Private Equity Turns to Small Add-ons for Profits

As market conditions worsen, private equity firms have become more risk-averse and adopted more conservative strategies.

Jill Connelly/Bloomberg

Jill Connelly/Bloomberg

As borrowing costs spike and exits get harder, private equity firms are increasingly buying smaller, specialized companies that can be bolted on to existing holdings.

Over the last year, these smaller add-on acquisitions have become a bigger part of the mergers and acquisitions market. According to several consultants, the strategy has always piqued the interest of lower-middle-market firms, but it has recently gained popularity among all sectors as private equity carefully scales up the platforms of portfolio companies in a risk-off environment.

In the first half of 2022, add-on acquisitions accounted for almost 80 percent of the deal activity undertaken by buyout funds, according to data from PitchBook. In the middle market, both the value and number of add-ons as a percentage of all deals reached all-time highs of 73 percent and 63 percent, respectively, according to the most recent U.S. PE middle market report from PitchBook. The report noted that the add-on market has been especially active in industries such as healthcare, financial services, and information technology.

“It’s a relatively safe strategy,” said Pari Natarajan, the CEO of Zinnov, a management and strategy consulting firm. “Platform companies tend to be expensive…and can be very risky. But once you add [to] a platform, it becomes less scary because you’re adding to a much larger company.” The increasing popularity of add-on deals, he said, implies that PE firms are getting more risk-averse. Add-ons are attractive because they help average down the price multiples of the platform companies, a practice known as “multiple arbitrage.”

Add-ons are likely to become the most robust part of M&A, according to Doug McCormick, co-founder and managing partner at HCI Equity Partners. “It’s one of the few areas likely to persist, because there are lots of strategic reasons why add-ons make sense,” McCormick said. He added that the strategy helps PE firms build better businesses, expand into new markets, and cut costs.

HCI Equity Partners, which focuses on the lower market, frequently employs the strategy to grow portfolio companies, but it has been especially busy with add-ons over the past two years. Tech24, for example, is an HCI portfolio company focused on repair and maintenance services. It has completed 12 add-on acquisitions since being purchased by HCI in May 2020. According to McCormick, Tech24 will do more transactions in the coming months. It’s an example of how private equity firms can scale up through strategic acquisitions in fragmented markets, he said.


Add-ons also come at a time when private equity firms need to adopt a variety of value-creation strategies, due to the slowdown in deals following the 2021 peak. According to Jeremy Swan, managing principal at the tax and advisory firm CohnReznick, PE firms are increasingly reliant on value creation instead of constant dealmaking to drive up profits. For this reason, strategies like add-on acquisitions, human capital management, and supply chain optimization have increasingly drawn the attention of dealmakers.