A common private equity value-creation strategy is drawing increasing attention from US regulators who are scrutinizing add-on deals by private equity portfolio companies for potential violations of antitrust laws.

Private equity firms completed 3,279 add-on transactions between Jan. 1 and Oct. 25, according to Preqin data, putting add-ons on course for a year-over-year decline from 4,799 deals in 2022 amid slower private equity dealmaking. Only a subset of those add-on deals — in which the acquisition target is combined with another business in the private equity firm's portfolio — might raise concerns with regulators focused on patterns of small acquisitions that consolidate a market, according to Thomas McGrath, US global practice head and antitrust partner for law firm Linklaters.

"It's the small [acquisitions] that go under the radar that they think are being stealthy," McGrath said in an interview.

The Federal Trade Commission in September sued U.S. Anesthesia Partners Inc., a Dallas-based anesthesiology practice, and its private equity sponsor, Welsh Carson Anderson & Stowe, alleging that a roll-up of Texas anesthesiology providers constituted a "multi-year anticompetitive scheme" that cut care options and drove up costs for consumers.

Increasing scrutiny

Healthcare ranks fifth out of the top five sectors with the most private equity add-on deals since 2018, according to Preqin data. IT had the greatest number of add-ons in that period, accounting for more than one out of every five private equity add-on deals since 2018.

"A lot of [add-on] deals are predicated on streamlining operations and just driving some operational efficiencies," said Pete Witte, global PE lead analyst for EY. While some are more opportunistic, giving the acquirer access to a key market or new capabilities, others comprise a roll-up strategy in which a private equity firm establishes a platform company and grows it into a dominant market player via a series of acquisitions.

Private equity roll-ups would be more likely to draw the attention of regulators under updated merger guidelines proposed in June by the Department of Justice and the FTC, which last year ordered a private equity fund operated by Jab Holding Co. SARL to divest several veterinary clinics assembled in a roll-up.

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"The more add-ons you do in a given market, whether it's a geographic market or a sector market, the more likely that is to draw scrutiny," Jesse Debban, a partner in law firm Allen & Overy's corporate practice, said in an interview. The risk for private equity firms is that it is hard to tell where regulators will draw the line.

"[If] there's a chance that this one will be the straw that broke the camel's back, you're going to think very hard about doing that deal because not only will that deal be under the microscope, but all your previous ones will, too," Debban said.

Sinking deals

The antitrust focus of US regulators "has a significant probability of sinking deals," according to law firm Dechert LLP's 2024 Global Private Equity Outlook report.

The Dechert Antitrust Merger Investigation Timing Tracker, a regularly updated analysis of deal investigations and litigation in the US and Europe, found that 60% of "significant investigations" by US regulators in 2022 resulted in a complaint or abandoned transaction, up significantly from 37% in 2021.

Of the 100 senior-level private equity executives surveyed by Mergermarket on behalf of Dechert in the second quarter, 71% said greater scrutiny from antitrust authorities will likely have a "negative impact" or "significant negative impact" on dealmaking over the next 12 months.

Debban said just the threat of an investigation can delay a closing and rack up attorney fees. "It can create all sorts of problems for your deal and your financial model," he said.