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Add-on acquisitions have emerged as a critical strategy for private equity (PE) firms, especially in an environment marked by rising interest rates and constrained access to debt financing.
Traditionally, add-on acquisitions involved acquiring smaller companies to complement or enhance an existing platform business, helping PE firms grow inorganically by building out a portfolio through strategic, targeted purchases.
Today, these deals have gained more prominence as firms look for more agile ways to create value in a changing economic landscape.
Historically, private equity's playbook involved large platform acquisitions, often financed by readily available cheap debt. But with the rise in borrowing costs, larger deals that require substantial leverage have slowed down.
Middle-market transactions—smaller deals in which companies are acquired at more manageable valuations—have become more attractive.
These middle-market transactions, particularly add-on acquisitions, offer a solution to the challenges posed by higher interest rates and shifts in dealmaking patterns.
Add-ons provide a more flexible, cost-effective way to create value while expanding the scope of existing investments.
Dan Kobayashi, president at SourceCo, emphasizes the growing importance of add-on acquisitions over larger deals due to their smaller scale and more manageable integration process:
"The buy-side industry tends to heavily favor add-on acquisition searches because add-ons can be smaller than platforms, making them more manageable and easier to integrate."
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A platform acquisition refers to the initial, often larger, company that a private equity firm acquires to serve as the foundation for future acquisitions.
Platform companies typically possess well-established market positions, robust management teams, and scalable infrastructures that enable growth both organically and through further acquisitions.
These firms usually operate in fragmented industries where they can pursue a buy-and-build strategy by acquiring smaller competitors or complementary businesses.
This allows the PE firm to achieve growth by adding scale, increasing market share, or expanding into new geographic or product markets.
In contrast, an add-on acquisition involves acquiring a smaller company to complement the operations of an existing platform company.
The purpose of an add-on acquisition is to integrate the target into the platform, leveraging synergies to drive value creation.
This process can involve expanding the platform’s product offerings, enhancing geographic reach, or consolidating fragmented markets.
Add-ons are typically smaller than platform acquisitions in terms of revenue, employee count, and market share, which makes them more cost-effective and easier to manage.
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The terms “bolt-on” and “add-on” are often used interchangeably, though some industry professionals make a slight distinction.
Bolt-on acquisitions tend to refer to businesses that are highly complementary and quickly integrated into the platform company’s core operations.
In contrast, add-ons may sometimes be more independent or diversified, potentially adding new verticals or customer segments to the platform company.
There are several reasons why private equity firms favor add-on acquisitions.
First, they allow PE firms to realize multiple arbitrage—buying smaller companies at lower multiples (e.g., 5x EBITDA) and then growing the consolidated entity to exit at a higher multiple (e.g., 10x EBITDA).
Second, add-ons provide scalability, enabling firms to grow their portfolio companies while minimizing the risk and complexity associated with larger platform acquisitions.
As Dan Kobayashi, President at SourceCo explained:
"Add-ons can provide immediate top-line growth and integration synergies, allowing firms to build platforms that are stronger over time."
These synergies can come in various forms, from cost savings to cross-selling opportunities or even technology integrations that enhance the platform’s overall value proposition.
While platform acquisitions serve as the anchor for a buy-and-build strategy, add-ons allow firms to accelerate growth.
Larger platform deals often require more extensive due diligence, a longer integration timeline, and more complex financing structures due to their scale.
In contrast, add-ons are typically less risky and quicker to integrate, especially if the target operates in a niche market or offers clear synergies with the platform.
Firms should choose between platform and add-on acquisitions based on their investment thesis, market conditions, and the maturity of their existing portfolio companies.
In an environment of higher interest rates, where financing large deals becomes costlier, add-on acquisitions may provide a more attractive path to value creation.
The add-on acquisition model has become a dominant strategy in private equity, enabling firms to create value through a systematic and scalable approach to acquisitions.
The underlying premise of the model is to start with a platform company that serves as the foundation and then acquire smaller, complementary businesses to enhance the platform’s market presence, capabilities, or geographic reach.
One of the central concepts in the add-on acquisition model is multiple arbitrage, which refers to the practice of buying companies at lower earnings multiples (such as 5x EBITDA) and then selling the consolidated entity at a higher multiple (like 10x or 12x EBITDA).
This gap between acquisition and exit multiples creates substantial value for private equity firms.
By purchasing smaller, privately held businesses that may not have access to capital markets or competitive buyers, PE firms can acquire these companies at attractive valuations.
And as Dan Kobayashi explains:
"If you can buy a small $1 million EBITDA company at four or five times EBITDA, and then eventually sell the platform at 10 to 12 times EBITDA, the multiple expansion alone can drive tremendous returns."
This strategy is particularly appealing in industries where consolidation is happening rapidly or where smaller companies remain under the radar of larger strategic buyers.
While multiple arbitrage is a significant driver of value in add-on acquisitions, it is not the only factor.
The integration of an add-on company into a platform can unlock strategic synergies that enhance operational performance, increase customer reach, or drive product innovation.
These synergies often take the form of cost savings through economies of scale, improved supply chain management, cross-selling opportunities, or shared technology platforms.
PE firms increasingly focus on planning integration strategies as early as possible, incorporating add-ons into the broader growth thesis of the platform.
Kobayashi underscores the importance of aligning strategic goals early in the acquisition process:
"Maximizing value involves translating the investment thesis into actionable integration plans. This allows for faster value realization and positions the platform for a higher exit multiple."
The add-on acquisition model offers private equity firms a level of flexibility that platform acquisitions often lack.
Add-ons are generally smaller, making them easier to integrate with minimal disruption to the core platform. This allows PE firms to pursue multiple add-ons in quick succession, scaling up the platform without overwhelming it operationally.
Moreover, the flexibility of the model allows for targeting companies with different specializations or market segments. For example, an add-on could bring new technology to the platform or give the platform access to a new geographic market.
As Kobayashi notes,
"There are companies that pursue 10, 15, or even 20 add-ons over a five-year period, each one adding a new dimension of value."
This scalability has made the add-on acquisition model an essential tool in the modern private equity playbook.
Finding the right add-on acquisition targets is both an art and a science. While the opportunities are abundant, identifying the right fit requires a methodical and proactive approach. The success of an add-on strategy depends on how well the target company complements the existing platform and how easily it can be integrated.
Given the fragmented nature of many industries, particularly in the middle market, sourcing add-ons is a crucial skill for private equity firms.
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One of the primary challenges in finding add-on acquisition targets is navigating the competitive landscape.
Historically, the middle-market space, which includes companies with $1-3 million in EBITDA, had little competition, making proprietary sourcing easier. However, as Kobayashi highlights,
"There was a time when there were so many deals at this scale that PE firms didn’t need to be as innovative or competitive in their proprietary sourcing efforts."
Today, private equity firms need to adopt more sophisticated sourcing strategies to stay ahead of the competition.
Proprietary sourcing refers to the process of directly identifying and approaching potential targets rather than relying on brokers or investment banks. This approach allows PE firms to access deals before they become publicly known, increasing the chances of securing favorable terms.
Buy-side firms like SourceCo specialize in proprietary sourcing by leveraging proprietary software, expert team, deep propretary datasets, and a thorough understanding of specific sectors to find companies that may not be actively seeking to sell but are open to discussions.
Kobayashi also underscores the importance of proprietary sourcing:
"Finding the right targets often involves contacting hundreds of companies to get just a few positive responses. But those responses can lead to highly valuable acquisitions."
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Industries with a large number of small, independent players are prime candidates for add-on acquisition strategies. Fragmented markets offer multiple opportunities for consolidation, where a platform company can acquire smaller competitors to build scale and create a market leader.
For example, industries such as healthcare services, IT consulting, and specialty manufacturing often have numerous smaller companies that can be rolled up into a larger entity.
Kobayashi notes that smaller companies, especially those with EBITDA between $500,000 and $3 million, are often easier to approach:
"Smaller companies don’t get as much contact, and they tend to have fewer exit options, which makes them more responsive to acquisition offers."
These companies may not have relationships with investment banks or might be less familiar with the M&A process, making them more receptive to conversations with private equity firms.
Another key tool in finding add-on targets is the use of data analytics.
Modern private equity firms are increasingly leveraging big data, AI, and machine learning to identify trends, track potential targets, and even predict which companies are most likely to be open to acquisition offers.
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By analyzing factors such as financial health, industry performance, and management team dynamics, PE firms can prioritize their outreach and focus on targets that align with their platform’s growth strategy.
Additionally, technology-enabled buy-side firms with proprietary databases allow firms to cast a wide net, identifying companies that might not be immediately visible through traditional channels. This data-driven approach helps streamline the sourcing process, allowing PE firms to focus their efforts on the most promising targets.
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The use of debt in financing private equity acquisitions has long been a defining characteristic of the industry. However, rising interest rates have reshaped the economics of deal-making, particularly in the middle market.
Add-on acquisitions, which have traditionally relied on a blend of equity and debt financing, are now subject to stricter lending environments and higher costs of borrowing. Understanding how to navigate this new reality is crucial for private equity firms pursuing an aggressive add-on strategy.
As the cost of debt rises, the ability of private equity firms to finance acquisitions with high levels of leverage has diminished. In the past, private equity firms would often finance deals with a significant portion of debt, benefiting from cheap borrowing rates that allowed them to enhance returns through leverage.
However, with current interest rates higher than in recent years, this strategy is less feasible.
Dan Kobayashi explains:
"When debt was cheap, it was easier to justify paying higher multiples because the cost of financing was low. Now, with rates up, firms are more conservative in what they're (PE firms) willing to pay, especially for larger platform deals."
In this environment, firms are increasingly cautious, focusing on smaller, accretive add-on acquisitions rather than larger platform investments that may require significant amounts of debt.
The relative affordability of smaller, bolt-on deals allows firms to avoid over-leveraging their portfolio companies while still executing on growth strategies.
Private equity firms are adapting by exploring alternative financing strategies to fund their acquisitions. For instance, some firms are turning to mezzanine financing or preferred equity as a way to fill the gap left by traditional debt financing. These instruments offer more flexibility but come at a higher cost, often with hybrid features that combine debt and equity characteristics.
Another approach is increasing the use of equity in deal structures, reducing dependency on external borrowing. By putting more equity into a deal, firms can avoid the risk of over-leveraging while still acquiring attractive assets. This approach can preserve the financial health of the platform company and its ability to make future acquisitions.
While these strategies can alleviate some pressure, higher interest rates are likely to dampen deal activity overall, especially for large deals that are more sensitive to borrowing costs. However, add-on acquisitions, which often require less capital, remain a relatively resilient strategy.
As Kobayashi observes:
"Even with higher debt costs, add-ons are still an efficient way to grow a platform because you're often dealing with smaller companies that don’t require huge amounts of leverage to finance."
One of the most critical components of a successful add-on acquisition strategy is the ability to identify and target suitable companies for acquisition.
In today’s competitive market, where private equity firms face stiff competition from both strategic buyers and other financial sponsors, effective sourcing is more important than ever.
Firms that are able to uncover hidden gems and strike proprietary deals stand a much better chance of creating value through add-ons.
Historically, the lower middle market, where add-on acquisitions are most common, has been less competitive than larger segments of the market.
However, according to Dan Kobayashi, the landscape has changed:
"There used to be an abundance of deals in this space with very little competition. Now, with more firms targeting the same types of add-ons, you have to be more innovative and aggressive in your sourcing efforts."
To find the best add-on targets, private equity firms must maintain strong relationships with intermediaries such as investment bankers, brokers, and industry consultants.
But these traditional channels often aren’t enough.
Firms are increasingly investing in internal deal origination teams and using data-driven sourcing strategies to identify potential targets before they come to market.
This includes mining public data, using software tools to track companies within certain industries, and monitoring business developments that could indicate a willingness to sell.
In addition to proprietary sourcing, industry specialization can help firms identify attractive add-on opportunities. By focusing on specific sectors, private equity firms can gain a deep understanding of industry dynamics, competitor landscapes, and emerging trends, which allows them to spot potential acquisition targets more effectively.
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Once potential targets have been identified, the next step is evaluating whether they are a good fit for the platform company. Private equity firms typically use several key criteria to assess whether an acquisition target aligns with their overall strategy.
One of the primary considerations is strategic fit.
Does the target company complement the existing platform in terms of product offerings, geographic reach, or customer base?
Add-ons should help strengthen the platform’s competitive position, whether by expanding its market share, filling a gap in its product or service offerings, or enabling entry into new regions.
Financial performance is another critical factor.
Firms look at metrics such as EBITDA, revenue growth, and profit margins to ensure that the target is a financially sound investment. Additionally, private equity firms assess the potential for cost synergies and operational improvements that can enhance the financial performance of the combined company.
Kobayashi notes:
"At SourceCo, we’re always looking for targets that can create meaningful value when integrated into the platform—whether through cost savings, cross-selling, or other synergies."
He emphasizes the importance of scalability, explaining that targets must have the infrastructure and capabilities to grow alongside the platform.
Lastly, firms must consider cultural fit. Cultural misalignment between a platform company and its add-ons can lead to friction and undermine the integration process. Conducting cultural due diligence, as mentioned earlier, ensures that both companies share similar values and work practices, which can make integration smoother.
At SourceCo, we specialize in helping private equity firms streamline their deal sourcing process and find high-quality, off-market targets for add-on acquisitions.
Contact us today to discover how we can support your next acquisition or learn more about our proprietary sourcing services.
Curious about untapped targets? Schedule a free call to find a pre-vetted fit even in the most niche of searches
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