As 2024 transitions into 2025, M&A activity is on the rise with significant capital ready to be deployed. Among the many factors influencing transactions, the impact of tariffs on M&A has emerged as a critical consideration. Understanding the specific effects of tariffs on various sectors and the downstream impact on valuations and the due diligence process is essential for buyers and sellers in today’s dynamic market.

The Growing Demand for U.S. Manufacturing Businesses

Short-Term Impacts of Tariffs on Manufacturing

While uncertainty persists around the nature and extent of potential tariffs—whether targeting specific industries or commodities— the introduction or adjustment of tariffs inevitably increases the cost of imported goods.

Key short-term effects include:

• Higher Prices & Reduced Margins: Supply chain costs rise thus squeezing margins.
• Increased U.S. Manufacturing Demand: Domestic manufacturing is expected to see a surge in demand. While this activity could create capacity constraints in the short term, manufacturing capacity is likely to increase in the coming years, leveling out the demand.

Historical Context: Lessons from 2019

During the first significant round of tariffs in 2019—primarily on imports from China—companies shifted to alternative sourcing from countries such as India, Europe, Mexico, and Canada. However, these alternatives often came at higher costs compared to pre-tariff imports.

Economic Effects of Tariffs

Tariffs implemented under the Trump and Biden administration resulted in:

• Higher producer prices
• Reduced manufacturing jobs

Despite intentions to boost local manufacturing, these measures showcase the nuanced effects of such policies and the failure to achieve the desired outcomes.

Present-Day Implications: Strategic Opportunities in M&A

Investing in U.S. Manufacturing

As technology evolves and global manufacturing costs rise, tariffs may target new regions, including former safe havens such as Canada and Mexico. Global companies are responding by investing in and expanding local or regional manufacturing capabilities.

• Efficiency of Existing Facilities: Acquiring underutilized U.S. manufacturing facilities, is faster, more efficient and more cost-effective than building new ones.
• Government Incentives Drive Growth: Tariffs alone are an inadequate tool for stimulating local manufacturing. Policies like the CHIPS Act are essential for enabling U.S. companies to compete effectively on cost and have demonstrated measurable success. For example, the CHIPS and Science Act of 2022, which was specifically targeted to stimulate investments in American semiconductor manufacturing is reported to have grown the US Production of semiconductors from 10%, to 30% of the Worlds Supply in the 30 months since it’s been in place. While short of the 40% of the World’s supply that U.S. had once produced, it clearly had a positive impact on the semi-conductor manufacturing industry. If the Trump administration is serious about increasing U.S. manufacturing, they will need to find ways, other than tariffs, like the CHIPS act, to achieve this outcome.
• Cross-Border M&A Opportunities: Global companies are increasingly pursuing cross-border transactions to localize manufacturing and mitigate tariff risks. This trend is expected to elevate valuations for U.S. manufacturers benefiting from positive industry tailwinds.

Impact on Other Businesses: Key M&A Considerations

Certainty is key to achieving higher valuations in M&A transactions. Uncertainty from tariffs poses a threat to business valuations, particularly for those dependent on imports. Here is how different businesses could be affected:

1. Importers with Alternative Sources: Supply chain disruptions are likely as businesses transition to non-tariff-impacted countries, most likely at higher costs.
2. Importers Competing Against Companies Supplying U.S. Products: Even with potential price increases, long-term margin compression is a significant risk, as importers might need to absorb some of the increased cost of tariffs.
3. No Alternative to Tariffed Goods: While initial margins may benefit from price increases, sustained market resistance to higher prices over time could lead to margin compression. This will be partially offset by the higher unit prices, resulting higher gross profit on same unit sales.

Businesses with strong value proposition and flexible sourcing strategies are better positioned to navigate these challenges and command higher valuations in the M&A process. Addressing tariff risks in the Confidential Information Memorandum (CIM) and sensitivity analysis in financial models is critical for instilling buyer confidence and mitigating uncertainty for the prospective buyer.

Effects of Tariffs on Gross Profit Margins (GP%) and Gross Profit Dollars (GP$)

Each of the above previously mentioned scenarios will generate different results on the businesses’ cost, the selling price, and the profit contribution to the business. 

This can play havoc on key business metrics and important to keep in mind when building out the financial models for M&A.

Scenario 1: Tariff Increase of 25%, which is able to be fully passed along to the customer

Pre-Tariff; Business Cost: $70.00, Customer Price: $100.00

Resulting in $30 Profit (GP$) and 30% Gross Profit Margin (GPM)

Post-Tarriff; Business Cost: $87.50 ($70 + 25%-$17.50), Customer Price: $117.50

Resulting in same $30.00 Profit (GP$) but a reduced margin of 25.5% GPM

Scenario 2: Tariff Increase of 25%, and company is able to maintain the same GPM

Pre-Tariff; Business Cost: $70.00, Customer Price: $100.00

Resulting in $30 Profit (GP$) and 30% Gross Profit Margin (GPM)

Post-Tarriff; Business Cost: $87.50 ($70 + 25%-$17.50), Customer Price: $125 (30% GPM)

Resulting in increased profit of $7.50 to $37.50 Profit (GP$) at the same 30.0% GPM

Scenario 3: Tariff Increase of 25%, which is not able to be passed along at all to the customer

Pre-Tariff; Business Cost: $70.00, Customer Price: $100.00

Resulting in $30 Profit (GP$) and 30% Gross Profit Margin (GPM)

Post-Tarriff; Business Cost: $87.50 ($70 + 25% (17.50)), Customer Price: $100.00

Resulting in $17.50 reduction in profit to $12.50 Profit (GP$) and a reduced margin 12.5% GPM

Conclusion: Adapting to the Tariff Landscape in M&A

Tariffs present a dual reality for M&A transactions:

• Challenges: Increased costs, supply chain disruptions, and valuation risks.
• Opportunities: Strategic acquisitions to localize production and mitigate risks

Successful buyers and sellers must adapt by incorporating tariff scenarios into due diligence, valuation models, and integration plans to effectively navigate this complex landscape. As the M&A landscape evolves, embracing these strategies will be key to unlocking value in transactions.

If you have questions about how tariffs may impact your business valuation or are interested in learning more about M&A opportunities in this shifting landscape, contact Protegrity Advisors. Our experienced team is ready to help you develop a strategic approach to maximize value and mitigate risks.