When it comes to selling a business to a private equity buyer, one of the most critical decisions an owner can make is whether to position the company as a platform investment or as an add-on acquisition. Platforms – and their founders – tend to be glamorized, but this type of transaction is not for everyone. The distinction between these two paths extends well beyond financial considerations, and even businesses that appear to fit the financial profile of a platform might find themselves better suited as an add-on. Let’s explore the key differences, considerations, and the implications of each path.
The Case for Platforms
A platform investment typically involves the company coming with a CEO who retains a significant equity stake in the business. In the lower middle market, this often means the current owner also serves as the CEO. The exact percentage of equity required can vary depending on the PE firm and the company’s capital structure before the transaction, but it’s most common to see a 20% or greater equity stake. In some industries minimum rollovers can be as high as 50%.
This level of commitment isn’t for everyone—some sellers may not be interested in such a significant investment of time or money. However, the potential upside can be enticing. Just like in most investments, those who join early in a successful venture often reap the greatest rewards. This holds true for owners who create a new platform. The equity they roll over typically appreciates more than that of any subsequent add-on acquisitions.
There is a lot more to consider when weighing the decision to be a platform, such as:
Size
Most private equity firms have a firm minimum of $4-5M EBITDA, and many target much larger businesses. It’s exceptionally rare for companies with <$3M EBITDA to be viewed as platforms, and it’s important to note that firms’ EBITDA calculations generally account for the cost of a management team.
Intensity
The job of CEO for a PE platform company isn’t for everyone. In fact, it’s only for a select few. It’s a position that’s very different from running your own business. Platform CEOs should expect a lot of hours, regular reporting to a board of directors, business performance evaluations that are both objective and critical, and aggressive targets for which they are accountable for meeting.
Growth
Platforms must construct an infrastructure that builds capabilities and resources while supporting an aggressive growth trajectory. PE firms will support this systems and operations building from a board-level—and may perhaps even provide some consulting—but it’s ultimately up to the management team to do the heavy lifting. Conversely, add-ons plug right into an existing platform’s infrastructure and require less operational support.
The Case for Add-Ons
For sellers seeking a simpler and potentially less demanding path, add-on acquisitions are an attractive alternative. These deals generally involve a lower rollover requirement and the possibility of a shorter post-close commitment to the business. While other leadership team members may need to stay on for a few years, this commitment is usually less strict than with platform partners.
We’ve had clients that fit the financial profile of a platform yet choose to partner with an established platform as an add-on acquisition. This typically comes down to two factors – the lack of a management team, or in the case of industries like healthcare the lack of an owner willing to transition out of day-to-day roles like patient care into a full-time executive role; and/or the desire to immediately plug into a fully built-out supportive environment rather than having to build it on their own.
Add-on acquisitions can still come at premium valuations, but likely don’t offer the same equity upside as platform structures. The path forward can also be less clear. Whereas platforms are almost always modeled as 5-year periods until the next recap and change of control, add-ons by their nature exist under the same ownership structure for less time. And two offers from established platforms that may appear on the surface to be equal may in fact be very different based on the following factors:
Hold Period: How long has the PE firm owned the portfolio company acquiring your business? Knowing that can help you estimate the return on your rollover equity. Additionally, if the portfolio company is likely to be recapitalized in the near-term, you need to prepare yourself for a potential regime change at both the board and C-suite levels as your employment agreement, earnout, and rollover equity all may automatically transfer to a new PE owner upon sale.
Equity Value at Rollover: The equity value at which you are rolling in is a critical factor, as it directly affects your return when you exit. Some PE firms consistently mark up the share price of their investments, while others do so less frequently. Even when controlling for hold period or investment cycle timing, these differences can significantly impact your potential returns.
Fund Investment Life Cycle: Private Equity funds typically have ten years to deploy capital, grow and exit their investments, and return capital to their investors. Your timing within that life cycle may impact the availability of capital and resources as well as the overall timeline from initial investment to target recap, and ultimately the return on your rollover equity.
Balancing Rewards and Challenges
Selling to private equity is often glamorized, but it’s important to recognize the realities of operating a business under PE ownership. The potential for great rewards is real, especially for the founders of platforms that thrive. However, the challenges are equally significant. And not all ventures succeed.
For sellers weighing their options, the decision between platform and add-on should be guided by personal goals, a willingness to commit financially and operationally, and an appetite (or at least an honest acknowledgement) for the inherent risks and rewards. Both models present great opportunities, but understanding the nuances of each helps ensure that the chosen route aligns best with the seller’s vision for the future.
In the end, whether choosing to sell as a platform or as an add-on, the key is to carefully consider the unique demands and opportunities of each—and to choose the one that best aligns with the long-term goals of both the business and owner.
