Globally, M&A activity so far has declined 23% in 2022 compared to 2021. Yes, that is a significant drop. But, as I wrote in a previous article, you must consider that 2021 was a historic record-breaking year of deal-making. So, in a sense, 2022 has been somewhat of a return to normal.
That said, while worldwide M&A activity has declined, what we’ve seen in the U.S. is little or no decline in deal-making. It’s essentially “flat.”
This is largely because of the increasingly common practice of purchasing “add-ons” instead of platform companies.
This buy and build strategy, also known as the roll-up strategy, entails adding a company to the portfolio and then building onto it with other acquisitions. Why add-ons? For many of the same reasons as any acquisition:
1. Scale/geographic expansion
2. Adding products/capabilities (less so for adding talent)
3. Reducing costs
4. Multiples arbitrage
This practice, which outperforms organic growth, has been increasingly common over the last 10 years or so. As Axial noted in their inaugural Add-On Report. Add-ons account for approximately one-fifth of total PE deal volume over the past five years. Financial Buyers (PE) averaged 3.1 add-ons per year and represented the majority of all 2021 M&A activity.
Add-ons vary in value from sub-$10M and $50 to $100M –more than 50% are $25M and under. A lot of these types of deals are under $5M…many are even under $1M.
Buy and build is an ideal way to grow a company through acquisitions like this rather than slow-moving organic growth. Plus, it’s usually easier to find and pay for a couple of inexpensive add-ons rather than a larger platform company that is fully built-out and pricey.
You can take a company worth 5X EBITDA, roll up a couple of add-ons, and then it’s worth 10X EBITDA. As Axial put it in their report:
“Add-on acquisitions have thus become an invaluable tool to help GPs quickly drive top-line growth. Add-ons can also support multiple expansion as portfolio companies gain scale while lowering investors’ all-in ‘entry’ multiples through smaller tuck-ins or bolt-ons transacted at lower valuations.”
More good news:
Buyersin add-on deals are using improved playbooks for more effective integration. This reverses the belief that most mergers fail due to poor post-merger integration planning.
Who Is Adding-On?
We’re seeing this practice in all sorts of industries and sectors. While the mergers and acquisitions of big companies like Google, Twitter, or Amazon are what hits the headlines, the majority of M&A activity, including buying add-ons, is actually with everyday businesses: landscaping companies, HVAC companies, accounting firms, small manufacturers, and the like.
Take the insurance agency/brokerage community. It used to be a couple of national firms buying up sizeable regional firms. Now smaller firms are acquiring boutique/micro firms and just rolling them up into their existing company.
I believe that thanks to this movement of add-on deals, despite macroeconomic headwinds, M&A activity in this country will continue into the foreseeable future, albeit at a lower level. In fact, the experts surveyed for the Axial report believe we’ll see add-ons at or above 2021 levels.
There will be a dip in those headline-grabbing multi-billion-dollar deals. And Buyers will be more cautious at all levels. Granted, Buyers do have a lot of cash burning a hole in their pockets, but there is less urgency right now to spend it. That will make them less aggressive than the frenzy we saw in 2021, which saw many acquirers overpay in deals.
So on the buy-side, you have more prudent Buyers. Sellers will have to face the reality of not having multiple potential acquirers bidding up the sale price. And Sellers must also face the fact that, with only one Buyer vying for a typical deal, we’re going to see more reasonable purchase prices.
In this case, it may not make sense to wait for a better offer to come along if they already have a potential Buyer and they are ready to exit. This is especially true for those Boomer-owned companies out there with founders looking forward to a big payday for retirement.
As we look at the rise of add-ons in M&A activity what does the future hold?
As Axial put it in their report:
“Add-ons, in many ways, represent an ideal vehicle for financial buyers to grow their platforms while adding economies of scale that can position the combined business to take on external challenges that may await.
“Make no mistake, there will be ups and downs across the M&A market. And the lower middle market, while insulated, certainly isn’t immune to the economic factors pressuring other segments of the deal landscape. At the same time, as it relates to fueling the lower middle market activity, add-ons can be expected to help drive buy-side interest.”