Valuation of machine shop purchase.

I have been contact to assist someone or otherwise provide a casual opinion of the valuation and health of a shop he is interested in purchasing. I am in no way an expert on some of these matters and my opinion is only that, being provided as requested to help someone 'not' get hung.

I will be reviewing active contracts, the relationship with the customers, how efficiently the company is being operated, and the inspection and review of the machinery. This won't be a fancy in writing detailed report, I am doing this as a favor as an experienced person in the business.

I am just curious if there are any here that have went through this process and how the valuation was obtained? From what I gather, the legal beagles are in there but as I have mentioned, they know squat about machines, programming, parts, etc. From what little I gathered, this sounds like a shop that was riding it out because the owner was preparing to retire. Due to this, I am not expecting to see newer machines, and a few have already been flagged as pointless to own.

I have concerns his inexperience will lead down a road of getting sub par equipment and probably decent contracts but are being ran very inefficiently. All things that can be fixed, but that valuation should reflect that. The company is decades old and I have been in several shops where they still live in the 70s, complete with fax machine. I don't want to see him buying crap, then have to fix it all. There is no value in that.

Now, these are firm contracts, but I know customers can and do pull them. There is usually cancellation costs but that is about it.

In all ways, I have grave concern about anyone just buying a shop without experience. Sure, expertise can be brought in, but I rarely see these small companies do very well if the owner is not savvy to the biz. This is someone that has never made a part.

I've discussed this with a owner friend recently who had his largest customer interested in acquiring his business. He opened his books to them and he had about 1.2M in sales and they were 1/3 of it. After several months-- they not only abandoned their purchase pursuit, but also started making the parts in house and pulled all the business over the following 6 months. They figured they could acquire the equipment and get operational more cost effectively than making the acquisition.

I think the most important figure is their net profit margin coupled with your best assessment of what the future margin will be once you own it. The sellers will more likely be stressing the "good will" factor of customer loyalty and longevity of repeat business. Plant and equipment can be easily assessed and discounted as appropriate-- I'd work up from auction value rather than down from dealer resale valuations or anything tied to current replacement cost.

Employees and customers are the more difficult to figure into the equation. I've seen companies with 40 people implode once 3 key people removed(one death and 2 retired); 2 years later-- I was at the auction.

I hit about 30 auctions each year-- could go to 2-3 per week in my tristate area. There are stories for each closure. Most having to do with loss of key customer(s) or key personal or owners or poor management. I've watched a company invest 4.8 million in plant upgrades only to close the facility 2-1/2 years later because the operation just wasn't hitting projected returns.

A former boss, now friend and customer of mine has never made a part or ran a machine-- but he is great with numbers and knows how to get people where needed. It's a strategy-- just not one I am comfortable with.... but he bought an existing business in 1985 with both customers and employees. 19 years ago I started my business from scratch: I did every operation initially to get things going and then trained others to repeat a year into it when I had enough business to have employees. I haven't been able to match his ability to staff yet. He manages from his background(large company) and I from mine(farm & small company).

Is your friend good with numbers and good with the management of people?

I appreciate that great reply. I could not honestly say my friend is the best with people, probably hugging the "too nice" side, which can be an issue in this business. What I am mostly doing here is covering his six! I don't want him to make a big financial mistake and my gut is saying without me running it, it may not have a prayer. If he is hinged on an existing manager to run it, and he leaves, where does that leave the company?

I guess I am just nervous for him and will probably shake down all parties whether I am asked to or not. I am also just waiting for this asset list and see a 1997 Fadal. Value = $40k....lol I am generally regarded as a nice person to work for, but if you become a problem, I become the solution. I don't want to get sideways where my interests in this are null, but I won't let him get blind sided because he doesn't understand the business. Thats what friends do.

Job shop...........Short run production shop..............I'd say the customer base and the contracts are worth absolute zero in the value of the shop..............end 'O story...................

david n said:

Job shop...........Short run production shop..............I'd say the customer base and the contracts are worth absolute zero in the value of the shop..............end 'O story...................

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Pretty much about the only thing that adds value over and above real estate and equipment would be a product line, preferably that was patented.

So many red flags here - sounds like he lacks both machining experience and running-a-business experience. Might be helpful to print out some of the other threads in this forum where people have dealt with buying / running a shop, and ask him to read to get more understanding of what he is getting into.

The only way I'd consider an existing customer as part of the deal would be if the seller would take a commission for 'X' amount of time after the sale................no added value to the sale price................if the customer sticks around the buyer gets the work and the seller gets a little bit extra $$$$......................all done up in a legal contract 'o course...................

All I know for sure is it's not worth anywhere near what the seller thinks it is.

Booze Daily said:

All I know for sure is it's not worth anywhere near what the seller thinks it is.

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It isn't like an average business where you can base it's worth on revenue. As we all know a machine shop can go from boom to bust overnight. I am a good example, back when I was selling my own product line to the limousine industry. Things went south just before the last recession hit. I went from 23 active customers to one in a little over a year. I went from lighting cigars with $100 bills to looking at the scrap barrels as grocery money.

ALL the previous replies are right ...

but in fact existing customer contracts are usually the most valuable part of a machine shop business.
And they are usually squandered, wasted, pretty close to 100%, in an acquisition.

Machines are worth very little, overall.
Tooling, procedures, people, skills, may be very valuable.

The true valuation of a manufacturing business lies squarely upon the quality of it's customer base. Real estate, equipment and or product line should not be deciding factors of value.

There is no substitute to having a "Blue Chip" NYSE Listed Corporation that continuously sends you RFQs. Secondly, a top notch crew of journeymen level craftsmen is "real" worth.

I don't think a customer base is worth spit unless you have a boat load of them and none are over 5% of revenue. I had a guy who had been with me since I started job shopping a little over 10 years ago. He ordered almost weekly and I got over 75% of what I bid for him. Most his jobs repeated and were mostly simple and out of materials that did not eat tooling, also they had a low overhead to final price ratio. 5 cent cost sell for $2 parts. He always raved how my prices were great, I delivered quick and never shipped a non conforming part. This past summer he vanished, sent him an e-mail, he sent all his business to China. Every year he was 10-25% of my revenue on a high margin.

Dualkit said:

Pretty much about the only thing that adds value over and above real estate and equipment would be a product line, preferably that was patented.

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This was my thought, as well. I wouldn't value the relationships and/or current contracts too heavily. I'd expect to have to start from scratch with most of that, and anything that sticks around is just a bonus. The value of real estate and equipment should run supreme in the valuation metrics.

I'd also figure in how organized and documented a shop is (beyond the books: more in terms of process, job flow, storage, etc). If the owners or operators are keeping track of stuff in their heads, it may work well for them, but replace them with someone else, and you could be looking at a BIG learning curve trying to figure it all out.

We bought 2 companies that were very disorganized and it literally took years to sort it all out. In the long run, it's been a good venture, but it took a lot of blood/sweat/tears to get it all back in the air.

I'd commit suicide before I'd buy a machine shop nowadays. If it's yours, and you built it, and you like it, and you feel happy producing something you like instead of making enough money to feed yourself, it's cool.

But as a business ? To buy, knowing nothing ? Huleo, your friend is nuts. Run away. Buy a hot dog stand and hang out in winter on New York streets hassling passersby. He'll make more money and have more fun.

hanermo said:

ALL the previous replies are right ...

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Well thank you for this.....

Your OPINION that is.

huleo said:

I have been contact to assist someone or otherwise provide a casual opinion of the valuation and health of a shop he is interested in purchasing. I am in no way an expert on some of these matters and my opinion is only that, being provided as requested to help someone 'not' get hung.

I will be reviewing active contracts, the relationship with the customers, how efficiently the company is being operated, and the inspection and review of the machinery. This won't be a fancy in writing detailed report, I am doing this as a favor as an experienced person in the business.

I am just curious if there are any here that have went through this process and how the valuation was obtained? From what I gather, the legal beagles are in there but as I have mentioned, they know squat about machines, programming, parts, etc. From what little I gathered, this sounds like a shop that was riding it out because the owner was preparing to retire. Due to this, I am not expecting to see newer machines, and a few have already been flagged as pointless to own.

I have concerns his inexperience will lead down a road of getting sub par equipment and probably decent contracts but are being ran very inefficiently. All things that can be fixed, but that valuation should reflect that. The company is decades old and I have been in several shops where they still live in the 70s, complete with fax machine. I don't want to see him buying crap, then have to fix it all. There is no value in that.

Now, these are firm contracts, but I know customers can and do pull them. There is usually cancellation costs but that is about it.

In all ways, I have grave concern about anyone just buying a shop without experience. Sure, expertise can be brought in, but I rarely see these small companies do very well if the owner is not savvy to the biz. This is someone that has never made a part.

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I've done lots of M&A and valuations professionally. As a general thing, businesses get valued one of two ways, net asset liquidation value and cash flow/income valuation (multiple of cash flow or DCF). While of course you have to look at everything in the business, don't confuse the two when it comes to valuation. You pick the approach to value that leads to the higher valuation, and ignore those things that don't affect that approach and are only applicable to the other. All to often you see people wanting to double count things.

In a good business, valuation by income will higher than liquidation (the difference is whats called goodwill). In other words the business, in how they use the assets, creates something that is worth more than the value of those assets. otoh if there are reasons to question the sustainability of earnings in what might have been a good business (like its one guy and all his customers are buddies), you'd use such a low multiple or high discount on income valuation that liquidation becomes be higher....and then the right approach to value is net assets not income.

Speaking strictly to valuation, you just have to be clear on what approach to value and don't confuse the two. Small business often trade on net asset value, whereas larger should trade on income. If trading for net asset value, customers and contracts don't really enter into valuation, whereas if trading on income valuation, value of machines etc don't enter into it on so on.

Buying an established business can work, but the new owner better be damn good at picking low-hanging fruit. There are a lot of reasons to sell a business, but making money hand-over-fist is not one of them.

Valuations are usually a multiple of EBITDA, 2-5X depending. Plus market value of equipment, plus inventory, plus work in progress. Don't go just by the current P&L on this- average the prior 3 years, and evaluate whether it is trending up or down, as that affects the multiple.

The new owner needs at least a 3 month cash flow cushion- and that is optimistic- he better have access to additional 3 months if it becomes necessary. He is going to start out with no receivables and no cash in the checking account. All the receivables, finished parts in inventory, and the WIP (as a percent of the finished price) will belong to the seller.

If everything goes perfect, money will start trickling in in about 45 days. Best case scenario, the new owner might see a positive cash flow in 90. So 90 days of operating capital is a shoestring budget. If it's a 5 man shop with 20K/month in expenses, you need 60K in operating capital to get going. That money stays in the company- you can't get it back out.

The seller will do everything to strip cash out of the business, from the day he receives earnest money until the day it closes. That means he will crank out as much product as possible, 3 shifts, temp workers, overtime, whatever it takes- he will do it. The new owner will walk in to a burnt-out workforce and all the high-margin work on the order book will have shipped early or be sitting on the shelf. The work in progress will be the low-margin stuff.

There will be no fresh consumables to replace what has been used up. The cutters will be dull and there will be no replacements. The barrel of coolant will be almost empty, etc. This began the day the owner listed the business for sale. He wants to maximize the EBITDA to increase the valuation. Every dollar he doesn't spend on expenses is worth 2-5 dollars on the selling price of the business.

There are tax ramifications to how the company is valued. Goodwill is amortized over 15 years, equipment is usually 7. So the more you put as equipment, the more you can depreciate in the early years, and the less you will have in the later ones. The seller usually has the opposite incentive- he wants to minimize his cap gains taxes. The buyer should consult a tax attorney about this.

If the prospective buyer recognizes all of this, and still has the confidence to take a swing at it, he may survive.

A bigger shop with good books and customer base is easy to valuate..Small outfits can be fudged up to look much better that they are.

danil said:

...He opened his books to them and he had about 1.2M in sales and they were 1/3 of it. After several months-- they not only abandoned their purchase pursuit, but also started making the parts in house and pulled all the business over the following 6 months.

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Surprise! That's known as Opening the Kimono. It's just about the same as giving a customer a shop tour and showing him how you make his parts, and them wondering why he stops ordering. If his big customer were only a third of his revenue they wouldn't be at all ahead by buying his shop, unless they wanted the capability to make other people's stuff as well. Which would probably be departing from their "core competency." Hope he had a serious nonrefundable segment of the earnest money (assuming there was earnest money).