Mergers and acquisitions (M&A) strategies have become a cornerstone for private equity (PE) funds aiming to accelerate growth and enhance performance. At a time when organic growth is challenging, add-on acquisitions are proving to be an effective approach for achieving outsize returns. These acquisitions accounted for 70% of PE deal activity in 2023, a notable rise from 57% in 2017.
The shift towards M&A strategies is largely driven by changes in the macroeconomic environment. In the past, PE funds relied on financial engineering, operational improvements, and strategic repositioning to meet their performance goals. However, with rising financing costs and tighter valuations, these methods alone are less effective. Instead, transformational M&A strategies now dominate, helping PE funds create synergies in revenue, cost, and capital efficiency.
The Rising Importance of Add-On Acquisitions
Add-on acquisitions allow PE funds to strengthen their portfolio companies in several ways. By capturing synergies, improving valuation multiples, and enhancing talent retention, this approach delivers substantial benefits.
Capturing Synergies
Add-on acquisitions facilitate revenue growth through cross-selling and market expansion, cost reduction via operational consolidation, and capital optimisation through financial restructuring. For instance, an enterprise software company specialising in commodity price hedging significantly increased its EBITDA and valuation by acquiring six strategic add-on companies. This strategy expanded its customer base, broadened its product offerings, and streamlined back-office operations, leading to substantial gains.
Achieving Higher Valuations
M&A strategies can drive higher exit valuations by enhancing return on invested capital (ROIC) and organic growth potential. For example, a software firm strategically acquired hardware companies and integrated their services into a comprehensive software-as-a-service solution. This integration unlocked new growth opportunities, resulting in elevated exit multiples and improved valuation.
Attracting and Retaining Talent
Add-ons also enhance career opportunities within portfolio companies, making them more attractive to current and prospective employees. A notable case involved an oil and gas company that retained a high-performing executive by promoting them to COO following significant geographic expansion through add-on acquisitions. The increased scale provided the executive with global exposure and career growth opportunities.
Building M&A Excellence in Private Equity
Executing a successful M&A strategy requires overcoming challenges such as cultural integration, regulatory compliance, and maintaining base business performance. Antitrust scrutiny, especially in the US, adds complexity, necessitating robust diligence and compliance measures.
Several key approaches can help PE funds and portfolio companies navigate these complexities effectively:
Early Acquisition Integration
Acquiring add-on companies early in the holding period is crucial for recognising synergies promptly. Early integrations, ideally within the first three years, provide portfolio companies with stability and enhanced growth potential during the holding phase.
Focusing on Value Drivers
Identifying and prioritising key value drivers ensures successful integrations. Common drivers include cross-selling opportunities, end-to-end service offerings, and operational consolidation. Establishing these priorities during the due diligence phase sets a clear direction for post-acquisition success.
Developing a Repeatable Process
Portfolio companies benefit from a systematic approach to integration. Evaluating decisions like IT system upgrades against ROI and creating detailed roadmaps aligned with value creation goals streamline the integration process. For example, using stage-gate processes ensures that large expenditures generate measurable top- and bottom-line impacts.
Rigorous Performance Tracking
Accurate performance tracking is essential for evaluating the success of M&A strategies. Many companies now use cloud-based tools to monitor key performance indicators (KPIs), such as margin expansion and synergies realised. These tools provide insights into the impact of each acquisition, helping identify areas for improvement and enhancing future M&A efforts.
Enhancing M&A Capabilities
Building internal M&A expertise positions portfolio companies and PE funds for sustained success. Training sessions, post-integration analyses, and lessons from past acquisitions can all contribute to developing these capabilities. For instance, a PE fund conducted virtual integration training for its portfolio company executives, ensuring readiness for future acquisitions.
The Role of M&A Strategies in Economic Uncertainty
Add-on acquisitions offer PE funds a flexible approach to deploying capital effectively, regardless of economic conditions. By leveraging M&A strategies, funds can unlock significant EBITDA growth and achieve higher valuations. However, success depends on focusing on key integration levers and maintaining rigorous diligence processes.
M&A strategies remain an essential tool for private equity funds seeking exceptional returns. By refining their approach to add-on acquisitions and prioritising sustainable integration practices, funds can continue to generate substantial value across their portfolios.
Source: McKinsey & Company (2024)
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