Manufacturing – Venture Capital vs. Private Equity

The current opportunities for investing venture capital into manufacturing is immense. I don’t think we will see a wider open landscape in our lifetime.

When I first started planning Forward Capital Fund, I really had a difficult time explaining to LPs (Limited Partners) how I was going to create a venture capital fund which invests in automated contract manufacturing. I really didn’t know what to call my unique brand of investing. Manufacturing is typically generational, siloed, insulated and private such that it is difficult for people on the outside to understand how it works. Modern machinery and robotics are helping to spur the change in manufacturing.

While there are a few CVC (Corporate Venture Capital) groups in manufacturing most of these focus on technologies related to their main point of business.

The more I have shared ideas about Forward Capital Fund, the more inbound inquiries I have received from manufacturing, robotics, IIoT, and automation engineers that didn’t know where to get started building and owning a business.

If you are a software company its easy, there is a cottage industry established to help you understand and train on how to make the leap. In addition to a myriad of incubators and accelerators there are a ton of articles, books and case studies which are all ready to help you learn. If you are developing hardware, you might need $100,000 – $200,000 just for the equipment. This doesn’t fit the incubator or accelerator model. That’s why at Forward Capital Fund we are building a bridge for mechanical engineers and automation engineers that want to make the jump into their own startup and we are not talking just about hardware startups, we are talking about contract manufacturing too.

If a robotics startup gets to revenue and profitability, they have their choice of venture capital funds or private equity funds to choose from but when they are just starting out it is not as easy.

We make it easier to get funded, find space, find mentors, get equipment and get going. Once going, there is a lot of opportunity for a young entrepreneur to grow, quickly. From vertical consolidation to automation to related markets to platform creation (quality, regulatory, sales) there is no shortage of growth directions for a young smart mechanical or automation engineer.

Venture Capital or Private Equity

Venture capital funds normally invest in fast-growing startups. Private equity firms normally invest in established manufacturing firms. There are quite a few “hardware” incubators, accelerators, prototypers, etc. but nothing remotely close to startup contract manufacturing. If you had to do a poll of how contract manufacturers get started, I think 99% have a machine in their garage or poll barn to build clients on the side. Who invests in manufacturing startups and why?

Financial Arbitrage

Private equity firms typically pay a multiple of EBITDA. Let’s generally call it 5x. When you purchase a manufacturing machine, you are strictly paying for the machine. A good rule of thumb for manufacturers is that you would like to get your machine paid off in 2 years. Granted EBITDA and the amount you pay for your machine are not the same thing but if you can put down 20% on your machine, pay it off in 2 years (5x) and then sell the company for a multiple above that, returns can rival those of a venture capital firm. This creates financial arbitrage.

There are also a lot of tax incentives in the manufacturing and startup space to which I am not going to go into as much detail but I would implore people interested in this topic to reasearch tax advantages to manufacturing in your area.

What are private equity firms looking for?

For one, they are looking for strong leaders. They may have a diverse portfolio of companies. The worst thorn in the side of a private equity fund is having a poor management team. It can take long time to find and train a team. Private equity teams would be willing to pay higher values for a strong young management team that could help grow a company and/or work with existing portfolio companies that have stalled. Plus the PE firms don’t have to worry about high overhead teams due to lean startup methodology.

Similar to private equity firms wanting to purchase teams they also want exposure to advanced technologies and ways of doing things. Companies started today are able to take advantage of a myriad of new technologies. These technologies can often be bolted on to existing companies but they are not as fluid as companies born into this environment. Manufacturing startups can help older legacy manufacturers improve systems and processes.

Private equity firms want companies that understand the financial process of private equity firms. Courting family business can take decades due to long term prospects of such companies. Manufacturing startups who take funding understand the value of investment and how to work with external partners.

If you are looking at PE firms that are strictly LBO i.e. buy with a lot of debt and pay down debt to realize value creation, it doesn’t seem like a great time with the current high values. These firms could get hurt by rates going up, by a recession, and by decreasing multiples. Independently or all at once. If you are able to find a firm that is able to grow operationally or through tech to move up the exit multiple spectrum it does seem like a good time.

Manufacturing Platform

With manufacturing comes jobs. Most economic development groups are interested to help manufacturing operations get going. In the Wisconsin area, there are two newer projects that I really like in terms of enabling manufacturing startups. They are the Janesville Innovation Center and Startup Hub in Green Bay. These spaces help startup manufacturers by making small bays available for rent. This does two things, it provides smaller rent than building out a space by yourself and it helps get like minded people together.

The fund will develop a platform to help startup manufacturers get off the ground. We will have small manufacturing suites available for low rents or for free with investment. We will have bank relationships that know how to work with startup manufacturers. We will have tool shop space and machines available to startups for standard equipment (mills, lathes). We will work with software and machinery providers to provide discounted prices to startups. We will work with manufacturing reps to identify markets and opportunities.

Why Now?

We feel that the current industry trends are creating fast mover advantages. Off the shelf, automation components can help create a paradigm shift for even old and entrenched manufacturers. Cloud based simulation and robotics tools are rapidly evolving too with new products from AWS, Google and Microsoft alike. We stay on top of current trends in automation to help our portfolio companies grow.

Manufacturing Network

Several of the key players in the platform also help create the network. Banks, engineers, sales reps, economic development, investors (manufacturers) and most importantly the other manufacturing startups. By building a network of manufacturers with a common thread, we should be able to help each other grow through knowledge sharing, networking and job sub-contracting.

Manufacturing Startup Bank Loan

If you are a manufacturing startup, that cannot get a bank loan, even based on assets, don’t hesitate to reach out. We work with a handful of banks to help manufacturing startups get going. If you are in the Milwaukee area we also can help you find some space.

More to come… Do you have thoughts on this concept (good or bad) feel free to email me at research@forwardcapitalfund.com.