Add-on Acquisitions in Private Equity: Turning Coal to Diamond Through Successful Integration

With dry powder continuing to pile up and valuation multiples at levels reminiscent of 2007, private equity (PE) firms are searching harder and harder to find deals that can achieve the returns their limited partners are expecting. Deal competition is red hot, money needs to be put to work, and deal teams are feeling the pressure to come up with unique ideas on how to illuminate a company that looks like coal to others into a shiny diamond that demands top dollar.

One apparent strategy that PE firms are turning to is borrowing a page from strategic buyers and seeking acquisition targets that are complementary to their current investments in order to gain synergies when combining with their portfolio. This strategy is long known in the industry as the “buy-and-build” strategy, and it allows PE firms to capture synergies from buying similar businesses. The firm will usually start with an initial purchase, referred to as a platform company, and use the platform company as a vehicle to acquire smaller companies in complementary businesses or with similar business models. The buy-and-build strategy works especially well in industries that are fragmented and possess no clear market leader, as building scale becomes a way to create competitive advantage.

With add-ons representing two-thirds of all PE deals during the first half of 2018, successful integration of new acquisitions has been the foundation on which these firms rely to make their buy-and-build strategy successful.

Successful integrations are quite difficult to come by, however. With the following six keys to success, PE sponsors can set themselves up for additional acquisitions to build the returns expected of them in this fiercely competitive time in PE.

1. Structured and Relentless Execution

A critical component of a successful integration is a well-thought-out integration plan that considers the objectives of a deal and includes an approach to meet those objectives, defined tactics to achieve cost targets, and clear revenue benefits of the acquisition. However, equally important is the execution of the integration plan. This often requires management’s focus on achieving deal objectives and a structured program that includes tracking progress against goals, issue management, and continuous communication to all key stakeholders (e.g., PE sponsors, company leaders, and banks).

2. Strategy-Driven Integration

It may sound counterintuitive, but not every function or process should be integrated post-close. Organizations should evaluate which functions should be merged within or across portfolio companies, the rationale for merging these functions, and the benefits of doing so. For example, MorganFranklin recently advised a PE firm that acquired a manufacturing company with various plants, each producing numerous parts. The procured raw material of each plant was different due to the nature of the parts being produced. After careful evaluation, it became clear that opportunities to integrate direct procurement spend across plants and negotiate better terms due to increased buying power were negligible. Several months later, the PE firm acquired a complementary business that used similar indirect materials to the previously acquired company. The organization was then able to integrate procurement across some plants, negotiate better terms, and realize increased cost reduction synergies.

3. Human Capital Decisions

Acquisitions have impacts on employees that can quickly lead to confusion, unclear decision-making authority, and a fractured culture. Determining the key executives and decision-making authority quickly and early in the integration process is key to resolving people issues. Companies can achieve this by evaluating the current and desired capabilities, identifying gaps, and determining the required roles and responsibilities for the merged organization.

PE firms employing a buy-and-build strategy also have a unique opportunity to deploy resources across portfolio companies. As an example, a PE firm that acquired two complementary businesses determined that it could leverage common HR personnel for both companies. This led to the immediate realization of cost synergies, which were achieved from taking a portfolio approach to resolving people issues.

As part of its integration, a separate portfolio company of the PE firm was faced with engineering staffing shortages to assist with data cleanup and alleviate possible delays of an ERP implementation. The company leveraged engineering staff from another portfolio company to assist with the data cleanup, ultimately meeting its go-live date for the ERP implementation.

4. Technology Optimization

The pre-close due diligence process may not always uncover all the required investments needed to not only stabilize an acquired business, but also position it for long-term growth. IT infrastructure and systems investments are often underestimated in the short term to position the acquired portfolio company to execute its investment thesis. PE firms employing a buy-and-build strategy should evaluate and identify opportunities to leverage such investments across their portfolio companies. Standardization of technology systems can provide PE firms with buying power when negotiating with technology vendors.

5. Shared Services for the Portfolio

PE firms can use a “Portfolio Company Shared Services” approach to enhance cost synergies, increase process efficiency and effectiveness, improve the controls environment, and establish a platform for future acquisitions.  With a “Portfolio Company Shared Services” approach, common processes are performed in a standardized and automated infrastructure with common leadership (e.g., technology, facilities management, project management, etc.) for all or many of a PE firm’s portfolio companies. This approach differs from the traditional model where each acquired portfolio company establishes or uses its own shared services. Processes integrated into a “Portfolio Company Shared Services” can span both back- and front-office functions.

6. Revenue Synergies—The Golden Goose

Though more difficult to achieve than cost synergies, revenue synergies can be a source of significant return. PE firms can realize additional synergies from revenue-enhancing opportunities across portfolio companies with complementary target markets. PE sponsors should work with portfolio company management teams to determine and implement these opportunities. PE portfolio managers should ask, “Do we have similar or complementary products, services, and customers? Are there cross-selling opportunities?”

Any integration has the potential to be successful and deliver massive value for PE firms. Done right, PE sponsors of complementary businesses are in the unique position to take a portfolio approach to integrating their acquired companies and exceed expected returns.

About the Authors

Matt Pencek is a Director at MorganFranklin Consulting, where he advises private equity firms in strategic finance, financial planning and capital allocation, and business transformation. He has significant experience in developing and implementing strategic initiatives that drive value creation and has served as a key executive advisor for companies ranging from startups to multinational corporations. Prior to joining MorganFranklin, Matt was with KPMG as a CPA, where he served clients in a variety of industries. He has a bachelor of science in accounting from Clemson University and an MBA in finance and strategy from The Wharton School at The University of Pennsylvania.

Ola Wright is a Director at MorganFranklin Consulting, where she develops and drives complex cross-functional transformation programs that enable Fortune 1000 and private equity companies to overcome their most pressing business transformation challenges. This takes the form of guiding organizations from strategy to execution of integrations and divestitures, redesigning business enablers, and building integrated shared services organizations. Prior to joining MorganFranklin Consulting, Ola led business transformation efforts at Deloitte Consulting, Johnson & Johnson, Ford Motor Company, and CoStar Group. She has a bachelor of arts in economics from the University of Chicago and an MBA from Duke University’s Fuqua School of Business.

2018-09-04T17:53:21+00:00September 4th, 2018|Insights, Insights - Companies|