Neil Patel

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When looking around for strategic M&A deals to scale your company, explore the buy-and-build approach to investing. Also called a buyout or roll-up strategy, this form of acquisition is typically executed by private equity firms.

However, entrepreneurs looking to expand their operations to other geographical markets or capture customer demographics can also explore the option. You can scout around to purchase startups that can add value to your company in terms of technology or talent.

The ultimate objective is to build a nationwide footprint and ultimately take the business overseas. Buy-and-build or add-on purchases accounted for 72% of the number of M&A deals across the US in 2022. This number grew to 76.1% in the first three quarters of 2023.

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The Ultimate Guide To Pitch Decks

Understanding the Buy-and-Build Investment Strategy

Private equity firms purchase companies at lower multiples and combine them into a platform company that has expertise. Acquisitions are typically within the same industry and increase overall value by leveraging economies of scale.

The platform company then commands a higher valuation, which allows PE investors to exit with a sizeable profit. These investors usually target fragmented markets that have a large number of small players. Their roll-up strategies effectively restructure the existing company by bringing in startups.

Small startups entering the market seeking out strategic partners to raise their revenues and profits opt to accept these deals. The collaboration makes the company more attractive to other investors and stakeholders, raising the possibility of getting more funding.

However, the success of the collaboration is reliant on the platform company and how well it can execute the synergies. The goal should be to build a combined business with a value that far exceeds the sum of its components.

While the buy-and-build approach to investing has the potential to yield rich returns, realizing profits can take longer for investors. That is, compared to other investment strategies, such as venture and growth.

Venture investment strategies aim to scale and profit from acquiring innovative and disruptive technologies and business models. On the other hand, growth strategies are more concerned with investing in established and proven businesses. The capital is then used to expand operations.

How Buyouts Work

Private equity firms start off by identifying and selecting a target company that is a suitable candidate with adequate potential. This company can serve as the platform or foundation for other add-ons.

The next step involves selecting and purchasing multiple acquisitions to create a larger enterprise. Once synergies are achieved, the newly formed corporation is poised to extract benefits of scale and maximize value. It can also assume a dominant position within the vertical.

The company targeted for the buy-and-build approach to investing can be a private company. Or, it can be a public company reverting to a private entity. PE investors are also open to working with divisions of public companies that can operate independently as private firms.

The ultimate objective is to identify a company with robust growth potential that is falling short for several reasons.

For instance, ineffective management, lack of top-notch skill sets, or inflated costs that cut revenues and profits. At the same time, it should have the scalability to integrate an advanced infrastructure and assimilate new acquisitions.

Smaller divisions, which are overlooked by management in giant corporations, are also good targets. PE investors evaluate potential buyouts against different criteria.

For instance, innovative IP and IA, a strong brand and market presence, a skilled core team, and excess productive capacity.

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Industries are also a Criteria

The particular vertical where the business operates is another factor that influences investor interest and decisions. PEs are more likely to invest in projects in industries that have the potential for further growth. And have gaps for new players.

Sectors that are saturated with products and dominant players competing for the customer base are no-gos. It makes more sense to back fragmented segments lacking dominant players where a leading company can be established.

Even if the sector is underdeveloped, private equity firms look for suitable startups as candidates for acquisitions. There should be enough upcoming startups with disruptive ideas that can align with a core business if identified.

Of course, the end game for any buy-and-build approach to investing is an IPO or a profitable exit. PE firms are concerned with the company’s ultimate sale at a premium price and accountability to their stakeholders. PEs stay vested for around three to five years, which ensures accelerated growth.

Why Roll-Ups are an Excellent Strategy

Buy-and-build investment strategies have several advantages for not just PE firms. But also for the companies they back and assist in scaling quickly. Here’s what they are:

Advantages for Acquired Companies

Private equity firms typically target corporations that are faltering and unable to reach their potential for growth. They also target smaller startups that have innovative technology and disruptive ideas but only need the capital to scale. Typically, the PE investor adds at least four sequential add-ons.

Getting this backing can prove to be highly advantageous for acquisitions. Here’s how:

  • Larger companies tend to get higher valuations in the market than smaller players in a roll-back deal. This factor enhances their credibility in the open market.
  • Once the integration is complete, the newly formed organization can quickly expand and grow at a rapid pace. It now has skill sets, expertise, capital, and other assets that can effectively fill the gaps and take the company forward. Developing the skills and assets organically and internally can be challenging and time-consuming, but roll-ups can resolve the shortfalls quickly. Not to mention at a lower cost.
  • Collaborating with a company that has a presence in other geographical locations gives instant exposure. Competing with established players is also easier.
  • Acquiring upcoming startups that can potentially become competitors is an effective strategy.
  • The consolidated company will have a more extensive product portfolio to offer customers.
  • The buy-and-build approach to investing works well for a platform company that lacks skills in its workforce.
  • Roll-up acquisitions allow for cross-selling opportunities and the ability to target the combined customer base.
  • Cost synergies work at every stage of the operational chain, whether sourcing inventory from suppliers or vendors. Or infusing efficiency in the sales process with low Customer Acquisition Costs (CAC) and accelerating revenues and profits.
  • Cost synergies also work in the internal functioning of the organization by removing duplicated roles and functions. The consolidated company quickly becomes lean and agile, resulting in higher profits.

Risk Factors for the Buy-and-Build Approach to Investing

Although the roll-up approach has the potential to bring rich returns to private equity firms, it comes with risks. PE firms need to have exceptional management teams on board that have the expertise and ability to manage the portfolio of acquired companies.

Detailed, in-depth planning, step-by-step processes, and precision are vital when executing the deals. Investing in different teams to run the various aspects of the M&A transaction is advisable. That includes hiring professionals to oversee the financials, integration, due diligence, and synergies that can be achieved.

Management must do the necessary research to identify critical synergies. They must also work out how the acquisitions will work together and the value they bring to the table.

An essential facet of the integration is a delivery time frame. Each new acquisition should have adequate time to integrate and align with the platform company before the next one. Deploying these measures can minimize some of the risks by addressing the areas where they can occur.

Keep in mind that storytelling is everything in mergers, acquisitions, or fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

Possibility of Failed Integration

Navigating acquisitions and the integration processes can be challenging, and the risks of the failure of the integration are real. The most crucial aspects of any integration are always human resources and culture.

Although the deal may look good on paper, bringing together teams with different mission statements can be challenging. The company culture extends to every part of the business organization, whether catering to customers or designing products. Or even the day-to-day functioning of the company.

Missed synergies and misaligned efforts can make it harder for the team to deliver in a new environment.

Inadequate Financial Reserves

Purchasing companies and restructuring them involves a large infusion of capital. PE firms wishing to engage in this strategy must first estimate the amount of capital they will have to invest. Researching and identifying startups for acquisition and managing them needs extensive resources.

The private equity firm may also have to extend continued financial support until the company is up and running. That is, until it can generate adequate profits and revenues and is stable enough to sell. Or take public with an IPO.

PE firms typically stay vested for around three to five years. This is why they’ll want accelerated growth that can only be achieved by infusing money. To make that happen, they must target a robust platform company that can align with their growth and expansion strategies.

Weak Platform Company

The entire buy-and-build approach to investing is reliant on selecting the right core company for restructuring and rebuilding. Any miscalculations in estimating its growth potential can prove to be disastrous for investors.

To avoid this risk, private equity firms must conduct extensive due diligence to evaluate the target meticulously. They must identify the strengths that can be a solid foundation to build on. One way to do that is to study the financials and other KPIs.

The company’s success track record of successful products, sales, customer demographics, and IPs is only the starting point. Next, PE teams must assess its shortfalls to understand the areas that need improvement. This information will help them identify good fits for acquisition and integration.

Missing Value from the Investment

Bringing value to the core or platform company is the main objective of a buyout strategy. That can happen only if the participating companies are a good fit and complement each other perfectly. For instance, post-integration, operating costs should be lower, and sales and revenues should rise.

The company should also demonstrate successful expansion by building a presence in added geographical locations and increasing the customer base. If the consolidated company is unable to achieve these objectives, the PE firm stands to incur significant losses.

Selling the company at a high valuation and recovering their investment could be challenging.

Regardless of the transaction you’re entering into, whether an acquisition or fundraising, due diligence is crucial. Check out this video I have created, where I explain in detail how to navigate the due diligence process.

Loss of Customer Confidence

The company’s customer base is the ultimate factor that makes the ultimate difference between success and failure. Brand value and credibility are essential for the company’s sustainability, sales, revenues, profits, and scalability.

Companies must keep customers well-informed about the internal workings when executing acquisitions and collaborations. Keeping them updated and providing assurance that their interests will be well taken care of is critical.

Instituting advertising drives during the acquisition and restructuring helps retain customers and maintain their confidence. Talking about the merits of the partnership and how customers can benefit from it is the key. Open communication lines to answer questions and allay concerns also work well.

Offering rewards like discounts and freebies to customers who stay loyal through the transition is also a good marketing practice.

Lack of Sustainability

Most PE firms aim to make a profitable exit in around three to five years. However, not all companies are able to achieve an accelerated growth rate and demonstrate success in such a short time. Particularly the buy-and-build approach to investing.

For instance, certain verticals like life sciences and health are capital-intensive, and R&D may take longer to yield results. Getting FDA approvals, conducting clinical trials, and manufacturing market-ready products also take time. PE firms may have to delay the sale longer.

Unrealistic expectations from the investment strategy, unexpected macro environment conditions, and unclear business plans are other risks investors must take. Several other issues that slip through the cracks during the due diligence can also impact the success of the investment.

To Conclude

The buy-and-build approach to investing has its pros and cons. Be aware of the potential pitfalls, whether you’re executing buyouts as a corporate entity or a private equity firm. Although you can benefit significantly from the transaction, the risk of failure is equally considerable.

Due diligence, meticulous preparation and planning, and hiring expert teams to assist could help streamline the integration and maximize synergies.

You may find our free library of business templates interesting as well. There, you will find every single template you will need when building and scaling your business completely for free. See it here.


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Neil Patel

I hope you enjoy reading this blog post.

If you want help with your fundraising or acquisition, just book a call

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