In an increasingly competitive landscape, private equity (PE) funds are turning to mergers and acquisitions (M&A) as a key strategy for generating superior returns.
As growth through organic measures has become more challenging, especially in a high-interest-rate environment, add-on acquisitions have emerged as a powerful tool for driving value creation across portfolio companies. In 2023, add-on acquisitions accounted for 70% of the total PE deal count, up from 57% in 2017, indicating a growing reliance on this strategy.
This shift in strategy is largely due to changes in the investment landscape. In the past, PE firms could achieve returns through operational improvements, financial restructuring and multiple expansions. However, the current environment demands more transformative approaches. PE firms are now looking to M&A to drive efficiency, capture synergies and create long-term growth in ways that go beyond traditional value creation.
Increasing focus on add-on acquisitions
Add-on acquisitions involve a portfolio company acquiring other companies to expand its market reach, reduce costs, or enhance its competitive position. In recent years, these types of acquisitions have gained prominence as PE funds seek to unlock greater synergies in revenue, costs and capital. By making strategic acquisitions early in the holding period, portfolio companies can achieve economies of scale, expand their product or service offering and increase geographic reach.
In 2023, add-on acquisitions accounted for 70% of the total PE deal count, up from 57% in 2017.
Add-on deals are particularly valuable in sectors where market expansion is critical for growth. For instance, a portfolio company in the enterprise software sector specialising in commodity price hedging significantly boosted its earnings before interest, taxes, depreciation and amortisation (EBITDA) by acquiring six add-on companies. This allowed the company to expand its product range, cross-sell services to a broader customer base and reduce costs by consolidating operations, such as back-office functions.
Key levers for driving value through M&A
While add-on acquisitions can create substantial value, not all deals are successful. Based on research and practical experience, several levers have been identified to ensure the successful execution of add-on strategies for both portfolio companies and PE funds. These include front-loading acquisitions, focusing on top value drivers, building repeatable integration processes, tracking performance rigorously and developing in-house M&A capabilities.
1-Front-loading acquisitions
To maximise the benefits of add-on deals, PE funds and portfolio companies should acquire target companies early in the holding period, ideally within the first three years. Acquiring and integrating companies early allows for the realisation of synergies over a longer period and helps create larger, more stable businesses. Early integration is crucial for establishing operational efficiency and aligning strategic goals.
2-Focus on top-value drivers
Successful add-on strategies require a focus on key value drivers, typically identified during the due diligence process. These drivers often include cross-selling opportunities, building end-to-end service offerings and consolidating operations to achieve cost savings. Identifying and prioritising three to five critical value drivers ensures that the acquisition delivers on its intended goals without overcomplicating the integration process.
3-Building a repeatable process
Portfolio companies must develop a repeatable M&A process to scale acquisitions efficiently. This includes evaluating integration decisions, such as IT systems or operational workflows, against return on investment (ROI) criteria. By developing a structured integration roadmap, portfolio companies can ensure that each acquisition contributes to long-term value-creation, while minimising disruption to the core business.
4-Rigorously tracking performance
Effective performance tracking is critical to evaluating the success of an acquisition. PE funds and portfolio companies should implement robust systems to track key performance indicators (KPIs) related to margin expansion, revenue growth and cost synergies. Cloud-based solutions are often used to track these metrics across multiple add-on acquisitions, providing greater transparency and allowing for timely adjustments if targets are not met.
PE funds must remain adaptable, leveraging their industry expertise and operational capabilities to identify and capitalise on opportunities.
5-Building sustaining M&A capabilities
Developing internal M&A capabilities is essential for long-term success. PE funds and portfolio companies should invest in training and development to ensure that management teams can execute M&A strategies effectively. This includes conducting seminars, providing on-the-job training and conducting post-integration reviews to refine the process for future deals. Building this expertise enables portfolio companies to be more agile and efficient in their future acquisition activities.
Capturing synergies and enhancing exit valuations
The primary goal of add-on acquisitions is to capture synergies that can drive value creation. Synergies often take the form of revenue growth, cost reduction and capital efficiency. For instance, a company may achieve revenue growth by expanding into new markets or cross-selling to a broader customer base. Cost savings can be realised by consolidating operational functions or optimising the supply chain. In terms of capital efficiency, companies can restructure financial assets or reduce working capital needs by integrating the operations of multiple companies.
In addition to enhancing EBITDA growth, add-on acquisitions can also boost exit valuations. By acquiring companies that complement or expand a portfolio company’s service offerings, PE funds can increase return on invested capital (ROIC) and create a more attractive growth narrative for future buyers. This can lead to higher multiples and elevated exit valuations. For example, a software portfolio company acquired hardware businesses and integrated them into its software-as-a-service (SaaS) offerings, significantly increasing its future organic growth potential and driving up its exit valuation.
Challenges and regulatory scrutiny
While add-on acquisitions offer significant benefits, they also present challenges. PE funds must ensure cultural compatibility between the acquiring company and the add-on company, maintain the revenue of the base business during integration and develop efficient M&A integration capabilities.
In the United States, PE firms also face increased regulatory scrutiny from antitrust agencies, which are closely monitoring add-on acquisitions for potential market concentration risks. Though this scrutiny has not yet resulted in a significant increase in blocked deals, PE funds must be diligent in their compliance processes to mitigate risks and avoid delays in closing transactions.
The future of M&A in private equity
Add-on acquisitions are likely to remain a core component of private equity strategies, particularly as firms seek to deploy capital effectively in a challenging economic climate. The ability to execute these deals successfully depends on a combination of strategic planning, operational expertise and rigorous performance management. By focusing on the five key levers of successful M&A—front-loading acquisitions, focusing on value drivers, building repeatable processes, tracking performance and developing M&A capabilities—PE funds can continue to generate outsize returns and create long-term value for their portfolio companies.
As the M&A landscape evolves, PE funds must remain adaptable, leveraging their industry expertise and operational capabilities to identify and capitalise on opportunities. The ongoing refinement of M&A strategies will be critical in navigating both current market conditions and future economic uncertainties.
