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Private equity firms make many small add-on acquisitions and not only large big-ticket deals. You as an entrepreneur can copy their strategy. Here are the reasons when you shall consider it and what an add-on acquisition can be.
An add-on acquisition refers to an acquired business that is added to one of the platform companies owned by private equity. Add-on acquisitions are smaller than the initially acquired platform company and are made to solve a specific challenge. Here are the 5 main challenges when add-on acquisitions make sense:
- Accelerate growth within a specific product, segment or market.
- Save time building technology or competence.
- Expanding a sales channel faster than organic growth.
- Production capacity add-on acquisitions.
- Industry consolidation.
Add-on acquisitions are almost always smaller than the initial private equity platform company or that of a technology business making such a move. The reasoning being that initiatives, steering, control and cultural integration is far easier with a business smaller than your own.
The number of add-on acquisition has been 40-50% of all private equity acquisitions in 2009 – 2018, according to Bain & Company’s Global Private Equity Report 2019. The number of transactions has increased 3x however and the share of 4th and 5th add-on acquisitions has increased.
Read more: How you can use the private equity model!
As an entrepreneur you can copy this core part of the private equity value creation strategy. Here are the situations and challenges when you shall consider making an add-on acquisition:
Accelerate growth within a specific product, segment or market
Small niche businesses can bring key resources to a business. Resources that otherwise will take much longer time to recruit, purchase or build organically with consequent slower revenue growth.
“Our firm have two people on the ground outside Stuttgart, but it takes us too long to build a sizeable presence. We have now identified five small engineering company’s that we will approach. We will try to acquire one of them to accelerate our growth in Germany.” (Founder of a fast-growing mid-size technology company.)
Saving time and short-cutting organic growth within a product area with the help of add-on acquisitions can often make sense. For example, when there is a new industry trend and first mover advantage and market positing has great value.
Many small businesses enter a new market through a local partner or recruiting one or two local sales representatives. That is a great way to map the opportunities and start making our name known in the area.
To accelerate growth however, more feet on the ground and connections with key individuals and teams with prospects are needed. Add-on acquisition can solve that challenge much faster than the usual and slow organic recruiting process. There are plenty of small businesses that are open to join a larger context should they feel that they will be backed-up by the larger company’s resources for expansion.
Save time building technology or competence
Activision Blizzard, a large French-owned U.S video-gaming company behind World of Warcraft and Call of Duty, needed to go mobile. Gaming titles on consoles where loosing traction against a flood of the mobile gaming experiences. Activision Blizzard acquired the Swedish unicorn startup King, the inventor of the mobile game Candy Crash Saga for a whopping $5.9 billion.
King has an attractive creative process that Activision Blizzard was lacking. Instead of betting $25-40 million into large, individual gaming projects to perfect new mega gaming launches, King was experimenting with a multiple of simple ideas for new games. Activision Blizzard paid to acquire the mobile gaming competence and processes, not the highly successful Candy Crash Saga game.
The electric passenger vehicle industry is expanding fast, fueled by the success of Tesla, consumer preferences and tighter emission regulations. The same technology trend is now happening also in the heavy commercial vehicle industry. Off-road vehicles such as airport towing trucks, airport baggage trucks and logistics handling trucks are rapidly being electrified.
German diesel engine manufacturer Deutz was being concerned. As a long-term diesel engine manufacturer Deutz realized they would have difficulties accelerating an electric engineering and software development program. Deutz identified and acquired Torqeedo, a small electric boat engine startup. With the help of Torqeedo’s electric engine and propulsion knowhow and Deutz heavy machinery application competence Deutz is now rapidly launching their new electric vehicle engine program. Securing their market position as an engine supplier to the heavy vehicle OEM industry.
Expanding a sales channel faster than organic growth
A less common reason for an add-on acquisition is to expand with a new sales channel. Digitalization and growing online sales channels may lead to a wave of small startup add-on acquisitions by larger incumbents.
Increasingly, online sales platforms and channels will complement and partially overtake existing physical sales channels. Not least within retail but also with transactional business to business goods and services, information products and learning. An add-on acquisition can be away to propel entering into digital sales for any traditional business.
Production capacity add-on acquisitions
Product engineering and manufacturing companies often start their life outsourcing production and assembly. At some point insourcing the assembly operation becomes crucial for engineering synergies, control and license to operate with larger customers. Gradually, as a third step, it may also make sense to start produce some of the key components inhouse.
Add-on acquisitions of production and assembly facilities may become an interesting alternative in the fourth stage. Customizing and modernizing an existing operation may be an easier and slower cash consuming way to grow than to build, recruit and train an entirely new production and assembly facility.
Industry consolidation with add-on acquisitions
Industry consolidation is sometime pointed to as a reason for add-on acquisition. In reality on ofabove 4 arguments are often the key reason for an add-on acquisition.
Industry consolidation acquisitions are different in the sense that they are often larger than the typical add-on acquisition. Private equity almost never consolidates an industry by acquiring the number two player to dominate a specific market. It’s simply too complicated of an integration and consumes valuable time away from sales and margin growth.
Traditional industries with large footprints and non-founder led management teams are more targeted towards industry consolidation acquisitions. Size, position and power are often key drivers as apposed to sales and margin growth driving entrepreneurs and private equity.
Conclusion: What are add-on acquisitions?
Ymer Technology, a $100 milllion heat transfer technology business supplying the wind power turbine OEM’s with cooling solutions acquired a small hydraulics startup in 2018. The rationale behind the acquisition was to gain access to the small team of engineers and their hydraulic system competence. With Ymer Technology’s sales and application competence they are now able to increase the scope of delivery to existing customers. Cementing the role as a key sub-supplier and increasing revenues and net margins where key rationales behind this add-on acquisition. Sourcing and purchasing synergies were also found with similar components. In sales synergies where found from talking to the same engineering teams at major OEM customers.
In conclusion: Add-on acquisitions can be highly value added and is one of the key components in the private equity toolbox. Entrepreneurs can and shall copy this strategy to accelerate growth beyond the organic growth. Start small and learn that add-on acquisitions can be a great time saver growing a business.