Private Equity vs Buy-and- Build Strategy

Private Equity is being the subject of heavy critics from Senator and presidential candidate Elizabeth Warren due to the modus operandi of some firms in this field. The democrat Senator is bringing to the mainstream media that PE firms fire too many workers, load up otherwise healthy companies with too much debt while extracting cash via dividends, consulting fees and other payouts, and she proposes a bill that would impose a 100% tax on fees paid from companies to the PE firms that buy them, prohibit dividends or other cash extractions for two years after an acquisition, and increase disclosure to investors. Even if itis highly unlikely fora bill like this to pass, all the social and media pressure is making the main players of PE invest more in the strategy that has been around since the beginning: Buy-and-Build.

We can define the Buy-and-Build strategy “as an explicit strategy for building value by using a well-positioned platform company to make at least four sequential add-on acquisitions of smaller companies” according to Bain Company, GLOBAL PRIVATE EQUITY REPORT 2019. The growth of an organization requires skills and expertise that support business processes and expanding to other markets successfully. The modus operandi of this strategy allows the company that was bought to grow and expand, which ultimately leads to more jobs created.

The popularity of this strategy comes also from the way an antidote is offered into soaring deal multiples. They give General Partners (GP) a way to take advantage of the market’s tendency to assign big companies higher valuations than smaller ones.

Source: PitchBook Data, Inc

A buy-and-build strategy allows a GP to justify the initial acquisition of a relatively expensive platform company by offering the opportunity to tuck in smaller add-ons that can be acquired for lower multiples later on. This multiple arbitrage brings down the firm’s average cost of acquisition, while putting capital to work and building additional asset value through scale and scope. At the same time, serial acquisitions allow GPs to build value through synergies that reduce costs or add to the top line. The objective is to assemble a powerful new business such that the whole is worth significantly more than the parts. Due to this, this strategy does not rely on interest rates nor on a country’s GDP growth, which are some of the biggest problems that the financial industry faces.

In conclusion, we can say this strategy is solving the most sought-after problems in the modern days, how to maximize profitability and be socially conscious at the same time. According to GLOBAL PRIVATE EQUITY REPORT 2019 from Bain Company, that is also why buy-and-build has become so popular that approximately one in five transactions today is executed as part of a broader buy-and-build strategy. Indeed, the report states that, while the strategy has been around as long as PE, it has never been more important than it is now.

Article published in our December 2019 Newsletter

Bernardo Pimenta, BSc in MAEG

Published by lisboninvestmentsociety


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