The value of your manufacturing company depends on a variety of factors, such as what products it manufactures, how it’s expected to perform, where it’s located and why you’re appraising it. Let’s take a closer look at the current merger and acquisition (M&A) market and how appraisers use three techniques to value manufacturers.
The scene is set for a stunning M&A display for the rest of 2014 and beyond: Many companies are sitting on large cash reserves, banks are offering inexpensive financing options, investors are more confident and equity markets are relatively stable. Reuters reports that worldwide M&A deal volume was up 75% in the first half of 2014 over the same period in 2013 — the highest level in seven years.
Hot manufacturing segments include technology, health care and life sciences, energy, gas and oil, and consumer markets. Sellers in these segments may wind up in a bidding war that drives up their values. But beware that some buyers are still trolling for bargains, so don’t take the first offer you receive without obtaining a formal appraisal first.
Three valuation methods
Appraisers use these three valuation approaches to value manufacturers:
- Cost approach. Manufacturers rely heavily on tangible assets, so the balance sheet is a logical starting point. Some items are worth more (or less) than book value.
For example, manufacturers sometimes use the same depreciation methods for book and tax purposes. Accelerated depreciation methods, including expanded Section 179 and bonus depreciation deductions available in recent years, have significantly lowered the net book values of fixed assets — including machines, large tools, heavy-duty vehicles, computers, software and office furniture — below current market values.
Receivables also may need to be adjusted for bad debts. Inventory may include obsolete or unsalable items. And contingent liabilities — such as pending lawsuits, environmental obligations and warranties — also must be accounted for.
But the biggest adjustment is for intangible assets, such as internally developed patents, brands and goodwill. The cost approach generally omits intangible value, but it can serve as a useful “floor” for a company’s value. Appraisers typically use another technique to arrive at an appraisal that’s inclusive of these intangibles.
- Market approach. Sales of comparable public stocks or private companies may be used to value your business. Finding comparables can be tricky, however. Many small manufacturers tend to be “pure players,” whereas public companies tend to be conglomerates, making meaningful public stock comparisons difficult.
When researching transaction databases, it’s essential to filter deals using relevant criteria, such as industrial classification codes, size and location. Adjustments may be required to account for differences in financial performance and to arrive at a cash-equivalent value, if comparable transactions include noncash terms and future payouts, such as earnouts or installment payments.
- Income approach. Expected future cash flows can be converted to present value to determine how much investors will pay for a business interest. Reported earnings may need to be adjusted for a variety of items, such as accelerated depreciation rates, market-rate rents, and discretionary spending, such as below-market owners’ compensation or nonessential travel expenses.
A key ingredient under the income approach is the discount rate used to convert future cash flows to their net present value. Discount rates vary depending on an investment’s perceived risk in the marketplace.
When using the market or income approach to arrive at a preliminary value, the appraiser may need to adjust for excess working capital if you carry more cash or inventory than the average manufacturer. Nonoperating assets are also added back to an appraiser’s preliminary value.
Additional adjustments may be required if a business owns its facilities, because real estate ventures differ from manufacturers in terms of risk and return. A real estate appraiser may be called in to value your facilities.
Appraisal pros do it best
These considerations are just a sampling of the subtle nuances that go into valuing a manufacturer. Each business is unique. Owners who rely on gut instinct or do-it-yourself valuations may leave money on the table when they sell — or risk overpaying when they expand through acquisition. Consider hiring a professional appraiser to value your company before taking any action.