Tuck-in acquisition: understanding pros and cons

With economic uncertainty and regulatory hurdles of 2023, more deal-makers focus on smaller-size deals, such as bolt-on and tuck-in acquisitions. In these transactions, a larger company absorbs a smaller firm to enhance its own operations and achieve strategic synergy.

This article addresses the hurdles M&A professionals and investment bankers deal with when navigating the complexities of tuck-in acquisitions. It also covers the pros, cons, and risks of these deals and offers practical solutions.

What is a tuck-in acquisition?

A tuck-in acquisition occurs when a larger company (also called a platform company) absorbs a smaller one from a related or the same industry. After the acquisition, the target company loses its original structure and business identity as it’s integrated into an existing division or business unit of the acquiring company.

As Kev Ryan from Accounting Firm Mergers & Acquisitions explains, “A tuck-in makes sense where organic growth would be more cost or time prohibitive than merging in a smaller business.”

With tuck-ins, the strategic buyer already has the necessary technology structure, distribution systems, and inventory in place. Its primary aim is to strengthen and enhance its existing operations and infrastructure.

Thus, to become an attractive target, a small company must present potentially beneficial opportunities for the acquiring company, such as complimentary services, skilled personnel, cutting-edge technology, or market share.

Let’s consider this example:

• Company ABC, a leading software developer known for its customer relationship management (CRM) solutions, is looking to enhance its data analytics and artificial intelligence capabilities. They identify Company XYZ, a smaller but highly specialized data analytics startup, as a valuable addition to their operations. After the acquisition, the Company XYZ’s team and technology are absorbed into ABC’s Research and Development division. As a result, ABC can now offer more advanced AI-driven analytics tools to its clients, thus strengthening its position in the CRM market.

A tuck-in M&A is just one of the strategies used by M&A professionals to meet specific goals. Understanding the differences between these strategies is crucial for success, as each has its unique benefits and requires a specific approach.

Just like there are distinctions between a horizontal merger vs. vertical merger, tuck-in deals are different from bolt-on acquisitions. Let’s compare them more closely.

Tuck-in vs. bolt-on acquisitions

A bolt-on acquisition deal occurs when a private equity firm adds a smaller business to a “platform” company. A platform is a large company that acts as the starting point for other acquisitions of smaller bolt-ons, allowing private equity firms to enhance the value of their overall investment.

Key differences between tuck-in vs bolt-on acquisitions include the following aspects:

1. Integration approach. A tuck-in acquisition involves fully integrating the target into the acquirer’s platform. Conversely, in a bolt-on acquisition, the acquired company retains a degree of independence and operates as a separate entity within the acquiring company’s portfolio.
2. Objective. Tuck-in acquisitions aim to achieve synergy goals by enhancing the acquiring company’s current business operations. In contrast, bolt-on acquisition strategies seek to expand the acquiring company’s capabilities or increase market reach without fundamentally changing its existing structure.
3. Name and branding. In bolt-on acquisitions, the acquired company typically retains its name and branding. In contrast, tuck-in acquisitions involve the rebranding of the smaller company. However, if the smaller company’s brand is widely recognized, it may be strategically beneficial to maintain its original name.

Let’s take a look at some real-world examples to see the differences between tuck-in and bolt-on acquisitions:

• Tuck-in acquisition example

Coca-Cola has a history of utilizing tuck-in acquisitions to expand its product offerings, including the acquisition of the juice brand Minute Maid in 1960 and the acquisition of Monster energy drinks in 2014. Both companies were fully integrated into Coca-Cola’s existing operations.

• Bolt-on acquisition example

When Facebook acquired Instagram in 2012, it made it a bolt-on company. Today, Instagram maintains its distinct brand identity while being integrated into the broader Meta family.

Identifying target companies

Selecting acquisition targets requires extensive data gathering and detailed analysis and, thus, seems tedious and time-consuming. But thorough target screening is totally worth it as brings benefits in the form of mitigated risks and maximized synergies.

The process can be divided into three main stages.

Stage 1. Filtering out inappropriate targets 

Start by defining and prioritizing key screening criteria based on your M&A strategic objectives. This can include:

• Cost

Set up the budget you can spend on an acquisition.

• Size

Determine the size of targets in terms of revenue, market capitalization, number of employees, etc.

• Profitability

Identify the necessary EBITDA/EBIT levels, net margin, and free cash flow requirements.

• Ownership preferences

Specify what level of control you’d like to have over the target.

• Marketing

Evaluate product lines, customer base, brand reputation, geographic presence, and distribution channels to ensure alignment with your market strategy.

• Production

Consider the availability of facilities, labor supply, and production techniques to ensure that the target’s production capabilities align with your operational needs.

When filtering out the targets, it’s also important to answer these questions:

1. What are the specific reasons for acquiring this company? Does the acquisition align with our strategic objectives?
2. What is the target company’s financial performance, including turnover and profitability?
3. Can the target be seamlessly integrated into our existing operations and culture?
4. What growth potential does the target company offer?
5. Is the timing right to pursue this target?

Once the data is gathered and analyzed, a long list of potential targets should be narrowed down to a shortlist of the most promising candidates.  

Stage 2. Strategic assessment 

At this stage, more qualitative data gathering and analysis is required. The main goal is to understand whether the transaction with the target is possible and potentially beneficial. 

The key questions to answer here are:

1. What synergies does the target bring to our current business operations?
2. What’s the target’s competitive position compared to other players in the market? What are its growth prospects?
3. What long-term value can the acquisition bring to our organization?

When answering, think of the potential reasons to eliminate a target from the list. This may include a lack of information, possible financing challenges, unexpected market changes, possible integration challenges, or mismatched products or services.

Stage 3. Target selection

Once the final list of candidates is created, develop a profile for each of them. It can be a concise summary or a detailed document, but its main purpose should be to help you prioritize and decide which target to pursue. 

You can include information like:

• Target’s business strategy
• Product or service summary
• Target’s financial health overview
• Competitive position
• Cultural alignment
• Customer relationships 
• Management team background

To make target identification easier and more efficient, consider the following strategies and tools:

• Market research

Conduct thorough market research using resources like industry reports, databases, and market analysis.

• Advisors

Work with financial advisors, investment banking representatives, and M&A professionals who have expertise in the industry. They can help identify suitable candidates.

• Acquisition search firms

Engage acquisition search firms that specialize in finding potential candidates for transactions.

• Technology tools

Utilize M&A software like virtual data rooms. Such solutions provide opportunities for proper due diligence and data analytics.

• Professional networks

Leverage your professional network and connections to seek recommendations and introductions to potential targets.

Key benefits of tuck-in acquisitions

Tuck-in acquisitions offer several strategic benefits to both the acquiring and acquired entity:

1. Access to new resource. Tuck-in acquisitions provide larger companies with the desired resources. For example, they gain intellectual property, complementary product lines, patents, and technology. Furthermore, they make raising capital for future acquisitions more accessible by expanding the range of assets that can be used as collateral for bank loans.
2. Revenue growth. By integrating the products or services of the acquired entity into its existing offerings, the acquiring company can access new customer segments and expand its revenue streams. For example, when Microsoft acquired LinkedIn, the business social network began demonstrating steady growth, surpassing $10 billion in annual revenue for the first time.
3. Market dominance. By acquiring smaller companies, large firms can access new markets, customers, and distribution channels, which ultimately strengthens their competitive position, facilitates long-term growth, and leads to business expansion. For example, when Amazon acquired Whole Foods in 2017, it expanded its customer base into the grocery sector.
4. Talent and expertise. Tuck-in acquisitions often bring talented employees and industry expertise to a large company. This infusion of knowledge and skill can improve the company’s capabilities and drive innovation. For example, Facebook’s acquisition of Oculus VR brought experts in the field of virtual reality, enhancing Meta’s capabilities in the AR/VR industry.
5. Cost synergies. The consolidation of operations and resources in tuck-in acquisitions often results in cost efficiencies. This includes savings through economies of scale, reduced overhead, and streamlined processes. On average, the cost synergies range between 1‑5% of total combined costs.

The risks and downsides of tuck-in acquisitions

While a tuck-in acquisition brings numerous advantages, companies involved should be aware of potential risks and downsides.

1. Financial risks

When seeking to gain control of a smaller firm, it’s an acquirer who is responsible for covering asset acquisition costs, attorney fees, loan fees, regulatory fees, and commissions. This can potentially lead to overpaying for the target company, increasing debt levels, or resulting in equity dilution.

To avoid financial risks, develop a detailed financial plan that includes cost estimates, financing options, and a realistic budget for the acquisition. Consider multiple scenarios.

2. Synergy risks

When a larger company acquires a smaller one, there is an expectation of synergy, where the combined entity is more valuable than the sum of its individual parts. However, the wrong choice of a target and incompatible cultures, strategies, or operations may result in missed opportunities, operational inefficiencies, and financial losses.

To avoid synergy risks, focus on appropriate deal structuring and conduct proper due diligence. Examine not only financial records but also cultural fit, management practices, and operational aspects.

Navigating the complexities of tuck-in acquisitions

Tuck-in acquisitions can be highly complex, involving a multitude of challenges that M&A professionals often face. Here’s an overview of the most common ones:

1. Valuation and pricing. Determining the fair market value of the target company presents several challenges due to subjectivity, market volatility, and the complexity of financial analysis, which includes assessing tangible and intangible assets. To address this challenge, employ experienced valuation professionals who can apply a mix of valuation methods and provide objective analysis.
2. Regulatory compliance issues. Ensuring that the deal adheres to relevant laws, regulations, and government approvals can be time and effort-consuming. Additionally, failing to address these requirements can result in costly delays, legal implications, and even deal termination. To avoid the risks, coordinate with legal experts to identify and address all regulatory concerns.
3. Stakeholder communication. Failing to meet employees’, customers’, and shareholders’ expectations regarding the strategic reasons and benefits behind the acquisition can lead to opposition, impacting the deal’s success. That’s why it’s critical to implement clear and transparent communication strategies to ensure stakeholders understand the acquisition’s goals, benefits, and potential impact on them.
4. Ownership transfer. This includes the negotiation and drafting of transfer provisions, addressing intellectual property rights, and managing employee transitions. Failure to execute a smooth ownership transfer can result in legal challenges or operational disruptions. To prevent such issues, seek professional expertise to guide the transfer process. It’s especially beneficial to engage an experienced legal counsel.
5. Post-acquisition management. Each company involved in a transaction has its own unique corporate culture and corporate identity, as well as processes, structures, and other operational aspects. That’s why company integration presents a challenge to realizing the intended synergies. Develop a comprehensive integration plan that addresses all business aspects, including technology, processes, and workforce.

Keep in mind that even though there are many differences between the buy side vs. sell-side M&A, two companies should be interested in addressing the complexities of a transaction.

Key takeaways

Let’s summarize:

• Tuck-in acquisitions meaning can be defined as a corporate strategy in which a larger company absorbs a smaller company, integrating it into existing operations to enhance product offerings, market presence, or operational capabilities.

• The key difference between bolt-on acquisitions vs tuck-in acquisitions lies in the integration approach. In a tuck-in acquisition, the target is fully integrated into the acquirer’s platform, whereas in a bolt-on acquisition, the acquired company retains a degree of independence and operates as a separate entity within the acquiring company’s portfolio. 

• Identifying suitable target companies for tuck-in acquisitions involves three stages, including filtering out inappropriate targets, strategic assessment, and target prioritization.

• Tuck-in acquisitions offer access to new resources, revenue growth, market dominance, talent infusion, and cost efficiencies, facilitating the acquiring company’s competitiveness.

• Tuck-in acquisitions are complex and involve challenges such as valuation and pricing, regulatory compliance, stakeholder communication, ownership transfer, and post-acquisition management.