Know your worth: How to value a manufacturing company

The manufacturing industry in Canada has gone through its share of challenges and transformation over the last few decades, including the advent of Industry 4.0, skilled labour shortages, and fluctuations in both the economic and regulatory environment. The COVID-19 pandemic has also presented a number of challenges.

For manufacturing business owners, a business valuation is a critical part of responding to today's ever-changing market. Knowing your business's worth is essential to help build and refine a strategy that can adapt to the current market and help the business thrive in the future.

Why do manufacturers need a formal valuation?

A valuation is necessary for a number of business activities, such as assessing strategic options, tax planning, fulfilling shareholder agreements, issuing stock options, and compliance with financial reporting requirements.

Two of the biggest reasons are to sell or exit the business and to raise capital for growth. In the case of the former, a valuation can provide realistic expectations about the value of your company and assist during the negotiation phase of selling your business.

For manufacturers who are expanding—through acquisition, digital transformation, equipment upgrades, or other initiatives—knowing the value of the company isn't just important for dealing with banks and equity investors, it's also a worthwhile planning tool. A valuation can help with the decision-making process by weighing the capital investment required versus the rate of return expected.

What factors drive your manufacturing company's worth?

A valuation examines a number of internal and external factors that can impact a manufacturing company, including revenue, costs, risks, market trends, economic conditions, and more. It can help business owners form projections and make decisions about the company's strategy and future.

While many factors are included in a valuation, manufacturers should consider the following in particular.

Equipment and technology — The type and condition of the equipment in your production facilities is one of the more significant valuation factors for a manufacturer. Consider the condition, efficiency, effectiveness, age, special licenses and approvals, and output of your systems and machinery.

The technology your manufacturing company runs on—from the plant floor to the back office—is just as important. A more digitally advanced business means less capital investment on upgrades for a buyer later on, which could command a higher multiple.

Production capacity — How much is your production or assembly line able to produce? Are certain lines under-utilized or underperforming? Are there areas where equipment and processes could be more efficient or upgraded to achieve greater output?

Reviewing and analyzing your production line can identify areas for improvement, risks, and potential new business opportunities.

Customers and contracts — Consider the customer and vendor contracts your company holds. How transferrable are they? What is the term length of the agreements? Will customers be happy under new ownership or could it affect retention? These are critical concerns for a buyer.

The diversity of your customer base is also key. If a large portion of your revenue depends on a small number of clients, it can present more risk for a buyer and affect the value of your company.

Inventory — The effectiveness of a company's manufacturing process depends on how it manages its inventory. Proper inventory management requires making optimal decisions about pricing, manufacturing, marketing, and new inventory orders, while lowering the handling of inventory to reduce investment or handling costs, risk of obsolescence, or theft of company property.

The management team and employees — The expertise of your management team could provide additional incentive for buyers to make an acquisition. An experienced leadership team that can carry the business through a transition and help generate further growth and expansion is an important value driver.

Your employees are another key valuation factor. A skilled, agile workforce can be an attractive selling point, especially as Canada continues to experience a skilled labour shortage. Compensation rates, burden costs, labour issues, and regulations can also inform a valuation.

Legislation and government investment — How does government activity in your subsector or region affect your company? Changing legislation, regulatory requirements, and government incentives can all play a big role in attracting potential investors or buyers. Tax incentives can also improve your rate of return and cash flow, which can help when focusing on value enhancements.

Real estate and location — For manufacturers who own their property and facilities, real estate is an important valuation factor. Industrial and commercial real estate is in high demand in Canada, thanks to trends like e-commerce. Location can also make an impact on your valuation; however, it may vary based on a buyer's or investor's plans for the business or a particular facility.

The investor perspective

Today's market has a healthy mix of both strategic (e.g., other manufacturing companies looking to expand) and financial (e.g., private equity firms or large funds) buyers and investors.

Examining your company through the lens of a potential investor can help you drive growth and achieve a more favourable deal. Questions a buyer may ask include:

• How has the pandemic affected the business?
• What is the health and outlook of the business? What is the quality of the current or expected EBITDA?
• What are the key business and market risks related to the outlook?
• What is the level of cash flow stability and how can it generate financing opportunities?
• Are there potential synergies related to the company infrastructure?
• Are there opportunities for new or bolt-on services that are in-demand?
• How do the strategies and business models of the two companies align?