Ross McWhir
Deal Advisory Director - M&A
The pursuit of inorganic growth via a well-deployed ‘Buy-and-Build’ strategy has been a popular one for private equity and large corporates over the last decade.
Many sectors are rife with fragmented businesses that could be consolidated and plugged into a centralised structure where services can be cross sold to customers.
Whilst a tough and uncertain economy will undoubtedly hinder the organic growth of many businesses, it may also spur opportunities for bolt-on deals.
In fact, despite a tumultuous economic backdrop, Europe’s private equity market had one of the busiest buy-and-build years on record in 2023, with 766 acquisitions (CMBOR at Nottingham University Business School).
The question remains, however - does the current economic slump spur on bolt-on acquisitions rather than slow them down?
The Head of Investor Relations at a large European Private Equity firm maintains that “last year we saw a clear trend of private equity firms putting a greater focus into supporting portfolio companies with strategic buy-and-build acquisitions, in a market where new platform investments were much harder to find. Buy-and-build is an effective mechanism to accelerate growth, realise operational synergies, and create value even in a market facing economic headwinds.”
This was further supported by the CFO of large multinational bank and financial services company, who noted “if the (economic) growth is a bit more timid, then that fuelling of additional growth - natural, organic - will be a tad slower. Depending on how the next year will unfold, yes (there) might (be a) shift a bit towards bolting on.”
Therein lies the likely answer – whilst the difficult financing landscape increases the hurdle requirements for inorganic growth via acquisition and integration strategies, value is very much still there, if a well-defined strategy is executed with operational excellence.
But what does this mean in practice? What should Private Equity and management teams be focussing on to ensure continued successes from their buy-and-build strategies?
1. Focus on the development of a robust and deliverable synergy case
In this market, companies pursuing revenue synergies cannot take them for granted. Leaders need a clear and realistic grasp of where those synergies lie and persistence in capturing them. With M&A activity showing no sign of slowing, a continuing focus on both revenue and cost synergy execution is critical in creating and executing value for shareholders. Understanding the sources of value, holding internal stakeholders accountable and delivering against a robust synergy case estimate can get a jump start on outperforming the market.
2. Consider whether historical results will reflect life post-acquisition
While one element of your financial diligence will be to ensure the numbers being provided to you by the target are correct, it is also important to consider how they will change post-acquisition.
Will you need to align salaries of the team with your existing staff? Will you need to replace the management team? Are there exceptional costs being excluded from their numbers that will be needed going forward (common examples of this are “exceptional” marketing or “one-off” bonuses).
3. Consider key commercial drivers and their longevity
Bolt-on acquisitions often come with multiple arbitrage benefit, with the acquirer having a higher EBITDA multiple than the target. That said, it is still vital to sense check the commercial levers of any bolt-on.
- Capabilities: does the bolt-on business own any capability that could be utilised within your core business, and does it appear to beat its competitors with these core capabilities?
- Channel: can you utilise the channels they go to market in for your products or services?
- Markets: does the bolt-on acquisition provide you with routes into new markets that you can exploit?
- Culture/people: does the business have a unique culture or key person risk that might be impacted by the acquisition?
- Products/IP: does the business benefit from any IP that you can maximise through your larger business operations e.g. with broader sales and marketing capability?
- Systems/Tech: are there systems a key differentiator and if moved to the acquirors systems does any commercial advantage get lost?
4. Identify whether changes in recent performance impact valuation
Where appropriate, you and your Financial Due Diligence team can look at the business on a run rate basis (i.e., annualising recent months results), rather than only using the last 12 months/most recent financial year.
This will reflect the benefit of any recent customer wins (or impact of customer losses), and help you understand how the business is currently performing. This may be a more accurate indicator of how the next 12 months of trading will go, and help you value the business more accurately.
5. Have a well-defined and tested Integration Playbook
Potential buyers will chip away at value if the integration of previously bought assets is sub-optimal -key areas of focus are systems integrations, ability to demonstrate a solid track-record of cross-selling and a confused organisation structure or delivery model.
An integration playbook can be critical for delivering value and minimising operational risk, providing a structured framework for managing a relatively complex process. It outlines clear integration plans, identifies potential challenges, allocates resources efficiently, and ensures consistent execution. Done well, the playbook acts as a roadmap, fostering coordination amongst teams, minimising disruptions, and maximizing synergies, ultimately optimising the success of the M&A buy-and-build strategy.
6. Scrutinise cash maturity and identify working capital upside
Growth requires investment. With interest rates remaining high, it is critical to focus on cash tied up in working capital as a cheap and readily available source of funding. Conversely, you need to avoid any businesses that have an understated and unsustainable level of working capital and require additional cash to fund day-to-day operations.
Understanding the cash-to-cash cycle of the target business, and the working capital maturity of all associated processes, can not only identify opportunities to release cash from operations, but can also help uncover additional synergies, new market strategies and any capability gaps.
7. Optimise the debt/funding package
In the current environment, where deal flow has slowed due to a mismatch of buyer and seller expectations, the importance of executing a successful buy and build strategy to drive equity returns has only been enhanced. There is significant lender appetite to provide flexible funding for bolt-on acquisitions as it provides a runway for deployment of additional capital. Lenders like to provide incremental facilities to existing borrowers because they are known credits and are perceived to be low risk. Assuming the borrower can get the lender comfortable that acquisitive growth will de-risk their credit, lenders may get sufficiently comfortable to re-leverage and fully fund acquisitions without the need for equity dilution.
To optimise the debt package, there are three key objectives to focus on:
- Choosing a funding partner that has the firepower to grow alongside the business
- Minimising conditionality on accessing additional capital enabling you to have certainty around funding transactions and deferred consideration
- Negotiating flexible terms which allows additional debt to be drawn without constraining covenant headroom.
To deliver these objectives it is crucial to spend time in preparing the business to create a robust story that demonstrates the credit strengths of the core business, the thesis behind the buy and build strategy, the previous track record and credibility of the integration plan.
8. Ensure that tax risks are mitigated to not damage equity value on eventual sale
Whilst tax may not be at the forefront of a buy and build strategy, neglecting tax considerations when transitioning from a collection of separate businesses to one wider group can impact future equity value.
A well adopted buy-and-build business which seeks to ensure proper processes and tax governance are in place, is better placed to withstand buyside pressure on an exit. It is therefore imperative that on each buy and build opportunity, the acquisition is not viewed solely through the historical lens of the company being acquired but through the lens of the wider group into which it will sit including the tax implications of the acquisition itself.
If you would like to find out more information or have any questions regarding this topic, please get in touch with our team.
