News and Views
| March 2019
Private equity funds often create growth by making “bolt-on” acquisitions. These are transactions where a platform business acquires other businesses that provide complementary services, know-how or capabilities to the platform business. The broad investment thesis is that the platform business can then expand more quickly rather than growing those capabilities organically which may be a potentially slower process.
Some examples of bolt-on transactions include:
- The Real Pet Food Company’s (a former Quadrant portfolio company) acquisition of Ivory Coat (a premium pet food and dog treats business), Consolidated Manufacturing Enterprises (a dry pet food manufacturing business) and Billy + Margot (a UK distributor of optimum nutrition for dogs in the UK business) in the pet food and accessories sector;
- Fitness First Australia’s (a Quadrant portfolio company) acquisition of Goodlife, Jetts, Go Health Clubs and Zap Fitness in the health and fitness sector;
- Allied Pinnacle’s (a Pacific Equity Partners portfolio company) acquisition of baked goods businesses in the flour, milling and food products sector; and
- Patties Foods’ (a Pacific Equity Partners portfolio company) acquisition of Leader Foods and Australian Wholefoods in the prepared meals sector.
This article explores some interesting considerations and issues in these types of transactions.
Due diligence for bolt-on acquisitions is a much wider exercise than due diligence for other traditional acquisitions. Given that bolt-on acquisitions are part of a broader buy-and-build strategy, issues that affect the target itself or the broader portfolio group would be relevant. In particular, the due diligence team may identify issues that affect the integration of the target into the platform business or the expansion of the portfolio group as a whole.
Below are some due diligence questions that may arise for consideration:
- Does the target need to be separated from a particular group?
- Are there any restrictions on expanding the business into other areas or geographies?
- Are there any obstacles to achieving the platform business’ growth or expansion plans?
The due diligence report should also recommend actions to address the identified issues or risks which should ideally form part of the subsequent action plans and ongoing integration plans for the business.
The sale and acquisition
In a bolt-on transaction, the sale agreement is the central document to orchestrate:
- the sale and acquisition of the target business;
- actions in response to due diligence findings;
- the entry into transitional arrangements;
- post-completion support, if any, required from the sellers; and
- allocation of ongoing liability and risk.
Some specific matters that may need to be addressed include:
- Wrong pockets: the transfer of assets that belong to or are used by the target;
- Contracts: the renewal of contracts or the entry into or novation of certain material contracts;
- Retention: minimum levels of acceptance of employment from key employees; and
- Confidentiality: obligations to keep the acquisition confidential, particularly if the bolt on transaction is part of a series of transactions where the buyer may wish to make a single announcement regarding all the transactions.
There is usually a period to transition ownership of the target to the new owner. The transition of ownership may sometimes begin before completion occurs.
During this phase, the buyer may need transition services to enable it to run the business until it can run the business on a standalone basis. Transitional services may include:
- information technology support;
- helpdesk services;
- payroll; and
- HR services.
The buyer may also need other support from the sellers such as:
- making introductions to suppliers;
- managing staff communications and meetings to introduce the new owners;
- arranging meetings with key managers to ensure that they remain engaged with the business; and
- providing access to sites, plant and equipment for inspection.
The integration of the bolt-on acquisition into the platform business is critical to the success of a buy-and-build strategy. It is an ongoing process from an operational, management and cultural perspective.
A large part of integration involves the management of people and the alignment of their varying interests. Some challenges may be:
- resistance to new systems and methods;
- clash of cultural values across the various bolt-on companies; and
- differences in priorities and interests of managers in the various businesses and the owners of the platform business.
A common way to align stakeholder interests and to reward group performance is through equity incentives. These are structured so that employees and key managers:
- have a vested interest in the performance of the group as a whole;
- remain with the business long-term; and
- are incentivised to work towards an exit.
Generally, equity incentives are more effective in driving long term group performance than cash bonuses which usually reward individual performance over a short period.
Private equity funds seek to exit a portfolio company (or group of companies) within a 3 to 5 year period. Sellers are sometimes offered equity in the platform business to incentivise them to remain managers and operators of the bolt-on business. As such, discussions about exit plans and processes start when the bolt on business is acquired rather than when the exit is due to occur. The processes to bring about an exit should be built into the management and shareholder arrangements at the outset.
These arrangements may cover:
- drag along rights;
- tag along rights;
- warranties on exit; and
- powers of attorney to achieve an exit.
Some potential flashpoints for tensions include:
- some shareholders may wish to set a minimum multiple before they may be forced to exit;
- some shareholders may prefer a particular exit path over another;
- managers may receive less consideration in an exit but are expected to assume more warranty liabilities due to their knowledge of the business; and
- there may be disparity in knowledge between the various managers, yet they are required to give the same warranties.
To address competing concerns and interests, there may be discussions regarding:
- limited recourse arrangements;
- allocation of liability for warranties;
- appointment of financial advisors to assess exit options; and
- requirement to obtain warranty and indemnity insurance in an exit.
Key takeaways for bolt on transactions are:
- view the transaction as part of a broader strategy rather than in isolation;
- the successful transition and integration of the bolt-on business into the platform business is critical to the success of the buy-and-build strategy;
- various competing stakeholder interests need to be carefully managed; and
- the exit of the portfolio group is the end game rather than the completion of the bolt-on acquisition.
About the Author
Peggy Ching is a corporate partner with extensive experience in advising private equity funds, VC funds and companies in acquisitions, disposals, joint ventures and raisings. If you would like to discuss any opportunities, please feel free to email [email protected]
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