What “Buy and Build” Strategies Mean for the Lower-Middle Market

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Acquisitions by private equity companies of lower-middle-market businesses has become the main source of value creation for their portfolios. Buy-and-build refers to the buying of a platform company with a well-developed management team and infrastructure, and then using those capabilities to acquire one or more add on companies to build out and grow the platform. According to Boston Consulting Group*, buy-and-build activity has increased from 20% of all PE deals in 2000 to 53% in 2012. The reason for the surge is clear: buy-and-build deals generate an average internal rate of return (IRR) of 31.6% from entry to exit, compared with 23.1% for standalone deals.

PE firms look to buy-and-build strategies due to the traditionally short holding periods of private equity. The typical PE investment thesis requires its portfolio companies be bought and sold fairly quickly, usually within three to five years. PE firms structure their portfolios to invest for their limited partners and then return this investment with value appreciation within a fixed, relatively short time period.

To be successful in this strategy, PE firms work to rapidly increase revenue and profitability of their portfolio companies, in order to structure a quick exit (and high return on investment). The fastest way to drive revenue is through additional “add-on” acquisitions versus traditional organic growth. Hence, the “buy-and-build” strategy is put to work to deliver the needed rapid growth.

So what does this mean for lower-middle-market companies? It means there is allot of capital in the market ready to be put to work in consolidating highly profitable businesses in fragmented industries. According to the Private Equity Growth Capital Council, there are 2,797 private equity firms headquartered in the United States that collectively invest in 17,744 companies. With the baby boomer generation retiring at an increased pace, there will be more businesses available for purchase than ever before. It is reported that 70% of businesses in the lower middle market are projected to change hands in the next ten years. These two market dynamics colliding will likely result in continued high levels of deal flow and valuations.

Therefore, business owners seeking an exit should try to understand PE’s motivations and strategies prior to negotiating a potential transaction. Likewise, owners need to be ready to move and react to opportunities quickly. The financial rewards can be extremely high, but owners need to know what they’re getting into and be thoroughly prepared. There is more to the process than just finding the right buyer, and owners shouldn’t try to go it alone. Seek out a trusted adviser to guide you through the process – without one you’ll be at a significant disadvantage in negotiating and closing your deal.

At Align, we specialize in helping lower middle market businesses navigate the capital market landscape and execute successful transactions. We’ve facilitated hundreds of transactions totaling over $1B in value, so we’ve been where you’re going and can take you there. Going through a transaction without an adviser is like playing poker when you don’t know the rules – only to find that the other players at the table are experts. You’re at an immediate disadvantage. Let us help you level the game and ensure that all walk away from the closing table happy.

*References: Buy and Build Takes Private Equity Value Creation to the Next Level; February 19, 2016; https://www.bcg.com