Private Equity 101: New Platforms vs. Add-Ons
In a recent article, we touched on the fact that private equity groups (PEGs) generally view acquisitions as a new "platform" business--meaning they will not combine it with their existing investments--or as a strategic "add-on" to complement to an existing platform business. Estimates vary across sources, but add-ons constitute roughly 40-50% of PE buyout activity, making it critical for business owners who are thinking of taking a private equity investment to understand some of the strategic implications of both views.
PEGs spend a great deal of time developing strategic plans and an investment case for a new platform to determine why they are buying a business and how they will generate an attractive return. This analysis is usually even more comprehensive for businesses that are new to a PEG. For add-on acquisitions, PEGs sometimes lean more on the expertise of its relevant portfolio company's management to determine the fit, synergies and strategic benefits of a transaction. When talking to a PEG, try to understand what their investment case is. Why are they interested in the business? Are they planning to consolidate the business with another company? What is their plan for helping the business grow?
For new platforms, PEGs view each transaction as stand-alone. There are no synergies, there is only a transaction with an investment rationale on how to grow the business and generate a targeted return. That rationale is the driver behind the deal, and it defines how the PEG will create value through things like capital infusions, operating partners and even future add-on acquisitions. As a result, the strategy behind the deal is more open-ended. The PEG has a greater degree of operating flexibility and seeks more avenues of growth to maximize the probability of a successful investment.
For new platforms, key questions PEGs focus on include:
- How attractive is this industry?
- Does the business have multiple avenues of growth?
- How can we, as a financial sponsor, add value?
- What is the path to generating an acceptable risk-adjusted return?
On the other hand, PEGs buying a company as an add-on are much more focused on the strategic and financial benefits of adding an acquisition to an existing portfolio company. The strategic side is more clearly defined because the add-on is serving a more specific purpose (e.g. geographic expansion, new products, complementary customer base, economies of scale, etc.). Thus, the add-on can be narrower in focus and growth potential.
For add-on acquisitions, PEGs ask questions such as:
- How does this acquisition support the platform company?
- Does this make the two businesses more valuable together than separate and what are the tangible synergies?
- How will this increase the overall return to investors and is this an acceptable return on capital?
Business owners need to be aware of these differences in perspectives because they have a significant impact on how PEGs will view your business and what they are willing to pay. If you're an add-on, you probably offer the PEG some synergies. If you are a new platform, you probably need to prove your growth story more.
If you are sticking with the business after selling, you should understand what the new organizational structure will be like and how much scrutiny to expect from PEGs. Platform investments will likely get more attention, whereas add-ons might see more oversight from the parent company rather than the PEG itself. If you're keeping equity, it is really important to understand what a PEG plans to do with your business, because they are more of a partner than an investor.
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Avondale's Sameer Pal contributed to this article.
KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.