Owners of manufacturing and distribution companies are often so focused on the here and now that planning for future catastrophes may fall through the cracks, especially if the owners are young and healthy. But operating without a valid buy-sell agreement is like driving without car insurance. Failure to execute an agreement or to update an old buy-sell for ownership changes can cause financial distress and even tear a company apart if tragedy strikes.

Cover All the Bases

Private companies enter into buy-sell agreements to address voluntary and involuntary changes in ownership that might occur in the future. Examples of events that could trigger a buy-sell agreement include: 

Death of an owner. When an owner dies, a buy-sell dictates how the deceased owner’s interest will be handled. Will heirs inherit the shares and have a say-so in future business decisions? Or will the company (or the remaining shareholders) buy the interest? If so, will the buyout be funded by life insurance?

Owner departures. When an owner retires, leaves to pursue other interests or becomes disabled, the buy-sell should spell out the departure terms, including the owner’s postdeparture role in decision-making, buyout terms and whether the departing owner’s interest will transfer to a designated heir if he or she dies. 

Irreconcilable differences among owners. When owners fundamentally disagree with a company’s direction and want to leave the business, the agreement states how disputes will be
resolved and what rights dissidents have.

It’s a good idea to iron out details when owner relations are amicable. Lawsuits are common when owners wait until problems have started to unfold to discuss issues related to ownership changes.

Address Valuation Issues

When a “triggering event” occurs, the parties are usually at odds over the value of the business. Resolving valuation issues when the agreement is drafted can help ensure that all parties are treated equitably when the unexpected strikes or disagreement mounts.

Some owners opt to have the business valued when they’re drafting the buy-sell agreement. Then, they use that static value to buy out a departing owner’s interest whenever the buy-sell is triggered. But fair market value can change as market conditions and the business evolve, and a valuation performed many years ago may become stale.

Alternatively, owners may decide to have the business valued annually, so fair market value is readily available and there aren’t any surprises when the buy-sell is triggered. Or they may prescribe valuation protocol to follow when the agreement is triggered, including how “value” is defined, who will value the business, whether valuation discounts will apply, who will pay appraisal fees and how the buyout will proceed.

Weight the Options

The two most common types of buyout structures are crosspurchase agreements and redemption agreements. Under the former, if an owner leaves the business (voluntarily or not), the remaining owners have the right to buy the departing owner’s interest either in one lump sum or in installments, depending on how the buy-sell is written. In case of death or disability, cross-purchase agreements also may be funded by insurance.

In a redemption agreement, the company itself, not the individual owners, buys out the departing owner’s interest. The value is effectively transferred to the remaining owners by reducing the number of outstanding shares. Life insurance policies (in which the company is named as the beneficiary) may be used to fund redemption agreements, too.

Iron Out the Details

In any buy-sell agreement, the keys are to be clear and comprehensive. The more details that are put in place today, the easier it will be for owners to resolve issues when the unexpected strikes, disputes arise or an owner simply decides to call it quits.

Many manufacturing and distribution companies are family owned. But passing the torch from one generation to the next isn’t always the best decision. Today’s owners should realistically assess whether their sons and daughters have what it takes to run a successful operation tomorrow.

It’s tough for owners to treat their loved ones as employees first, but that’s how to objectively evaluate their abilities. Promoting a relative who’s not up to the task typically backfires. It could cause reduced morale among workers who aren’t related to the owners and eventually lead to the departure of key employees.

Owners can draft ownership transfer agreements that list benchmarks for a potential successor to achieve before acquiring an interest in the company. For example, a potential successor could be given the goal of achieving a certain growth percentage in his or her division or hitting predetermined sales targets over the next 12 months. Whatever the goal, the agreement should be specific.

Also meet with potential successors to find out whether they even want to take over. Parents sometimes find out that their dreams of passing on a legacy don’t align with their children’s future plans, forcing them to find an alternate exit strategy — sometimes at the last minute.

By Bill Virgin

Who would want to buy a manufacturing business, and the financial challenges, the competition from imports, the regulatory burdens and all the headaches that come with it?

Lots of people would, it turns out. Entrepreneurs looking for an overlooked growth opportunity, private equity firms adding to their investment portfolios, established companies seeking to bolster their product lines or production capabilities and capacity, foreign companies looking for a presence in the U.S. market, they’re all on the hunt for manufacturing acquisitions.

Even in the depths of the Great Recession, circa 2009, the mergers and acquisitions market for manufacturing companies didn’t dry up completely. With the economy’s recovery, however sluggish it might appear, and financing easier to obtain, the pace of deals has picked up in recent years.

Assigning specific numbers to that trend line is nearly impossible.
Unlike the initial public offering market, there’s no central reporting or tracking of deals, many of which involve private entities on both sides of the transaction. Some don’t get any publicity unless one of the parties chooses to announce it.

The market does ebb and flow. Recent reports from regional M&A firms indicate a slowing of deals overall and in the aerospace sector.

But anecdotal reports gleaned from recent editions of Washington Manufacturing Alert indicate there’s still a decent market. Consider a sampling of deals announced this summer:

• Liberty Hall Capital Partners, a private equity firm that invests in businesses in aerospace and defense, bought J&M Machine LLC in Renton.
• Woodinville-based contract plastics manufacturer Mold Rite Inc. was acquired by Sound-Rite Plastics Ltd., which owns Accurate Molded Plastics in Coeur d’Alene, Idaho.
• TNTGamble Inc., a Redmond company that operates under the name Nutraceutix and which makes probiotic dietary supplements, was acquired by Probi AB.
• BASF Venture Capital America Inc. bought Seattle-based EnerG2, which produces advanced carbon materials for energy storage devices.
• Brunswick Corp. acquired Clarkston-based Mills Manufacturing Inc., parent of the Thunder Jet brand of heavy-gauge aluminum boats.
• Weyerhaeuser Co. sold its liquidpacking operation in Longview to Nippon Paper Industries. Now there are reports that Nippon plans to sell its Port Angeles mill that makes telephone directory paper.

That’s a lot of activity for a supposed market lull.

Whether that activity stays at current levels or picks up will depend on a host of external factors, including the outcome of the election and what buyers and sellers think that might mean for tax and economic policy, the value of the dollar and stockmarket returns. There’s often a flurry of deals announced at the end of the calendar year, when buyers and sellers want to wrap up transactions to coincide with the end of the fiscal year (or because they want to beat the expiration of some favorable tax rule).

But external factors are only a part of the forces influencing whether deals get done. For buyers and sellers alike there are internal, individual factors weighing on decisions.

For buyers, especially those that are active owners and managers (as opposed to those like private equity firms building portfolios of companies), acquisitions are often driven by the buy-or-build decision. If a company wants to extend its geographic reach, enter a new market or plug a gap in its product offerings, it can go through the long, laborious and expensive process of doing that itself. Buying an existing company that already has that territory, market or product shortcircuits the time needed to execute that strategy, and can be a more attractive option if a reasonably priced candidate is available. (Of course, there’s always the risk of a badly-managed integration of the acquiree after the deal, but that’s a separate topic.)

For sellers, demographics play a huge role in deciding to find an acquirer.

Impact Washington, which provides consulting services to
manufacturers, says the average size of manufacturing companies in the state is about 44 employees. More than half of the state’s manufacturers have fewer than 20 employees.

Companies of that size tend to be owned by individuals or families.
Many of those owner/managers, being in the baby-boomer cohort, are at an age where retirement and estate planning become very real considerations.

The recession pushed many of those business owners to postpone decisions to sell; they figured they’d wait out the storm to see if more and better offers might materialize in the recovery. But that sentiment wasn’t universal. Some decided they’d rather take the money on the table and get on with retirement than run the risk of waiting for bigger offers that never arrive.

But the recovery, such as it is, is getting a bit advanced in years, as
are some business owners, who face the choice of selling now or waiting, the risk of the latter being that another recession tramples acquisition prices.

Meanwhile, private-equity firms are constantly rearranging their holdings, selling off pieces that no longer fit or hold promise for great improvement. Foreign buyers are looking as well; China in particular looks to be a larger player in the American M&A market.

What this adds up to is continued buying and selling of manufacturing companies. The segment appears less prone to the wild gyrations that are a regular feature of the tech sector. For now there’s a balance between buyers finding decently priced opportunities in manufacturing and sellers getting buyouts they’re comfortable with. Even if that changes – the economy tanks, one of the two major presidential candidates actually gets elected – don’t look for an end to M&A activity. Whatever the conditions, whatever their reasons, there’s always someone somewhere looking to make a deal.

BILL VIRGIN is a veteran business journalist and the founder of the newsletters Washington Manufacturing Alert and Pacific Northwest Rail News. He is also a columnist for The News Tribune, Seattle Business Magazine, and the energy newsletter Clearing Up. He and his wife own Page 2 Books, a retail store in Burien and a Shannon & Associates client.

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