With buy and build strategies being so popular, I want to discuss what other PE managers think about the add-on component of your value add.
Do add-ons work regardless of your fund size? When will it be less effective (threashold)? How do you guys think about the bought CAGR in revenue and EBITDA, do you pad yourselves on the back or know that inherently is unsustainable?
Please discuss and appreciate all the inputs!
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The strategies I’ve seen with the greatest returns (just observation) are ones where you take a small business that is founder operated, diffuse the founders expertise through the organization while phasing them out so the company doesn’t depend on them, build out departments that aren’t necessarily there or running properly (sales, marketing, finance) and go from flying by sight to flying by instrument in general. To the extent that you can make introductions, replace or add on to the management team, and acquire companies to improve the product (such as expand into logical adjacencies to provide a comprehensive product rather than point solution), all the better. You will likely need a management team with vested ownership interest, and to make sure they actually understand what that means and what the payday looks like the end. The downside risk is that these companies see declining ebitda in year 1 and 2 frequently due to significant investment required upfront. Eventually these make good sales and often to strategics; the strategic would not have acquired it pre-professiinalization because they are just too much work and , potentially, likely too small.
Please comment on my post to critique this response and help me learn about things I may be missing, misunderstanding, or things you want me to expand on.
I am interested to hear more from people who have experience with buy and build with more mature companies that have professionalized more (probably similar to OP’s interest as well). What I’m describing is probably what a fund size of $500m would do. But what about someone with a fund of $1.5-$2b who does buy and build frequently, like HGGC?
@making gravy your response and question both hit the nail on the head. Just like you said, I'm equally interested in hearing from investors who dabble in an upper market ($1B-2B) on their views on buying and building more mature companies and the return profile of that segment.
Regarding your declining EBITDA comment, investors are usually using equity capital to buy a platform but then debt to do add-ons, what are your thoughts on this? Concerns?
Add-on strategies also work very well for industries that are highly fragmented between certain customer sets i.e., government contracting. Just look at what Arlington Capital did with Polaris Alpha; acquired a bunch of high-end intel contractors that were very small/niche/lacking in back-office infrastructure and packaged it as a sale to Parsons over the course of like 4-5 years. A strategic would have struggled to organically grow its customer base in a fragmented market that is driven by relationships.
All about that arbitrage...
This. If you have a roll-up strategy, where the "platform" will sell for 9-10x (generally, lot of variables in that assumption), but can scoop up add-ons at 5-7x which are predominantly (if not entirely) debt-financed, you're already in the black on the deal by a meaningful amount before you even start getting creative with adjustments. The hard part is finding deals that "work" at 5-7x, usually proprietary in nature (i.e. no IB).
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