Understanding buy and build strategies
A buy-and-build strategy is a distinct approach to business growth and investment. Primarily utilized by private equity firms, this strategy involves acquiring multiple smaller companies within the same industry.
The initial step is to purchase a platform company. This company is a larger competitor with significant growth potential. It is the foundation for subsequent add-on acquisitions.
Following the initial nucleus acquisition, the strategy includes buying additional smaller companies. These are often referred to as add-on acquisitions. They are usually companies within the same industry. The aim is to create synergies among these acquired businesses and expand operations.
Achieving synergies can involve merging operations, integrating sales forces, or consolidating administrative functions. This process enhances efficiency, cost savings, and increased market reach.
Examples of a buy-and-build strategy
Elderly Care Facilities
Elderly care facilities are an excellent example of a buy-and-build strategy. An aging population drives a steady demand and the industry is highly fragmented.
Many elderly care facilities are standalone companies or part of small regional groups. This presents a consolidation opportunity for strategic buyers. By applying a buy-and-build approach, PE firms can accelerate growth and increase operational efficiencies by centralizing administrative tasks.
Additionally, by creating a more extensive network of facilities, companies can provide a continuum of care that addresses the varied needs of the elderly population, from independent living to assisted care, making the service offering more attractive and comprehensive.
Dentistry
The field of dentistry is another excellent example of a buy-and-build strategy. It consists of numerous small practices operated by individual dentists or small partnerships.
These practices will benefit from a professional management team that takes care of tasks such as supply procurement, marketing, and administrative support when brought under a larger portfolio company of a PE firm.
A buy-and-build strategy allows for consolidating these practices into a cohesive brand, offering consistent quality and service across all locations. It is a growth strategy that expands the business by attracting a broader client base and enabling cross-referral among the consolidated practices.
It also helps develop expertise for technological advancements, such as digital record-keeping and advanced diagnostic tools, which can be too expensive for smaller practices.
Industries suitable for a buy-and-build strategy
Fragmented competitive environment
Industries with a fragmented competitive environment are prime targets for a buy-and-build strategy.
In these sectors, most competitors are small to medium-sized businesses with no clear dominant market leader. Such fragmented markets offer enough targets for add-on acquisitions for private equity firms.
PE firms can execute multiple strategic acquisitions and consolidate these smaller entities into a larger, more competitive organization. By consolidating businesses in these sectors, firms can achieve economies of scale, increase market share, and improve negotiating power with suppliers and customers.
Location-based business
Industries with a strong emphasis on location are also suitable for a buy-and-build strategy. These are sectors where geographic presence is crucial for service delivery or market penetration.
Examples include hospitality, retail and trade companies. Acquiring businesses in diverse locations enables a company to expand its geographic footprint in these industries.
This expansion is not just about physical presence. It also involves gaining access to new customer bases and local markets. A successful buy-and-build approach in these industries can lead to a comprehensive network of operations, offering improved services and products to a broader range of customers.
Benefits of buy and build strategies
There are many benefits to a buy-and-build strategy.
First, multiple arbitrage increases the valuation as smaller companies consolidate into a larger entities, often commanding higher market valuation multiples.
Expansion and growth opportunities arise from this strategy, enabling rapid scaling into new markets and customer segments.
Lastly, cost synergies are realized through operational efficiencies and economies of scale, reducing duplicate expenses and optimizing overall expenditure.
Multiple arbitrage
Multiple arbitrage is a fundamental benefit of the buy-and-build strategy. Smaller companies can increase their deal multiples when consolidating into a larger entity. Private equity firms are particularly drawn to this point.
Smaller businesses typically trade at lower valuation multiples due to their size, market reach and risk profile. They are just not dominant in the market. The larger entity commands a higher valuation multiple when these businesses are consolidated.
This is due to improved market presence, increased revenues and EBITDA. Thus, private equity firms can create significant value by acquiring smaller businesses and consolidating them into a larger combined entity.
Revenue growth and expanding customer base
A buy-and-build strategy can drive significant growth for the platform company. By acquiring multiple businesses, the platform company can quickly increase its revenue and customer base instantly compared to organic growth.
The acquired businesses are already up and running. There is no need to push out a competitor. The platform company buys them outright and consolidates them into one entity.
This strategy allows instant access to new geographical areas, customer segments and products. It also allows cross-selling products or services across the expanded customer base. Such growth is not just about size; it's about enhancing market presence in a competitive landscape quicker than organic growth.
Cost synergies
Cost synergies are another significant advantage of the buy-and-build strategy. When companies are combined, there are opportunities to eliminate duplicate costs, increase negotiation power and enhance internal capabilities.
Duplicate operational processes such as administration, procurement, production and supply chain management can be combined.
Economies of scale can be realized as the larger entity can negotiate better terms with suppliers, streamline the supply chain and reduce per-unit costs.
Operational improvements and integration of internal capabilities across the combined entity further drive efficiency and cost-effectiveness, leveraging best practices in supply chain optimization.
Challenges of buy and build strategies
While buy-and-build strategies offer many benefits, they are also difficult tasks with particular challenges.
The right industry
Choosing an industry that's suitable for buy and build strategies is crucial. The industry must be sufficiently fragmented to allow for consolidation and not dominated by a few large players. The industry should also have favorable long-term prospects and resist rapid technological change.
Finding a proper nucleus investment
Identifying the right platform company is essential. It should be a well-established business with a strong management team, scalable operations and significant growth potential. This nucleus investment will serve as the foundation for subsequent add-on acquisitions.
Having enough small targets to consolidate
There needs to be a pipeline of potential small targets available for add-on acquisitions. The strategy falls apart if there aren't enough suitable companies to buy that would lead to meaningful consolidation. You need to be able to run the acquisition process for years to come.
Acquiring targets at a low enough valuation
The financial success of a buy-and-build strategy is based on acquiring smaller targets at lower valuations. Overpaying for acquisitions will lower your multiple arbitrage when it's time to exit the investment.
Integration of add-on acquisitions
Perhaps the most challenging aspect of a buy-and-build strategy is effectively integrating the acquired companies. This includes aligning corporate cultures, systems and processes and realizing the expected synergies. Integration is a significant challenge in buy-and-build strategies and needs to be executed properly. The platform company needs a management team with considerable experience to integrate multiple add-on acquisitions successfully.
