Is Your Business an Add-on or a Platform? And, Why It Matters

One question small business owners rarely ask themselves, “Is my business an Add-on or a Platform?” That’s a real shame, because that’s a question Buyers regularly think about when evaluating a business. Sophisticated Buyers always ask themselves, “Is the business that I’m reviewing an Add-on or Platform?”

What’s the difference between an Add-on and a Platform? Why do Buyers care if the business is an Add-on or Platform? How are each of these businesses valued? Why should you transform your business into a Platform?

What is a Platform Business?

Fenwick’s definition of a Platform is a business that serves as the anchor for future growth. Platform Businesses are well rounded businesses. They have previously demonstrated the ability to grow. They typically have stronger EBITDA / profit, consistent profit growth, management depth, less risk, stronger branding, greater moat, more developed product offerings, and well thought through processes. Platform businesses are more turn-key and require less clean-up post-acquisition. Platforms are businesses that you can invest capital into, and they will grow.

For roll-up strategies, a Platform is the business that roll’s up Add-on’s. Why? Because Platforms have more talented teams, better branding, and better processes. Platforms do the acquiring.

Fenwick position is that Platform businesses can also serve as the anchor for an organic growth strategy or a combination of organic growth and roll-up strategy. While not typical of PE Buyers, many Buyers prefer an organic growth strategy because it eliminates post-acquisition integration issues that can cripple growth. Platforms have good fundamentals for growth, regardless if the growth is organic or roll-up.

What is an Add-on?

Add-on’s are businesses purchased by Platforms for a specific reason; a strategic capability or product offering, a customer list, geographic expansion, to increase economies of scale, or to eliminate a key competitor. Especially in small-to-medium sized businesses, Add-on’s typically have weaker EBITDA / profit, less consistent annual growth, less developed processes, or are niche. Because Add-on’s typically have weaker EBITDA, Platforms also frequently acquire Add-on’s for multiple arbitrage. Multiple arbitrage occurs when the Add-on’s profits are valued with the Platform’s profits. For example, if the Add-on has $1.5M in profit at a 3x multiple, valued at $4.5M and the Platform $3.0M in profit at a 5x multiple, valued at $15M, the combined valuation is $4.5M in profit at a 5x multiple valued at $22.5M. Thus, creating $3.0M in arbitrage value.

Why You Should Transform Your Business into a Platform

The most obvious reason for transforming your business into a Platform is the higher valuation. More profit, more consistency, better talent, stronger processes all lead to better valuations and sale prices. A Platform also makes your business more marketable, causing it to sell faster and thus, attract more Buyers. The fact is, 70-80% of small to medium sized business never sell. Why? Not enough profit, too much risk, poor processes. Buyers simply cannot financially justify buying business that don’t provide an ROI or worse, lose their money. Don’t believe us? Speak with a few Buyers and ask them how many businesses they have reviewed and not even signed an NDA to see them CIM. Now, imagine a Buyer sees your business as a Platform. They no longer pass on your business. On the contrary, they envision themselves owning it, running it with confidence, not having to re-build it, but instead growing it, and furthering your legacy. If you have developed your business as a Platform, it's likely you will receive countless offers. You may even avoid the costly penalty of hiring a banker or broker.

Whoever buys your business is going to want to create more value. As stated above, the valuation increase may either come through multiple arbitrage through selling your business as an add-on or through transformation into a Platform. Either way, a Buyer needs to find growth value in buying your company. Our question is, why pass on the increased valuation to a future Buyer if you can increase the valuation yourself. If you are concerned that by transforming your business, Buyers may feel there is not enough value creation opportunity? Have no fear, there will always be Buyers for great businesses.

How to Transform Your Business into a Platform – Three Major Themes

Theme One – Derisk Your Business

The number one deal killer for any Buyer is risk. In small and medium sized business, risk most often manifest in three areas: Keyman risk, customer concentration, and vendor concentration. There are other risks like product market fit or macro issues with the market, but the three most frequent risks we see are keyman, customer and vendor concentration. And of those three, Keyman is the number one. So, the first thing you must do is address your risks head on. If a key Salesperson is driving the majority or revenue, it must be addressed. If 80% of your revenue is generated by one customer, it must be addressed. Just like going to the doctor, your business risks must be addressed and a plan must be put in place to reduce the risk. The more you can reduce the risks in your business, the more your business will look like a Platform, and the higher valuations you will achieve.

Theme Two – Add Scalable Processes

One of the most frequent comments we hear from SMB business owners is, “I started a business, so I don’t have to be crippled by processes and I for sure don’t want meetings to take up my day. My customers love our custom approach” The reality is, when Buyers see a business running without processes, it quickly looks out of control. The business looks like it doesn’t have a plan. Sure, customer like a custom one-on-one approach, but that is very hard to scale. Where not here to tell you to lose the creativity and customer focus, but sales, finance, and operations crave repeatable processes. This means, starting with an operating meeting, determining your KPI’s, budgeting, developing a sales pipeline, etc… When a Buyer evaluated a business what repeatable processes, it’s a business they can quickly learn and grown. It’s a Platform business.

Theme Three – Increase Your EBITDA / Profit

Increasing your EBITDA will always be limited if you do not de-risk your business and add scalable processes first. Rarely are they independent. Why? Let’s start with risk first. Risk is a governor on your business, just like a governor on a school bus limits its maximum speed. If your customers are too concentrated, they will occupy the majority your time. If sales are dependent on one person, they hold your business hostage. Both governors. Second, without sound processes in place you cannot scale. You cannot increase your sales base without a well processed sales pipeline and you cannot meet customer expectations with strong operational processes. And above all, you cannot translate it to Buyers without sound financial processes. Stronger EBIDTA is an output of de-risking your business and adding scalable processes. Stronger EBITDA is the Platform.

Should You Transform Your Business into a Platform Yourself or Hire a Partner?

If you have not transformed a business into a Platform before, we always advise not to do it alone. Ask for help. Whether it’s Fenwick Partners, another firm, or a key hire, bring on someone who not only knows what good looks like, but has also transformed businesses in the past and has a track record. There are a few reasons why we advise asking for help. First, and most obvious, is you are able to quickly skill-up without the having to train. Sure, you could task one of your current employees, but have they been responsible for transforming businesses in the past? Second, by investing your capital into the project, you are more focused on the results. You simply cannot look away if you are investing your hard earned money. Third, you will achieve results faster. A consulting group or key hire that has transformed multiple business across a wide variety of industries understand many of the pitfalls, how to avoid them, and how to best focus on ROI driven initiatives.