The Covid-19 pandemic suddenly threw the world into complete economic turmoil. Inflation, high interest rates and sluggish growth have been the new normal since – and private sector (PE) companies have rapidly had to adopt new strategies in order to survive.
Many investors are also still highly cognisant of the lessons of the 2008-09 global financial crisis, which often saw inflated deals using debt to finance transactions.
Consequently, add-on deals have become increasingly common. In fact, about 76% of US PE deals in 2023 were add-ons, compared with just 49.6% in 2013. It essentially means that a PE firm purchases a company to add on to one of the platforms within its portfolio, usually with less complicated financial and administrative infrastructure.
Within this category of deal-making, there are three types:
- Bolt-on deals refer to companies offering capabilities that complement the platform organisation.
- A tuck-in acquisition provides new kind of product functionality, meaning that the platform can almost instantaneously improve its offerings and revenue.
- A roll-up acquisition is when various smaller companies are integrated into the larger entity, usually within a fragmented sector.
What are the key reasons add-ons are a primary driver in PE activity?
Tactical
One common reason that PE firms seek add-ons is to provide new or complementary functionalities. Just think of the $4.6 billion acquisition of Diversey Holdings by Solenis, a Platinum Equity portfolio company, in 2021. This brought in various new cross selling opportunities from two companies with adjacent offerings.
That can also mean expanding into different geographical locations too, offering the platform new opportunities to expand, seek talent and build revenue – especially in markets with radically divergent tastes that need specific localisation for their products.
Arbitrage
This is a tactic that sees smaller companies added on to the platform to drive a higher selling price at a later point – essentially, making the sum greater than the value of its parts.
Given that larger companies sell for a higher price-to-EBITDA multiple, as smaller companies are regarded as riskier, add-on acquisitions are used to ‘build up’ the platform.
Resilience
Big deals and leveraged buyouts are simply too risky until credit becomes more affordable. As such, add-on deals can make both the investors themselves and their portfolio companies more resilient during this tumultuous time. There are other benefits for PE firms, too. Add-on deals are less costly, close quicker and attract less scrutiny.
Internal synergies
Aside from overall product offerings, there are various internal synergies that add-on deals can unlock to drive greater revenue and higher valuations.
These include:
- Reducing overlapping workforce functions
- Streamlining internal processes with new best practices
- Improving buying power and access to new suppliers
- Depending on the companies integrated, there could be less need for previously outsourced services like design, marketing and advertising
Innovation
Add-on deals have long been used to drive innovation, from integrating the smaller company’s product offerings and technological know-how to bringing together new teams with different expertise to nurture new product ideas.
One example of this comes from the recent acquisition of Drift, which has developed conversational and buyer experience artificial intelligence. Bought by the Vista Equity backed Salesloft, a sales engagement platform, it will allow for various, interesting synergies.
Regarding this capability overlay, the CEO of Salesloft, David Obrand, said: “This acquisition will fundamentally change how B2B buyers and sellers engage, but also how sales and marketing teams come together to drive pipeline efficiency and revenue outcomes.”
While it might seem like a cheat code when organic growth is slow, add-ons give an immediate boost to portfolio company multiples and can offset interest rate costs.
However, like any other deals, add-ons come with their own complexities and considerations that need to be taken into account, from sourcing the deals to evaluating them effectively, to creating a robust post-acquisition plan.
On Tuesday 27th of February we'll be diving into the insights, strategies and best practices for add-on acquisitions together with Richa Aggarwal, Partner at PwC, and Yale Kwon, Partner at AlixPartners.
To listen to the discussion and gain invaluable insights on add-on acquisitions, register and secure your spot here.
