Over the years, private equity firms have increasingly fueled value creation via add on strategies.
“Build and buy” refers to the buying of a platform company which is then leveraged to make acquisitions of one of more other companies as a means to build out the business. This strategy makes sense in an industry with shorter holding periods, as it often drives revenues more quickly than organic growth strategies.
The 2017 Annual US PE Middle Partner report from Pitchbook suggests that while investor appetite for add-ons has traced back over the past ten years or so, most of the activity has taken place in the middle market. Upper-middle-market activity, which saw the lowest growth over the period between 2009 and 2017 compared to the lower and core middle market, accelerated by more than 1,000%, with 14 add-ons in 2009 compared to 171 last year.
The turning point in which buy and build became an integral part of the buyout market dates back to the financial crisis, wherein investors were trying out new approaches in desperation to quickly outperform the market. A decade later, investors are typically expected to have a list of roll-up targets before they even acquire a platform. Potential buyers will often compete based on roll-up plans. This changing industry dynamic has given smaller companies a greater role in the private equity space, as firms can offer their managerial expertise and capital to newer firms.
“The strategy is most successful when the portfolio company is small or medium-sized, has a PE sponsor with operational and buy-and-build experience, and is in a low-growth, low-profitability, highly fragmented industry,” stated Boston Consulting Group partner Michael Brigl in a 2016 industry report. The report showed buy and build activity up from 20% of all PE deals in 2000 to 53% in 2012.
“Value in buy-and-build deals often results from traditional synergy levers – such as scale effects in procurement and in selling, general and administrative expenses – and from improved sales force effectiveness and pricing,” stated the BCG report.