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The Popularity of Add Ons in Mergers and Acquisitions

By Generational Equity

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As we have discussed in several articles over the past few months, add-ons as an M&A strategy have become increasingly popular with both equity firms and corporate buyers. In fact, based on the latest research, the vast majority of all deals closed could be considered in the add-on size bracket (although not all are defined as add-ons).

In fact, according to research from Axial*:

In a capital market environment flush with capital, private equity firms are exhibiting renewed focus on improving the operations of their portfolio companies through a buy and build strategy. As a result, the add-on space has seen a fair amount of growth. The latest data tells us that add-ons comprise of 61% of private equity acquisitions, up from 49% in 2012.

This research only encompasses purchases and investments made by equity firms in the add-on space. If you factor in the same strategy being pursued by strategic buyers, this percentage could be quite a bit higher. This is great news if you are the owner of a privately held company with revenue below $100 million.

However, most analysts adhere to a traditional definition of add-ons, based on the size of the target (most add-ons are smaller in size than platform acquisitions). Interestingly, Axial uses a much broader definition of what an add-on can look like:

Add-on companies often aren’t viewed as industry leaders and might suffer from issues with management, undercapitalization, lack of broad distribution, or limited exposure to their industry. Often, these smaller companies are recognized as missing some key ingredients such as:

  • Lack of sales distribution
  • Management gaps
  • IT fragmentation
  • Less detailed accounting and understanding of cost structure
  • HR issues, such as increased costs when merging benefit platforms
  • Cost of merging operational logistics

I find this expansive definition fascinating for several reasons. First, it recognizes that revenue is not the only determining factor in what buyers view as add-ons. Secondly, it also factors in that most privately held companies, especially those below $100 million in revenue, lack key attributes that are holding them back from becoming much larger. And, in fact, by augmenting these weaknesses, a buyer can take a $25 million company, combine it with the synergies of a larger platform company and, in many cases, significantly improve the operations of the acquired company, growing both revenue and profits.

To the list above, I add these common traits that add-ons can also have:

  • Owner dependence
  • Customer concentration
  • Lack of marketing expertise
  • Lack of financial reporting

Here is the really good news: The real-world definition of an add-on used in this piece tells business owners that their companies do not need to be PERFECT before negotiating with buyers. In fact, if you and your M&A advisor use a methodical buyer search strategy, you will most likely find both equity firms and strategic players that are looking for add-ons that provide them with the opportunity to make operational improvements post-acquisition that can really help the bottom line.

Here is how some of our clients describe the benefits to their business of the post acquisition add-on role:

In the last video clip above, our client, Brad Hennrich, expands on one of the real benefits of an add-on transaction to the seller – retention of partial ownership of the new entity and the potential for a “second bite of the apple” via a secondary transaction 3-5 years down the road.

As you can see, the popularity of an add-on strategy is also driven because it is a win-win for both seller and buyer.

Interested in learning more? I have a great idea for you: Attend one of our complimentary, M&A conferences. These are designed to help you significantly expand your knowledge base relating to all types of transactions and buyers and to help you position your business to take advantage of the current seller’s market. Here are some links to help you learn more:

*Note:  Axial is a website that connects capital providers with firms seeking same.

By Carl Doerksen, Director of Corporate Development at Generational Equity.

© 2021 Generational Equity, LLC. All Rights Reserved.

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We had the pleasure of working with Mr. Ahmad Behjati Managing Director, M&A, for Generational Equity during our acquisition of Papa's Dodge in late 2021. Generational Equity and Mr. Behjati represented and marketed Papa’s Dodge. As our primary contact, Mr. Behjati was professional in every facet of this acquisition process, conveying valuable advice most times and assisting us in every step of the process.
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