Using Add-ons to Bridge the Growing Valuation Gap

Sourcing & Origination
Venture Capital
Private Equity
Industry
Last updated:
August 12, 2022

Last year, private equity and investment banking firms experienced a post-COVID boom of inbound interest and deal activity like never before. 2021 saw nearly $6 trillion in transaction volume and more than 63,000 deals.

Unfortunately, 2022 hasn’t followed suit. International tensions, a sputtering supply chain, and sky-high inflation rates have led over two-thirds of analysts to predict a recession in 2023. Deal activity has already begun to slow, and firms that invested in platform companies at peak multiples are preparing for less than ideal returns.

Add-on vs. Platform Investments

“Platform companies” refer to foundational investments firms make in high-growth industries or emerging categories. They typically have decent market shares, resources, and revenues in their given space.

In contrast, “add-ons” refer to faster, cheaper, and lower-risk investments firms make in smaller companies to help enhance the value and accelerate the growth of platform acquisitions. This makes add-on investing a perfect strategy to help firms bridge the valuation gap.

As previous Director of Business Development for Serent Capital and SourceScrub’s own Co-founder and CEO Tyler Fair said in a recent interview, “It’s a good time to focus on add-on acquisitions. In a lower valuation market, this will help bring down your overall entry multiple. If you bought a platform company for 10x revenue, ask yourself where you can deploy additional capital into your portfolio through add-on acquisitions at lower multiples than what you paid for your platforms.”

However, traditional methods for identifying, researching, and closing add-ons are highly manual and time-consuming — a process that’s even slower and more stressful when you’re up against a rapidly changing market.

That’s why modern dealmakers  are turning to the latest technology to take a data-driven approach to add-on investing. Building accelerated, purposeful, and precise add-on strategies can be broken down into two distinct steps.

Step 1: Research and Discovery

Having an up-to-the-minute understanding of current market dynamics is critical to identifying ideal add-on candidates for platform companies. This requires firms to map out each player in a platform company’s current and/or prospective space to gain a deeper understanding of where they fit and the opportunities that lie within the larger ecosystem.

It involves detailed market mapping and segmentation based on size and health. This process allows dealmakers to develop deep domain knowledge and expertise before pursuing an add-on acquisition, which ultimately sets them apart from other dealmakers in today’s highly competitive market.

Modern firms are using new data services that offer a wealth of information about private, non-transacted add-on opportunities, including 9 core data signals that indicate investment readiness. Some tools are even able to surface companies with comparable signals to help build out market segments in minutes.

Step 2: Scoring and Sourcing

At this point, it’s critical to determine whether your add-on goal is to grow revenue, enter a new market, gain additional product functionality, or expand geographically. Pinpointing the add-ons that best fit your goal has historically meant dredging Google and making hundreds of phone calls.

Newer approaches use lead scoring to automatically rank add-ons according to how well they match your criteria. The latest technologies not only empower firms to enter their precise needs and assign values to each corresponding datapoint, but they also automatically apply these scores and sort lead lists accordingly. This allows you to spend more time on opportunities with real potential and the highest probability of balancing your market entry multiples.

Bridge the Gap with Data

What goes up must come down, as the saying goes — but your firm doesn’t have to ride the recession rollercoaster. Developing a data-driven add-on strategy gives firms an opportunity to thrive through uncertainty and maximize returns over time.

To learn more and see how leading firms like Copper Run and Boathouse are building a data-driven add-on strategy, download our free guide: Bridging the Valuation Gap with a Data-driven Add-on Strategy.

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