Article originally published September 9th, 2019, on LinkedIn By our Founder, Dena Jalbert: https://www.linkedin.com/pulse/whats-add-on-dena-jalbert
What’s an Add-On?
This is a question asked by many of our clients. It is important for owners and CEOs of lower-middle-market businesses to know what this is and how it can be extremely lucrative. And what defines a lower-middle-market business? Traditionally, it is a business with revenue between $10MM and $100MM per year.
An add-on acquisition (“add-on”) refers to a company that is acquired and added by a private equity (“PE”) firm to one of its platform companies, or by a strategic buyer pursuing a consolidation investment strategy. In both cases, the investor acquires companies within a specific vertical, pools them together, and creates a larger enterprise (or larger market share in the case of strategic buyers). Increasing returns on investment are achieved by improving operations, organic growth, and via other add-on acquisitions. This is also known as a “buy-and-build” strategy, and it makes up nearly 65% of PE’s portfolio strategies.
This investment trend was the largest driver of PE middle market investment activity in the first half of 2019. Add-ons comprised 59.5% of deal value and 68.8% of deals closed in the middle-market, higher than any other full-year figures on record.
So, why is this so important to owners and CEOs of lower-middle-market businesses? Well, the majority of the add-on transactions are acquisitions of lower-middle-market businesses. This means that investors are paying top dollar for your exact type of business.
So, why is this so important to owners and CEOs of lower-middle-market businesses? Well, the majority of the add-on transactions are acquisitions of lower-middle-market and middle-market businesses. This means that investors are paying top dollar for your exact type of business. The median multiple of middle market PE buyouts in the first half of 2019 was 12.3x EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). Due to heightened competition for quality assets and plenty of capital ready to invest, valuations continue to climb as financial and strategic investors fight for the seat at the closing table.
It is clearly a sellers’ market, so it is important for owners to understand what they, personally, want to come out of a transaction. If you want to stay-on and grow the business beyond it’s levels today, then a financial investor is likely the better option. In this scenario, you will “cash-out” handsomely via your current business, but you will stay on and (likely) have equity in the platform company that your business is being added-on to. So, you’ll have the opportunity for a “second bite of the apple,” which means you’ll get to earn again on the equity in the platform company when it sells. This is often as lucrative, or more so, then your initial exit of your business.
However, if you are ready for a full exit and desire to move onto greener pastures, then a strategic buyer may be the better option. They will oftentimes pay rates higher than PE investors because they don’t have the constraint of re-trading in the future as PE does. So, because you wouldn’t get that second bite of the apple in the future, they tend to pay up for that opportunity cost now via higher multiples paid at closing.
It really all boils down to personal choice. The rampant increase in add-on investments means you have a slew of choices at your disposal. As they say, timing is everything. The time, is clearly, now.
Align is a national, lower-middle-market mergers & acquisitions advisory firm headquartered just outside of sunny Orlando, Florida. The firm works closely with lower-middle-market investors in executing their add-on strategy, and we can place your business with the right partner to maximize value. Give us a call today for an introductory meeting to start exploring your options. www.alignBA.com / info@alignBA.com