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Private Equity Firms and Strategic Growth – Add-Ons Make Sense

By Generational Equity

PE add on strategy

As we have discussed, one of the most popular methods for private equity (PE) growth is via an add-on strategy. Add-ons (a.k.a. bolt-ons) are relatively smaller companies that equity firms invest in and then “bolt on” to an existing platform company.

Usually the initial investment by an equity firm into an industry is a fairly large transaction – often companies with revenue in excess of $50 million or earnings of $10 million plus. After the platform or portfolio company is acquired, PE firms then do extensive research, looking for synergistic additions to that platform. Synergies can be either vertical or horizontal and are often both.

The Data Proves It

Skeptics out there might say, OK, that is only a sample set of four deals. What about some real data? According to PitchBook’s 1st Quarter 2016 U.S.PE Breakdownadd-ons as a percentage of all PE deals completed have leaped dramatically so far this year. This is how they describe the current situation:

Transactions closing between $25 million and $100 million represented 26% of all 1Q deals. We still have plenty of room to run in the year, yet 2015 as a whole saw transactions in this size bucket represent just 22.5% of all activity. Deals in this range also continue to be a haven for add-on acquisitions, which accounted for68% of all 1Q buyout volumemore than any other year we’ve tracked to date.The buy and build strategy will continue to be essential for PE buyers as they look to position portfolio companies to endure any dip in the economic and business cycle.

And for you visual learners out there, you can see this trend graphically:

This trend is statistically significant, doubly so if you are the owner of a business in the U.S. today. An increase from 43% to 68% is a massive shift, and the percentage change from 2006 to 2015 (959 deals vs. 1,752) represents a compound annual growth rate (CAGR) of over 9%. Keep in mind too that the starting point of this chart, 2006 was actually two years before the recession hit, which affected deal making dramatically. But as you can see, the percentage of add-ons just kept on climbing.

In the paragraph preceding the chart, PitchBook makes some points about why private equity firms are pursuing “buy and build” strategies. Although theirs are certainly accurate (enduring any dip in the economic and business cycle), I want to add an even more fundamental reason that add-ons have become a key part of the PE model: It just makes sense! By that I mean, the fastest, most efficient way to grow a platform, and eventually take it public or sell it outright to a larger strategic is via synergistic add-ons over a 5-7 year period.

Don’t confuse an add-on strategy with the heyday of roll-ups personified by Harold Geneen and ITT, where over a 20-year period in the 60s and 70s hundreds of unrelated businesses in completely divergent industries were acquired. No, PE add-ons are “additive” to the overall growth of the platform and ultimately generate tremendous returns for limited partners that invest in these funds.

What does this mean to you, an owner of a company that is typically under-capitalized but has great growth potential and ideas?

Simply this: A partial sale to a private equity firm could make tremendous sense. A partial sale is usually how these add-on deals are structured. Current management is retained in “newco” with new ownership structure, where you may retain a minority position. Then the PE firm infuses the business with capital investment, along with sales, marketing, operations, and management advice that will enable you to take your company to a new level as part of a larger platform investment (and you retain a partial interest in the new company).

That may sound too good to be true, but the reality is it is entirely possible. Generational Equity has closed a number of deals using this same structure with great success.

Of course not all businesses are good fits for PE firms even as add-ons. By their very definition, bolt-ons have to meet specific criteria such as location, industry niche, intangible assets, management team experience, potential growth, etc. In addition, a partial sale requires the business owner, if retained, to be able to manage on a collaborative basis AND in most cases to be able to answer to a board made up of PE firm leaders, as well as management of the platform company. For many entrepreneurs this can be a challenging transition.

But it can be a great deal structure for many business owners. If you would like to learn how, and begin to research if it might be a good match for you, reach out to a Generational Equity Senior Business Analyst at 972-232-1121 or fill out a contact form. Our team will discuss your options with you and help you begin the path towards an exit time and strategy.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

© 2021 Generational Equity, LLC. All Rights Reserved.

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