Business owners thinking about exiting their business may be hearing the terms “platform” and “add-on” acquisitions. Understanding these terms, and knowing which category you might belong to, can help you prepare your business for a competitive, higher value sale.
Private equity firms make up a sizable buyer category in today’s market. Generally speaking, private equity firms are investment firms that generate returns by buying and growing companies for resale, typically within three to seven years. These firms categorize acquisitions as either a platform or an add-on.
An add-on, also called a bolt-on, is typically a smaller organization that can be incorporated into a core business to make it larger and more valuable. A platform, on the other hand, is what it sounds like. It’s the core, or the mothership, around which a larger organization is built.
As you can imagine, platforms are special. A private equity firm may do 15 add-on deals for every platform acquisition. That platform is usually the initial investment from which they build the rest of their strategy.
Businesses that get tapped as platform investments typically have some common characteristics:
Strong management. Most private equity firms do not come in and roll up their sleeves to operate the business on a day-to-day level. They need someone to manage the company, and ideally that “someone” is your proven management team.
Better yet, private equity firms are attracted to engaged, committed owners who want to stay on and partner with them on a go forward basis for the next several years. If you are looking to sell 100% of your business and leave tomorrow, your business is less likely to qualify as a platform.
Owner equity. Similarly, private equity firms generally want the owner and/or management team to keep some equity in the business, usually in the 20 to 30% range.
As a seller, this allows you to take some of your net worth off the table and diversify your risk. Later, you’ll get a second bite at the apple when the private equity firm pursues divestiture. If the business grew according to plan, in an ideal scenario, your 20% retained equity could be worth more than the 80% equity you sold in the initial transaction.
Growth plan. Management has to have a clear vision of how they can continue to grow the business, particularly through strategic acquisition. Private equity buyers aren’t looking to maintain the status quo. Most of the time, they’re looking to increase value through growth, although cost-cutting is sometimes a viable value enhancement strategy.
A platform is the business at the center of an acquisition strategy. That means there must be a realistic way for bolt-on acquisitions to add value to the operation. Even if you meet all the other criteria, but have no way to grow except organically, you’re probably not the best fit as a platform deal.
Profitable and predictable. Usually, a platform business will have EBITDA margins of at least 10%, if not closer to 20%. That way, as the organization grows, a significant amount of money will fall to the bottom line and allow them to get a better return on their investment.
Investors also look for businesses with recurring revenue streams. The more consistent and predictable the revenue, the more salable and valuable the business.
Critical mass. In terms of size, the lower floor for a platform business is generally $2 million in EBITDA. Although, some firms will peg $5 million in EBITDA or more as their platform minimum.
Scalability. A platform company needs to be able to scale quickly and profitably. What does that mean? It means you can generate exponential profit on incremental investments. A scalable business is also one that has existing infrastructure (e.g. talent and systems) to support growth.
The bottom line is that the most attractive acquisition targets will be those that can position themselves as a platform business. These businesses will typically see the strongest competition from buyers and earn higher multiples. Private equity may pay more for a platform opportunity than strategic buyers will pay for the same operation.
Private equity firms can bring a lot of value to your business in terms of business acumen, connections, and capital infusion. To capitalize on those resources — and make your business significantly more valuable — work on building a business with platform potential.
By Scott Bushkie
Scott Bushkie is Managing Partner and Founder of DealCoach.
With more than 20 years in the M&A industry, Scott is a recognized leader in the field, providing exit strategies, business valuations, and M&A advisory services to business owners in the lower middle market. He has successfully executed sales to domestic and international buyers, private equity firms, family offices, and strategic buyers. Follow DealCoach on Linkedin