Why are add-on acquisitions attractive as part of an investment strategy?

Add-on acquisitions are one way to buy down the entrance multiple for investors – smaller businesses can often be acquired at lower multiples, providing an opportunity for value creation when they are integrated into larger platform companies. For example, a platform investment with $30M in revenue might command an 8x revenue multiple, but that multiple might be slightly lower (~7x) for a $10M ARR add-on, and much lower (2-3x) for an add-on with $2M in revenue.

Add-on sourcing can be valuable for firms that mostly buy platforms through brokered sales – sourcing add-ons can be particularly beneficial for investment firms that struggle with proprietary sourcing and haven’t built a multi-year sales cycle setup for sourcing platform investments.

Value creation: well-sourced deals have a 1+1=3 effect – there is often the potential for significant value creation when two companies are combined, exceeding the sum of their individual values.

“Buying” can be more effective than “building” – many private equity firms have realized that M&A can be more effective than in-house development or go-to-market efforts in expanding their product libraries and customer bases, especially on a short timeline?

What kind of multiple can you expect on add-on acquisitions?

Multiples vary depending upon market conditions and the quality of the company – these multiples are a simplification of lots of different facets of the business that will affect the valuation like retention, growth rate, etc.

What are the different stages of sourcing acquisitions? 

Stage One: Source – build a list of potentially relevant companies to target for acquisition and enrich it with data that will help you understand the market and prioritize the list for your outreach.

Stage two: Engage – deploy a programmatic outreach cadence to introduce yourself to targets and attempt to schedule a meeting to discuss the acquisition opportunity further.

Stage three: Qualify – seek out additional relevant information about the targets of your outreach and ensure they fit the specifications of your search. 

Stage four: Nurture – until you have hit your acquisition targets, continue to find compelling reasons and ways to get in front of your top prospects to nurture the relationship and revisit the viability of an acquisition. 

Note: for more on engaging, qualifying and nurturing, read Dan’s companion guide

Before you begin a sourcing project, what kind of preparation do you need to conduct?

First, sit down with the executive team and devise a strategic plan – outline what you’re looking for in an acquisition. This might be informed by board conversations or investment committee (IC) materials. Include whoever is sourcing opportunities and key decision makers like the CEO, Board Members, Corp Dev, and the IC at the relevant PE firm. 

Everyone needs to be aligned on the reasoning for the transaction – figure out why you want to make an acquisition (e.g. to enter a particular vertical, to open up cross-sell opportunities) and communicate to everyone so they can make informed decisions about what a successful acquisition will look like. 

Create a scorecard for potential acquisitions  – this should include the characteristics you’re looking for, the detailed specifications within that characteristic, and the degree of importance of each factor. This framework states your priorities and helps you weigh them and align on them before you begin looking for relevant candidates.

How do you build your list of prospective add-on companies to reach out to? 

Start by asking the portfolio company for their thoughts – don’t run to Sourcescrub and pull in a huge list of companies. Rather than beginning with a list drawn from the entire world, start by asking the people who already know about the space—a lot of work might already be put together for you. Ask the executives and corporate development at the platform for the biggest competitors in the space. 

• Ask the Sales team for the companies on their battle cards – who is Sales going head-to-head against as the other alternatives to your product? This list might include direct competitors, as well as alternatives or tools your prospects are already using to handle the problem. 
• Consider your partners – whatever products the platform is integrated with may end up as relevant acquisitions. Get a list of integrations and align on whether any of them would make for strong acquisitions. 

Put the initial list of names you find into a spreadsheet – you’re going to have duplicates, but the name of the game is to get as much information into the spreadsheet as possible. You don’t have to get perfect detail. Get domain and company names and then go expand your search. 

Supplement your initial list with best-of, related, and competitor searches – look at Capterra, G2, LinkedIn, etc. to build out your list. You can do a Google search formatted as “related:companydomain” (e.g.  related:theguardian.com) and it will show you all of the companies related to a specific domain.

Map out conferences and associations that relevant companies are affiliated with – look at other attendees, then look at the other associations or conferences they attend, and so on. This creates a nested, recursive process where you’re finding interesting companies, looking at their associations, finding other interesting companies in those associations, and then looking at their conferences and associations. You end up building a list of lists, including associations, conferences, and best-of lists.

Take all of your lists and combine them – get all of your lists in Sourcescrub (or wherever they are), and combine them. With some light cleaning, you end up with a mutually exclusive, collectively exhaustive (MECE) list. The primary consideration is building a list that’s collectively exhaustive, so you don’t miss opportunities.

How do you enrich your list of potential acquisitions with data relevant to your sourcing?

Start by putting the list in your CRM – this will help you manage, prioritize, track, different opportunities as you’re enriching their data and when you eventually reach out to them. 

Enrichment is crucial to properly prioritize opportunities – after creating a broad list of potential acquisitions, the next step is to layer in additional datapoints to help identify the most interesting fits for your business. 

Oftentimes, firms outsource data enrichment – some people use Upwork to outsource the legwork of enrichment, others will use Sourcescrub, Grata, Pitchbook, etc. Acqwired can help by taking a massive list and crawling through it for interesting companies given your specifications. The tool reads the websites of the 1000’s of businesses and adds attributes to your list to help you make smart prioritization decisions. 

How should you filter and prioritize outreach to your list of potential acquisitions?

Prioritize your list, don’t filter it – filtering out companies can cause you to miss good opportunities because of poorly defined (or too narrowly defined) specifications. Most people try to use some kind of boolean logic like, “All companies between 15-150 employees, & who haven’t raised >$2M before, & aren’t PE or VC-owned, & have a growth rate >1%”. This will cause you to miss companies that fall just on the wrong side of the line but could still be really interesting fits. 

Take a stacked ranked approach – it’s important to still look at a combination of scorecard factors to find businesses that make for an attractive target. Use a stacked rank approach rather than filtering out companies to find the exact fit in a range of values. 

Go back to relevant executives to get their take on the most important targets – you can show them the list and ask for companies they’d include or exclude, and if there are any important ones to go after. Asking the CEOs to identify acquisitions that would be game changers can be particularly useful. It doesn’t always make sense to have executives go through the list one by one, and rate each potential acquisition.

It’s important to anchor on accuracy over precision – if you shoot a quiver of arrows at a target in a very tight grouping, if the grouping doesn’t hit the bullseye, you’ve just been “precisely inaccurate”. That can happen if you dial in too much on characteristics in sourcing. The better approach in sourcing is to create a scattershot around the bullseye. You don’t want to be totally off target, but you want to have a wide enough range that you can learn where the best fits are. Otherwise, you’ll make invalid assumptions early on that lead you off track. 

Don’t waste time over prioritizing your list – it’s important to know which companies are the top priority game changers, but outside of those, you should end up calling everyone because you want to be thorough. Let yourself find out which opportunities are the most interesting. 

Engage

How do you begin reaching out to your list of potential companies for acquisition?

Start at the bottom of your list – start with the least interesting companies. You’ll learn a lot of information from these conversations to deploy for the next conversation up the chain—so that you’re smart on the industry when you talk to your most important targets. You don’t have to step-wise all the way from the bottom to the top, but start at the bottom until you feel comfortable having smart conversations with high-leverage targets. 

Start with cold outreach – I don’t start with a trip or a conference, the first steps are sitting at home and doing cold calls and outbound research to prospective 

Hone your skills and develop knowledge by approaching low-hanging fruit – you can reach out to lower-priority companies and have low-pressure conversations to learn about the space, the key players, and who else might be interesting to you. 

What should your outreach cadence look like? 

You need to have an intentional process – take a programmatic approach to reach out to prospects during your search. Most people send an email, then they have a million other things going on, and maybe they follow up every once in a while. So over a period of three or four months, you may send several emails but they’re ad-hoc, not building up to anything, and those efforts end up dying on the vine. 

Build a sequence with 5-10 touches in a dedicated period of time – it needs to have a starting time and stopping time, with a set cadence for each touch. Be tenacious. I borrow from sales best practices for cold calls and outreach. Most people will give up after 2-3 tries, and the reality is that you need to get to 8-9 different touches during outreach. 

Give contacts a chance to respond – these are busy CEOs. Start with giving them a week to respond, then you might shorten the intervals where you’re giving 5 business days, three business days, and one business day. 

Use all available mediums to reach your targets – it might escalate to calling on the phone, pursuing on LinkedIn, even calling their connections and telling them to bug you. You might send them gifts, or even show up at their office. The CEO can tell you to buzz off, but the point is to get an answer.

How should you alter your approach to engaging with an add-on they’re a competitor? 

Assuage their concerns by creating a barrier between the fund and the platform doing the acquiring – send the target an NDA from the PE firm and ask them for a high-level P&L, but let them know that you’re not just going to pass everything on to the portfolio company who’s their competitor. As investors, you wouldn’t be in business very long if you violated their trust. You also won’t gain a competitive advantage through seeing their P&L. At some point, you’ll have to get other people at the portco involved, but to start you can keep the interactions relatively separated. 

Don’t position yourselves as doing corporate development at the portco – this makes it a lot tougher. People run into issues every day not being able to share information with competitors. You’re never going to get them to be as open with you as if you position yourself as dealing all day with highly sensitive, confidential, and potentially competitive information. 

Have an NDA that explicitly states you won’t share the initial info with the portco – you can tell the target that the NDA is not going to be between them and the portfolio company, but rather will be between them and the investment firm.

What are the most important pieces to get right?

Pitch the opportunity as 1+1 = 3 – share that together, you can accomplish something more than what you can independently. So instead of competing with each other on building products, the customers and businesses would be better off with combined resources. Come be shareholders. Even though it’s an acquisition, talk about it with the vocabulary of a merger because that allows people to get a lot more comfortable with it. Talk about how combined forces can accomplish something together.