With private equity firms opting for more bolt-ons rather than primary acquisitions, James Tetherton explains how commercial due diligence has emerged as a key tool to help GPs unlock the full potential of bolt-on deals and drive growth in a volatile market

If the 2023 Real Deals Private Equity Awards had a ‘word of the year’ category, ‘bolt-on’ might have been it. Bolt-on deals have been thriving, making up 62% of the total European deal count in 2022, the highest proportion on record, while Q1 2023 data indicates the trend prevailing.

The appeal of bolt-on deals in the current climate is clear –  a shortage of scaled assets and a tightened leveraged loan landscape (combined with record levels of dry powder) mean that GPs are choosing to ‘double down’ on high-performing existing assets rather than exposing themselves to the risks of a primary acquisition in an uncertain market.

From a commercial due diligence (CDD) perspective, diligence on bolt-on acquisitions needs to address the core issues that any standalone CDD would, including: quantifying TAM size and growth, assessing customer satisfaction and competitive positioning, and analysing track record and growth prospects. 

There is also the fundamental challenge of delivering work efficiently on what is likely a smaller deal size. That means making good use of existing management teams while being careful not to overwhelm them, remembering they are often smaller in size and less well advised than those in primary processes.  

Matchmaking

Bolt-on deals raise additional key questions that warrant more thorough consideration, which rise because of the nature of the bolt-on itself. Being a good business in a growing market isn’t enough on its own – a target must also complement and enhance the offering of the platform company. The success of a bolt-on deal lies in identifying companies that ‘match up’ with each other.

Many bolt-on acquisitions rely on the potential of the cross-sell opportunity in their investment thesis. At Graph, we’ve seen this as a lynchpin of deals across many sectors. After all, cross-selling can be an enticing opportunity: increasing salesforce productivity while delivering higher value for customers is an obvious win. 

However, sometimes the opposite is true – either customers just don’t perceive value in a more extensive solution, or additional product offerings drive down margins (due to expectations for price concession). Or even worse, a combination creates confusion and makes individual elements less appealing. 

Teasing out detail with customer segmentation analysis and gauging appetite with customer referencing can bring out the attractiveness of the cross-sell to the customer sets of both the target and platform businesses. Do they sell to the same customer segments? Do they have enough overlap in their ideal customer profile? What is the current customer appetite for additional service lines? 

Businesses must get input from both customer groups during the CDD process – testing budgets, prospective interest, and perception of the current brands – and then come up with a scoring system. Customers may like an idea but not have the budget, or simply might not want it. There may even be significant points of overlap between customer sets that help to inform post-acquisition strategy. 

Even if customers across both platform and target are open to the prospect of a cross-sold offering, if their respective decision makers operate in different business areas, or at different points in a process, the reality of reaching and convincing the right person might prove difficult.

Good CDD

Good CDD work should test this: are the decision makers across both customer sets one and the same? And if not, are there realistic and actionable referral agents within the customer organisation? And are there sufficient operational, relationship or economic incentives to activate these referral agents? The platform company and its target might have adjacent offerings but have decision makers that operate in entirely different, unconnected parts of a business. 

Similarly, what is the timing of the purchase for each item in the product or services portfolio? In cases where purchasing is based on large projects – for example in construction or IT  – there can be significant advantages to having items in your portfolio that are purchased first (or early) in the process, enabling pull through for items purchased later. 

Conversely, products that are too distant in a project lifecycle might not make sense to customers combined. Understanding these dynamics can help to practically establish whether the cross-sell opportunity is real and whether two companies match up.

Testing the brand and cultural compatibility of the platform and target must be at the heart of CDD work on bolt-on deals. Are these brands synergistic, or does their combination create confusion in the market? Two businesses might each be highly regarded in their respective niches, but if customers do not perceive their core capabilities to be sufficiently similar or complementary, the deal may not make sense. 

Cultural compatibility is also essential. Customers may reject a pairing that creates mixed signals from newly formed teams. A business with a sales-led culture, for example, may struggle to integrate into a parent company with a strong engineering-first ethos. 

On an internal level, if a merger is not managed effectively, cultural rifts can lead to unwanted departures. This is especially important to avoid in small, founder-led businesses – it is not always the most senior people who make outsized contributions to culture and performance. A rigorous bolt-on CDD can help to identify these individuals, so GPs can ensure appropriate incentivisation is in place to retain them.

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