Add-on Acquisitions: Another Way for M&A
Narrator: Turbulent conditions are nothing new to private market veterans. But as interest rates climbed to record heights in 2022, many lost their stomach for new deals. M&A volumes plummeted 48% in the first quarter of 2023, as deals were put on hold or cancelled outright. Many of the most experienced managers have pivoted from new money deals to add-on acquisitions. But what is an add-on acquisition? In private equity, an add-on deal is when a portfolio company acquires a business directly, as opposed to the sponsor.
Justin Hutchinson: One of the reasons that add-ons are achievable, they tend to be smaller, they require less debt. Add-ons can often be financed by the existing portfolio company off its balance sheet. We’ve seen this a lot in the veterinary industry. We’ve seen this a lot in healthcare with different clinics, where a lot of times historically those have been fragmented businesses, buying them all at a relatively low multiple, aggregating them into a larger business that hopes to then exit at a whole with all the benefits of synergies and scale that you would expect.
Narrator: Despite being relatively cheap compared to a fully leveraged buyout, add-ons are no less complicated, requiring a detailed examination of company strategies, operating structures and legal frameworks. So what are the principles for anyone attempting such a deal?
Justin Hutchinson: So I think in that sense you’re looking at how that target company operates, you know, how it deals with its suppliers, what it’s kind of overhead is in terms of managing HR, how it operates its IT systems, getting into the details.
A lot of times, realising the value will depend on being able to very quickly execute on the integration plan, dealing with employees and legal implications of looking to terminate contracts and whether that’s possible. Even kind of more techie, legal things of…you know, you’ve got multiple operating companies now in a particular jurisdiction. Do you need them all?
Management incentivisation is a key part of any private equity transaction as a mechanism to align the interests of the shareholder owners and the managers that are going to run the business going forward. If there is available equity, there can often be a question around price. You’re then acquiring a business with its own management in the acquired asset and you need to consider how and whether they’re able to integrate into the existing management equity plan.
Narrator: With all that in mind, managers must still keep one eye on the exit. While the average holding period for a leveraged buyout ranges from around 3 to 5 years, the integration of a smaller business into a larger portfolio can often take longer to yield results. But despite this, the current shield economic climate and reduced availability of bank debt has actually had the effect of making small add-on acquisitions more attractive.
Justin Hutchinson: Faced with those circumstances, sponsors that perhaps were contemplating a near-term exit for a particular portfolio company might think that it’s now or two years away, it’s three years away. And given that additional time, we’ve got now time to focus on this company, maybe execute on some of these add-on transactions that we didn’t think we had time to do.
Narrator: Identifying the right acquisition target and at the right time remain key to the success of add-on deals – deals that many portfolio managers are turning to in these uncertain economic times.