Understanding Value Arbitrage from Tuck-In Acquisitions
While private equity and strategic acquirers are fully aware of the immediate value creation and arbitrage from add-on acquisitions, which Harbor Ridge Capital frequently sells companies to such parties, I repeatedly have discussions with founders that are interested in being the acquirer, where they can capture such value arbitrage themselves, yet seek support across the board to execute on such an initiative, especially with first-time acquirers.
Where the discussion gets especially intriguing from my perspective, is an M&A opportunity born out of a CEO having a relationship with a peer CEO in an overlapping or complementary business, who perhaps they have known and respected for years, and understand their business to a certain degree given the overlap. This existing relationship, the deep understanding of the space, offering and operations, coupled with strong financial performance, significantly de-risks the opportunity. To put it in perspective, private equity firms acquire businesses every day, which in most cases they did not even know the company’s name or industry six months prior to the acquisition. They expect to make between 2-4x their money on every deal, and the vast majority of the time they realize such outcome.
This is why we call such acquirers “strategic”, as there’s inherent synergies across the board in addition to the financial aspect of the deal. Harbor Ridge Capital advises companies pursuing add-on acquisitions, where the entrepreneur can capture the vast majority of the upside, while often maintaining control. The buy-side advisory services include deal origination, structuring, financing, and due diligence support. Further, we seek to participate with our clients to align interest by rolling part of our deal fees into equity vs. cash at closing. Below is a buy-side acquisition template we use for clients pursuing add-on acquisitions, to map out long term objectives and to assess feasibility.
As you can see, if executed properly, this can yield significant value creation for the equity, within a much shorter time frame. There’s quite a bit of variability with the inputs in this model, except what’s generally consistent across different business types, whether its software or service, is the multiple arbitrage that comes with size, which you can see from the Stand-Alone Acquirer Multiple to the Pro-Forma Combined. Once integrated, and if you apply some modest growth over a three-year period, the multiple is likely to increase even further.
The natural follow-up question to the above model, is how to best get this strategy financed, with the cheapest, most flexible type of capital. Please stay tuned for Part 2 of this series, which I will share the specifics of various acquisition financing options, cost of capital, and the different attributes of each.
If you have an interest in an add-on acquisition or roll-up strategy, have a target or two in mind, and would like to discuss the particulars, please email cmaghami@harborridgecap.com to set up a time to discuss. Please note, the strategy, as depicted above only applies to stand-alone acquirers with ~$2mm+ in EBITDA for service companies, or $5mm+ in ARR for SaaS companies.
Harbor Ridge Capital has deep add-on acquisition and financing experience over the last 15 years, across direct private equity investing, investment banking and C-level management. Notable add-on acquisition transactions include a technology service business that grew from $25mm to $250mm in revenue by way of 7 acquisitions and organic growth, and an ad-tech business that was $3mm in EBITDA which acquired its much larger competitor doing $20mm in EBITDA.