, as a buyer immediately adds your capacity, experience and customer base. However, the buyer will closely assess how well your knowledge is actually safeguarded. Is critical know-how mainly held in the minds of just a few people? This immediately creates the risk that part of the value disappears as soon as those people leave.
2. Machinery: spare capacity offers growth potential
Is there room to grow without immediately having to make substantial investments? If so, this is a positive. An outdated machinery base puts pressure on value, as a buyer will immediately factor future replacement investments into their calculations.
This is also a consideration we regularly encounter in practice among business owners contemplating a sale. Finding good and ambitious staff is difficult, while market demand continues. Investments in new machinery can then be attractive: achieving higher production with fewer people and increasing productivity. But will I still recoup that investment, or is it wiser to transfer ownership now? There is no straightforward answer to this question. It depends on timing, efficiency gains and your personal horizon.
3. Technical knowledge: embedded within the team
Even in capital-intensive manufacturing, people create value. Is critical knowledge held solely in the entrepreneur’s mind, or is it firmly embedded within the team? Companies where engineering, work preparation and process knowledge are firmly embedded in the organisation are more readily transferable and therefore more valuable. A buyer who discovers after the acquisition that half of the technical knowledge leaves with the previous owner has a problem. They will price in that risk, which puts pressure on the valuation.
4. Customer base: diversification reduces risk
Do you have a customer that accounts for forty per cent or more of your revenue? That is a valuable relationship. At the same time, it is a risk every buyer recognises. Not because the relationship is poor, but because losing it would have a disproportionately large impact on your cash flow.
The more widely your customer base is spread across multiple customers and sectors, the lower the risk and the more attractive your company. Loyal customers, long-term relationships and predictable purchasing provide reassurance for a buyer. The quality of the sectors in which your customers operate also matters. Customers in sectors with stable, non-cyclical demand provide greater certainty for your revenue.
5. Recurring revenue: predictability is rewarded
Does your company have recurring assignments or a well-filled order book? If so, your business will generally be valued more highly than if you mainly work with project-based or incidental orders, even if the absolute volume is comparable.
Ad hoc orders or projects make your company more difficult to value: a buyer cannot be certain that the same volume will be secured next year. Do you have multi-year contracts, maintenance subscriptions or established supplier positions? Then you do provide that certainty. The more predictable your revenue is, the stronger the foundation of your company.
6. Type of investment: growth or maintenance
The direction of your investments tells a buyer something fundamental about the future of your company. Do you primarily invest year after year in replacing existing equipment? Then your company faces ongoing replacement investments without efficiency gains. Do you invest in new capacity, processing technologies or automation? Then you demonstrate that your company is growing. This direction is rewarded in the valuation.
7. Management: continuity after the transfer
Price is rarely the stumbling block in a transaction. What does put pressure on a deal is the question of who will be at the helm after the transfer. The less dependent your company is on you personally, the more attractive it is to a buyer. A strong management team and the willingness of key individuals to remain involved after an acquisition increase confidence and, consequently, the value of your company.
Is your organisation still too dependent on you? Then it pays to address this well before a sale: delegate responsibilities, strengthen the second layer of management and make your organisation less dependent on specific individuals.
Value is built well before a sale
Your company becomes more valuable when it is distinctive, predictable and readily transferable. Each of these elements can be influenced, but improvement takes time. As a business owner, it is therefore worthwhile to understand in good time where you stand and where there is scope to enhance value. Not only with a view to a sale, but also to run a stronger business today.
About the author
Joost Streefkerk is a Manager at Rembrandt M&A and an Industrial Sector Specialist. He advises on sale processes and acquisitions of industrial companies in the Dutch mid-market.
