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November 30, 2021
Even before the onset of the COVID-19 pandemic, years of tightening restrictions on migrant labor usage, minimum wage increases, and shifting social and demographic trends had proved disruptive to the many food businesses that rely on hourly workers and operate on thin margins.
These issues were dramatically compounded with the sudden mass shutdowns, huge disruptions to supply chains, and the abrupt transition to remote work as a real option—albeit primarily only for white-collar workers. Now, as the economy moves toward recovery and consumer demand has surged back, food businesses of all types across the country are struggling deeply with labor costs and worker availability.
At the executive and management levels, that means difficulty hiring for in-person positions due to abrupt shifts in talent distribution. Many professional-class managers and executives now prefer to opt into remote roles; some even used the pandemic as an opportunity to relocate to more attractive geographies.
At the lower-skilled and entry levels, it means an inability to fill many roles, with labor shortages so acute that many food businesses have had to shorten hours or days of operation, cut manufacturing runs, or eliminate entire shifts of workers.
The Automation Solution
For many companies, the logical, at-hand solution is automation.
Let’s say you own a California-based food manufacturing business that produces multiple products. You’re looking at a $15-per-hour minimum wage by 2023 (the state has been stair-stepping its way to $15 via $1 per hour annual increases since 2017), plus benefits. But even at that pay level, you still can’t attract steady workers to clean the manufacturing line between food runs (as an example).
And this phenomenon is not unique to California, as all states in the country have seen an increase in wage rates over the past 12 months (measured March 2020 to 2021), with some states seeing more acute pressure.
Installing an automated cleaning system that demands minimal human labor would require a one-time capital expenditure and necessitate closing lines down for a few weeks. But after that one-time expense—potentially costing millions of dollars—your long-term cost basis for cleaning is permanently reduced, and you’re no longer at the mercy of the labor market for that function. We often find that when clients assess this sort of investment through a return on invested capital (ROI) model, they determine the expense also has a short-term payback.
Perhaps the next step after that is to consider automating some of the human-performed sorting and packaging labor on the manufacturing line—a second significant cap-ex investment. This is the sort of cost-benefit tradeoff that many in the Food, Beverage, and Agriculture industry are sorting through today.
Our team also witnessed clients in the tree fruit industry experience the same transition following restrictions on the use of migrant labor in the sector. That industry’s adoption of automation has dramatically transformed it in just a few short years. In fact, those who have implemented the latest automation are significantly cost-advantaged over their competitors who may not have.
So, is now the time to bite the bullet and automate?
A Generational Pivot Point
We’re seeing this question play out against the backdrop of a generational transition from Silent Generation and Baby Boomer owners to their Gen X or Millennial children. Some existing owners are either resistant to change or not interested in paying for automation costs that will only amortize over the long term. At the same time, COVID and its attendant stresses were the last straw for many members of these elder generations. They’re ready to hand over the reins and move on.
That reality is forcing many families to grapple with a generational transfer that can clear the way for change but brings severe challenges. In many cases, private company owners know they need outside capital to move forward, but they are uncertain of how to think about it: as a source of liquidity or a funding mechanism to vault the automation hurdle—or both?
Interestingly, the 2019 U.S. census data shows approximately 51% of all business owners who reported data were 55 or older. With two additional years of ownership—during a very painful and confusing COVID period—many of these owners have decided to sell their businesses.
The two most common structures under which outside capital might come into a family-owned business would be in the form of a growth capital investment or under a traditional private equity control transaction.
A growth capital investment is typically $20 million or more and will generally provide working capital to the business for major, growth-related cap-ex expenditures (like automation initiatives) or M&A activity. Some of the investment can also be used to provide liquidity to partially de-risk the family’s financial position. In return for their capital, the investor takes a minority ownership stake in the business.
A private equity control transaction is more appropriate in a situation where liquidity is the priority, perhaps when the younger generation wants to allow the older owner or owners to cash out of the business while they maintain a management and ownership role (albeit in a non-control position). In this scenario, the PE investor typically ends up with a 60-80% ownership stake in the business but would likely bring resources to the table to offer liquidity and make cap-ex investments that could future-proof the business.
A traditional third exit path for food businesses has been via sale to a strategic, which is still a viable option. Most food strategics are trading at all-time highs in the stock market, have significant cash (or borrowing capacity), and continue to look for ways to grow—increasingly through acquired innovation. The tight labor market and rise of automation are also producing an emerging trend: strategics are fervently seeking experienced talent. Acquisitions can provide a wealth of tenured talent and infuse new, innovative thinking. In today’s market, we are seeing less “synergy capture” in M&A deals: retaining human capital and maintaining the unique DNA of the acquisition target has become paramount.
How to Prepare?
Through our experience advising family owners of food businesses on similar transitions, we’ve learned a few important lessons:
A New Era Calls
While it’s easy for food businesses to be discouraged by the one-two punch of labor market challenges and COVID, the reality is that the advances in automation and robotics over the last decade make this a ripe time for consolidation and transition in the business. In addition, private equity and growth investors remain flush with capital that they are eager to put to work in companies with a vision for how they can evolve to stay relevant in a fast-changing world.
If you would benefit from a conversation about how to navigate into the next era, we would be happy to offer our perspectives based on what we are seeing with current market dynamics.
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