Platform Acquisitions - A PE Perspective

January 2021

Platform investments serve as foundational companies for private equity groups (PEGs), strategically positioned to facilitate future acquisitions or add-ons. Typically, these platforms operate within high-growth industries and hold a substantial market share, making them the ideal candidates for supporting further acquisitions. They are well-capitalized and broadly exposed to their market, although their focus usually remains within a single industry. When it comes time to sell, these platform investments often receive premium valuations.

In contrast, add-on companies tend to be smaller and less established, often grappling with challenges such as undercapitalization, limited market exposure, or management inefficiencies. These firms are usually presented by boutique investment banks or smaller financial entities and are acquired by platform companies to enhance their service offerings, technology, or geographical footprint. Significantly, add-ons are estimated to represent about 40–50% of private equity buyout activity, and, in certain cases, they may even compete with the platform company itself. Their primary role is to drive up overall revenues and earnings.

The synergy between platforms and add-ons fuels the “buy and build” strategy, a prevalent approach within private equity aimed at maximizing returns. This strategy entails acquiring a robust platform with effective management systems and leveraging it to integrate subsequent add-on acquisitions. While this method can be highly effective, it demands a significant level of expertise in platform management due to the intricacies involved in merging multiple companies. Furthermore, the buy-and-build approach often proves advantageous in slower economic periods, providing a means to enhance value and returns despite the fact that the process requires time and meticulous execution.

What Does a Platform Acquisition Look Like?

Platform acquisitions serve as essential launchpads for growth, particularly through further add-ons. When buyers are on the lookout for potential companies to acquire, they typically seek those that exhibit specific characteristics.

First and foremost, these platform companies often hold a position as market leaders within their niche. They excel in various areas such as sales, brand recognition, client relations, and operational efficiency, even if they are not the largest players in their respective industries. A strong and experienced management team is also critical; retaining skilled and motivated executives, including the CEO, is essential for driving growth after the acquisition. These key leaders are usually expected to remain for three to five years, often with incentives tied to post-acquisition performance.

Additionally, having a strong operational infrastructure can significantly facilitate future growth. Robust systems covering areas like accounting, human resources, marketing, customer relationship management, and other operational tools enable a smoother integration process for any subsequent acquisitions. While having a geographic presence, including multiple locations, is not a strict requirement, it can be advantageous for enhancing client service both locally and internationally. In terms of financial metrics, platform companies typically generate revenue exceeding $25 million and boast EBITDA figures of over $5 million.

Criteria for Platform Acquisition

When it comes to selecting a platform company, private equity firms prioritize industry leadership and competent management. A solid market share and experienced leadership team are vital to ensure smooth operations and mitigate potential internal challenges. Furthermore, established standard operating procedures (SOPs) are invaluable; proven processes streamline integration and onboarding, cutting the time it takes for new acquisitions to reach productivity by as much as 60%.

Scalability is another essential criterion. Companies need to have scalable operating platforms, especially in technology, to support future growth and integrate additional bolt-on acquisitions effectively. Private equity firms often consult with experts to assess the scalability and viability of prospective platforms.

Nonetheless, platform strategies are not without their challenges. Technical scalability is a significant hurdle, as upgrading hardware, software, and manual processes to facilitate growth can require substantial investments. Target companies frequently need to address issues such as bottlenecks, technical debt, and scalability concerns.

Moreover, the complexity of integration presents its own set of challenges. Aligning various systems, teams, and processes demands considerable time and resources, emphasizing the importance of effective planning.Despite these challenges, a well-executed platform acquisition strategy has the potential to drive substantial growth and create significant value for private equity firms.

Valuing Platform Acquisitions

A platform acquisition is distinct from other types of acquisitions in several significant ways, particularly when it comes to valuation. Platform companies often command higher valuations due to their leadership in niche markets, established infrastructure, and experienced management teams. Buyers recognize the worth of these attributes and are generally willing to pay a premium for them.

In addition to the upfront investment that platform companies require, buyers often adopt a strategy known as "cost averaging with add-ons." This approach allows them to mitigate the average acquisition cost by acquiring smaller, lower-cost businesses that complement the platform. Over time, this “roll-up” strategy not only enhances the platform's scale but also increases its overall value.

For sellers, the rewards of owning a platform company can be substantial. They may realize significant returns when the roll-up is ultimately sold. This payoff typically occurs within a timeframe of three to six years and can exceed the initial proceeds from the transaction, especially in rapidly growing sectors such as technology.

The concept of platform value carries different implications for both buyers and sellers. Sellers benefit by extracting a premium that reflects the future advantages the buyer is expected to gain from the acquisition. For buyers, platform value embodies the potential for future growth, particularly through investments in new markets, products, or technologies that the acquired platform can facilitate.

Understanding the value of a platform can also be approached through the "real option" framework. This perspective allows buyers to evaluate potential future opportunities alongside the uncertainties involved. Several key considerations emerge from this framework. Buyers must assess the scope of new markets, products, or technologies that could be unlocked, evaluate the associated risks and variability in returns, and determine the necessary investments required and their timing.

Through this lens, buyers can make informed decisions about how much to pay for the platform, weighing potential future gains against the inherent risks. Sellers, on the other hand, often intuitively recognize these future benefits and incorporate them into their price expectations as a premium.

The dynamics of negotiation play a critical role from both perspectives. Sellers seek to maximize their platform’s perceived value by emphasizing its growth potential, which may be presented as a stated premium or woven into pricing multiples. Buyers, conversely, need to manage the risks involved in realizing the platform’s potential. Their goal is to constrain their offers to align with the core business's fundamental value, while also accounting for the real option value of possible future opportunities, minus any costs associated with capturing those advantages.

Ultimately, the success of a platform acquisition hinges on the delicate balance between the price paid and the value derived from future investments and growth opportunities. This careful consideration can determine the long-term viability and success of the acquisition.