The core principle of ‘buy and build’ is this: revenues can, in many cases, be driven more quickly by making additional acquisitions rather than by growing a business on an organic basis.
The central tenets of ‘buy and build’
Typically employed by private equity firms, ‘buy and build’ involves purchasing a platform company with its own established – and proven – management and systems. The goal is to buy a target company with the specific intention of making a series of add-on acquisitions in the same sector. In other words, using the infrastructure of the new company to build out and grow the platform before selling the group on. For the purposes of ‘buy and build’, the platform can be an investment made by a private equity fund in a company that goes on to make further acquisitions, or an investment in a firm that is merged by the private equity fund with another company.
It’s an oft-used strategy that yields results. Research shows that when private equity professionals were asked about their most often employed approach to operational improvements in portfolio companies, more than nine in ten said they conduct ‘buy and build’ deals.
Nevertheless, there are other considerations. For instance, ‘buy and build’ strategies give rise to a myriad of legal and commercial considerations that are not necessarily inherent in a one-off transaction. But this need not be a stumbling block. Undoubtedly it will be necessary to devote serious thought to how the add-on acquisitions will be paid for, but flexibility can be built in at the start to allow for extra financing.
‘Buy and build’ as a successful strategy
A report from a major consulting group and HHL Leipzig Graduate School of Management, published earlier this year, found that, according to the latest data, ‘buy and build’ deals generate an average internal rate of return of 31.6 per cent from entry to exit, compared to 23.1 per cent for standalone transactions. Typically this is the result of ‘multiple arbitrage’, the practice of buying smaller bolt-on businesses for a valuation multiple significantly below that of your platform company. As multiples are often a function of scale, by growing the business through bolt-ons, this becomes a self-fulfilling prophecy.
There is a much favoured school of thought that ‘buy and build’ stands the most chance of success when the portfolio firm is small or medium-sized and the private equity purchaser has extensive experience in this area. A key positive of ‘buy and build’ is this: it is easier to improve the performance of a company with low margins and low returns on invested capital than that of a high margin, high ROIC firm.
In addition, there is a central reason why ‘buy and build’ strategies are increasing in popularity and that is the fact that private equity groups look to improve returns in a slower economy. A sluggish economy can hamper organic business growth and even the most efficient operations may not be sufficient to generate acceptable results.
There are challenges inherent to ‘buy and build’. Finding a management team experienced in acquisition integration is an integral part of the process and can be a lengthy endeavour. And, as previously mentioned, ‘buy and build’ has its own problems, including complex legal and tax issues and of course simply finding the target companies.
Furthermore, creating a bigger enterprise which benefits from economies of scale can give rise to desired results, but making sure value is generated from traditional synergy levers requires careful diligence.
The appeal of ‘buy and build’ is not a copper-bottomed promise. The short holding periods and relatively rapid buying and selling in order to quickly increase revenues and profitability are not guaranteed. It can take years to properly acquire a number of firms and implement a smooth integration; that initial three to five-year plan sometimes ends up being a decade.
The successful route to building your business
But with an experienced and deft adviser on hand at every stage, even the most daunting of processes will be much easier – and less arduous – than you think. Building your business need not be a struggle with the right team on your side.
** Silverfleet Capital’s annual European Buy and Build Monitor