When does a theoretical value become really valuable? 

When do you decide to buy or sell a business, particularly a precision machining business? How do you assess its value? How do you determine whether a business is a collection of machinery, tooling, and real estate, or if it is something of significantly more monetary value?

Another way of saying this is, “does a business have an intangible value,” often called intellectual property? Does it have a valuable identity or brand, even if it is a limited one known only to people in a specific location or specialized field? Or, is it simply a collection of physical assets on an appraiser’s report?

In recent years, our used machinery business, Graff-Pinkert & Co., has become increasingly devoted to making sense of this issue because both potential buyers and sellers approach us seeking our knowledge in valuing a business, either their own, or one they are interested in buying.

This pursuit means that the knowledge, connections, networking, and even our skill at finding serendipity, gives value to our effort.

As more of our past and present clients reach an age where selling their business becomes a primary concern, our industry knowledge becomes a larger and more important part of the Graff-Pinkert business portfolio, an extra dimension to what was once seen as an operation trading other folks’ junk.

If a precision machining business is more than physical assets, what is it worth? 

In recent years, the value has been usually determined by a multiple of “EBITDA, ” which is an abbreviation for “earnings before interest, taxes, depreciation, and amortization.” This is another way of evaluating sales minus cash costs.

It is a vitally important number for buyers and sellers because acquisitions have traditionally been largely financed by lenders like banks and usually sold to companies in a similar line of business. 

This has changed somewhat in recent years as buyers have become more financial aggregators with less specialized knowledge and backup managerial talent. They are trying to buy predictable earnings streams with an eye toward turning them over in five years or less when their depreciation is depleted. This has been a great game during fairly stable or rising periods, but during a recession when business is less reliable, the former owners are gone. The hired managers running them are looking for the next opportunity and their value becomes more unstable.

Again, this is where our company or another expert in the field, even one with a possible interest to step in as a buyer of last resort, becomes a useful ingredient. 

I have found that as a seller becomes more committed to selling, either for health or emotional reasons, asking prices tend to sink to an EBITDA multiple that is palatable to a lender. Then the crucial element needed for a sale is an understanding of the intangibles. Is the intellectual property transferable to a new buyer who may have to hire professional managers to make the acquisition viable over the longer term? This could be quite tricky and is often misunderstood by both parties. 

A bonus arrangement or an equity position for a new hire is often a necessity today. It also carries its own risks. Often, the best hope is to hire a family member familiar with all the aspects of the business or to hire a long time employee. There is never a guarantee of success in a change of hands.

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What do you buy and what do you sell in a transaction for a machining firm?

It is naive to think that it is simply the sale of an income stream and a package of machinery and real property. In today’s environment, setup people, programmers, and operators may be a huge piece of the value of the business. Will they stay if the old owner is gone? This may be the biggest issue in whether a sale goes through and for what price.

Another key element in a deal is how sticky are the customers. We had a deal where one client provided 60% of the seller’s sales. If that client had left, the deal would be a disaster for any new buyer, no matter how low the sales price, because the machinery was old and ugly. 

Ultimately, the new buyer retained the customer because he continued to operate the plant and learn the nuances of the business. He gradually moved orders to Taiwan and the rest to the parent plant 400 miles away, but the process took almost two years.

In a recent acquisition we were involved with, the buyer planned to move all of the machines and hopefully customers to other facilities. They paid almost twice what they would normally pay just for the machines to get access to new clients.

For me, the buying, selling, and brokering of whole companies is a fascinating new venture. It is much more complicated than buying and selling individual pieces or even bidding on factories to auction off. A lot more emotions to deal with. What makes it worthwhile is evaluating the “intangibles” and “intellectual property.” They hold both the profit and the seeds of a disaster. Figure it right and massage the egos, and everyone might win big.

Question: What were your problems when your company changed hands?

 

This article was originally posted on https://todaysmachiningworld.com/the-value-of-a-business/