Four principles and five practices that CFOs can follow to get maximum value from their integrations
Lots of private equity companies use add-ons to scale portfolio companies. And one strategy that’s gaining traction for the companies that are pursuing add-ons is the “buy and build” strategy. This strategy involves creating platforms and pursuing add-on acquisitions to grow and scale rapidly. In 2004, add-on transactions made up approximately 43% of private equity companies’ deal volume. By the end of 2020, this share had risen to approximately 71%. [CM1]
Although “buy and build” is often an effective strategy, mediocre integrations can turn deals that have revolutionary potential into slow-growing add-ons. Inconsistent integrations can stem from slow decision making, lack of expertise, and/or poorly defined roles. At worst, these integrations may corrode investor returns.
However, the divisional and group CFO Gary McGaghey explains that private equity companies can capture maximum value from their integrations by following four important but often overlooked principles and pursuing five practices. This way, they can deliver successful integrations, capture the full value of these deals, and maximize the potential of their add-on strategies.
Four Important Principles in an Integration
Gary McGaghey notes that the private equity companies who succeed in their integrations tend to approach integration planning with the same discipline that they apply in deal sourcing and diligence. These companies understand the material value that they can derive from successfully integrating acquisitions. He explains that these four themes often lead to their success.
1. Quick Pace, Short Timeframe
After the intense focus needed to advance a deal to signing, many private equity companies call on management teams that lack merger-management experience to perform the integration. Gary McGaghey explains that the leaders of these teams may have experience in running private companies, but they often don’t realize that an integration requires specialist expertise until it’s too late. In these cases, the integration may falter. Instead, to achieve full value, merger-management teams must act at a much quicker pace and make more decisions in a shorter timeframe.
2. Driving Value
Secondly, private equity companies must consider how quickly they can realize cost synergies, the potential for revenue growth, and any additional value. These factors form the basis on which they can make effective financial decisions. However, many companies find it easier to unlock value once they have assumed ownership.
Gary McGaghey explains that successful integrators revisit the factors that drive value for the merging companies. These integrators look more aggressively at the targets that could be possible through at-scale cost reductions and consider transformational productivity shifts that could accelerate growth. For example, companies can sometimes improve productivity by adopting agile techniques or professionalizing the sales force.
3. Splitting Responsibilities
In an integration, the private equity company’s deal team or operations team and the portfolio company have important but different roles to play if they are to achieve a successful integration. The private equity company’s team should:
- Identify sources of risk and primary opportunities for collaborations.
- Identify and install an effective management team for the newly acquired company (this team may comprise the company’s current leaders).
- Develop and continuously monitor the newly acquired company’s financial and operational performance requirements.
Meanwhile, the portfolio company’s team should:
- Deliver on the deal thesis by mitigating risks, capturing opportunities, and launching plans to capture value from initiatives, perhaps by reducing capital usage and costs.
- Operationalize the newly formed company; its managers should design and establish the organizational structure, talent-selection process, operating model, governance and decision process, change-management program, and cultural initiatives.
- Design a glitch-free day one, enabling swift transitions for customers, vendors, and employees.
During an integration, portfolio company leaders need to make quick decisions while taking on a heavier workload than usual. This can make some management teams hesitant to commit to ambitious targets and/or widen the aperture on value and expand their perspective on potential collaborations and opportunities.
4. The role of experienced integration professionals
The governance, oversight, and support model for a portfolio company pursuing an add-on strategy is similar to the model that companies might use for a standalone acquisition. While this model can be effective, some companies miss out on opportunities by failing to include individuals who have direct integration experience on boards and in company-level operating teams.
Gary McGaghey explains that when lean leadership teams run portfolio companies or have substantial M&A activity, it often makes sense to add experts from these teams to the private equity company’s deal team rather than the portfolio company’s management team. This helps the new company share lessons learned and realize M&A synergies across the portfolios.
Five Add-On Practices for Private Equity Sponsors
Executing a successful add-on strategy requires both the private equity company and the portfolio company to offer integration capabilities, expertise, and unique mindsets. Gary McGaghey explains that private equity sponsors can follow these five practices to achieve the maximum value from their deals.
1. Share a Mission
Both the private equity company and the portfolio company should share their mission to ensure the deal reaches its potential. This shared mission is the glue that should make the partnership sustainable. A lack of shared mission is often the reason behind disrupted mergers, and this lack of alignment tends to manifest as missed targets, talent attrition, and lost momentum.
2. Enable Quick Decisions and Focus on Value Creation
Deal planning often sees integration planning take a back seat. However, top-performing integrators invest a lot of time before closing a deal and tailor their integration approaches based on the deal’s value, risk, and rationale. Gary McGaghey notes that top-performing integrators also follow an integration program that allows quick decision making. Successful deal and operations teams in private equity companies also often focus on value creation to overcome secondary objectives. Together with their management teams, they prepare, present, and use road maps that ensure prioritisation, focus, and transparency.
3. Establish an Apples-to-Apples Financial Baseline
After closing the deal, the private equity company and the portfolio company should establish an apples-to-apples financial and full-time equivalent baseline. This will allow them to understand how each company classifies its employees and functions. A granular insight into each role, salary, and department enables management teams to make accurate estimates, identify collaboration opportunities, and track the outcomes of these collaborations.
Private equity companies’ teams can set quantified targets that top managers can buy into. These managers can also request highly detailed planning and prioritize execution through value-capture summits. Meanwhile, sponsors and managers can align and prioritize initiatives.
4. Retain Talent
Private equity investors are usually skilled at identifying and retaining leadership talent. However, they can also use their talent-spotting skills to ensure the retention of mission-critical talent (employees who complete important activities and are difficult to replace), high-potential talent (high-performing employees who may rise to more senior roles), and value-creating talent (value creators who deliver the deal thesis and synergies).
5. Maintain a Healthy Culture in Management Practices
A healthy culture is equally as important in management practices as it is in teams themselves, especially when combining practices between marketing, sales, R&D, and other teams. Gary McGaghey explains that an aligned culture enables a united front and streamlines teams so they can all focus on the core deal rationale. If a company doesn’t address cultural-integration challenges, it will likely see lowered productivity, friction in the top team, and talent attrition. That’s why successful teams rigorously examine top-management practices and working norms to address cultural risk early.
Improve Your Integrations
Gary McGaghey explains that following these practices can quickly improve integrations so you can generate improved top- and bottom-line results. An M&A integration can fuel return on investment across the ownership cycle, and, with these strategies, you can make this a core pillar of your portfolio strategy.
About Gary McGaghey
As a chartered management accountant in the UK and a chartered accountant in South Africa, Gary McGaghey has achieved financial transformation for private equity, privately owned, and listed companies on a global scale. He has completed a postgraduate Bachelor of Commerce degree with honours from the University of South Africa, a Bachelor of Commerce degree from the University of Natal, and the Financial Times’ Non-Director Executive Diploma. He is currently the Group CFO of the €1.3bn end-to-end marketing production and business services group Williams Lea Tag.
[CM1]Source: Rebecca Springer, Q2 2021 Analyst Note: Exploring trends in add-on acquisitions: US PE sees the buy-and-build escalate, innovate, and sophisticate, Pitchbook Data, April 12, 2021, pitchbook.com.