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What Are Add-Ons and Why Do Private Equity Firms Acquire Them?

By Generational Equity

what are add-ons

There is a common misconception among many lower middle-market business owners that private equity firms are only interested in making large “platform” acquisitions. In reality, nothing could be further from the truth.

Certainly equity firms do create funds that have very specific goals in terms of the types of companies acquired and their size. And most often the initial investment in an industry player will be larger and is often termed “the platform acquisition.” However, after that, size restrictions are often less important, and the focus is on synergistic investments in smaller companies that bring key resources to “add on” to the platform company.

As we have examined in the past, during the last few years, add-ons as a percentage of all deals closed by equity firms has risen from 39% in 2005 to more than 60% midway through last year. And this increase is not an aberrational spike; the percentage of deals that are add-ons has grown every year since 2005.

So the question we are often asked is, why? What makes an add-on strategy so popular today? The answer takes us back to the merger and acquisition bubble years of 2007 and 2008 when professional investors were gobbling up large deals at inflated valuations and loading them with significant debt to finance the transaction. The recession that hit in late 2008 and carried over into 2009 taught these buyers a valuable lesson in how not to acquire over-valued assets, place too much leverage on deals, and try to hit home runs with a single acquisition.

Axial, a leading B2B database that connects businesses with capital providers, indicates that the following are some of the benefits of an add-on program:

Analyzing possible synergies makes a critical difference when valuing add-ons. The most desirable add-ons can bring benefits like:

  • Lowering costs by merging sales staff with similar expertise
  • Expanding sales into regions not currently served, either domestically or internationally
  • Increasing product offerings
  • Cross-selling/upselling opportunities for existing products
  • Eliminating duplicate management
  • Consolidating financial functions, such as treasury and tax
  • Eliminating idle manufacturing capacity
  • Boosting buying power

In addition to these, one of the greatest benefits we have seen over the years is this: Private equity firms that are in the process of building a larger entity in an industry via add-ons also bring key managerial, financial, operational, sales, and marketing skills to the newly acquired entities. These are key areas that most lower middle-market companies do not have access to either because of lack of capital or lack of bandwidth to add to their operations.

Too often private equity firms are lambasted in the mainstream business press for acquiring then tearing apart operations via financial re-engineering. However, most of the firms that we deal with in the lower middle-market acquire companies for one simple reason: to help them grow and expand

If you are the owner of a lower middle-market company (typically a company with less than $100 million in revenue) and are profitable and growing, you may be surprised to learn that you could be a good add-on for an equity firm investing in your industry. Of course the first question that needs to be addressed is, are there equity firms operating in your space? Given the literally thousands of firms out there, the odds are good that there are one or many that are rolling up your industry.

To learn more about this interesting type of buyer and to learn about all buyer types (equity firms are only one slice of the pie), attend a Generational Equity M&A workshop. While there you will be exposed to a significant amount of information that will educate you and allow you to begin formulating your own exit strategy for the business you own.

To learn more, visit our website and take a look at the agenda for one of our meetings. If it looks interesting, call us at 972-232-1121 or fill out a contact form and one of our M&A associates will arrange for you to attend a meeting in your area.

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

© 2021 Generational Equity, LLC. All Rights Reserved.

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