Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.
CEO and Founder of DealRoom
A study conducted by McKinsey over the course of two decades into successful M&A set out will disappoint followers of megadeals.
Pursuing a series of smaller deals, the total value of which is relatively close to the acquiring company’s market capitalization, rather than focusing on eye-catching ‘big bang’ transactions, tends to generate far more value.
In short, the research advocated a roll-up strategy for companies considering M&A.
In this article, DealRoom takes an in-depth look at the roll-up strategy, how to execute them, and the pitfalls to avoid.
Above all, we show how, in some industries, the leaders have gained their winning position through successfully executing roll-up strategies rather than being so-called disruptors.
So while McKinsey’s research refers to an M&A roll-up strategy as ‘programmatic M&A’, a far more accurate term may be ‘pragmatic M&A’.
What is a roll-up strategy?
A roll-up strategy is a focused acquisition strategy that involves the acquisition of multiple smaller companies (sometimes referred to as ‘bolt-on acquisitions’).
The roll-up strategy tends to be more common in industries that are fragmented but can happen anywhere that these bolt-on acquisition opportunities present themselves.
The end goal of a roll-up strategy is a company of much larger value that is more than the sum of its parts.
Why do investors love roll-ups?
The roll-up concept is attractive to investors for its value-generating potential. This value is achieved in a number of ways:
Economies of scale: The entity created from the roll-up strategy should enjoy economies of scale (e.g. increased buying power) well beyond any of the smaller companies that it is composed of.
Benefits of synergies: A well-executed roll-up strategy should benefit from a range of synergies that generate value at the margins. For example, shared administration and marketing costs.
Increased exposure: By virtue of being a bigger company, the entity created from the roll-up strategy will have increased exposure, giving it access to a larger audience and making it the focus of increased media attention.
Access to better opportunities (including capital): Bigger companies, as a rule, tend to enjoy a liquidity premium that lowers their cost of capital and allows them to access opportunities (e.g. more acquisitions) than smaller companies can.
Importance of having a disciplined roll-up strategy
A roll-up strategy doesn’t generate value on its own.
As DealRoom is constantly at pains to emphasize, acquisitions are complex projects that require diligent project management.
This means excellent planning, ensuring cultural and operational fit, thorough due diligence, and sound deal structure for each one of the acquisitions.
By extension, when there are many acquisitions, this workload should increase. Just because the companies are smaller, it doesn’t mean that you can take shortcuts in the process.
Best practices in Roll-Up strategies
The nature of an acquisition roll-up strategy is that most strategies are implemented over a period of three to four years.
Here is what can be found amongst best practices:
In general, the more diligent about roll-up and its strategies your business is, the higher your chance of achieving a successful outcome.
That said...
Here is a detailed overview of key steps to start with when you're considering roll-up as a strategy for acquisition:
Planning: Lots of it. Nobody should consider a roll-up strategy without planning five years ahead. At this stage, the team should be considering the maximum multiple of EBITDA that will be paid for the acquisitions, the geographies that the company is interested in, and the level of equity that it is willing to hand over to each of the acquired companies owners.
Develop systems: This should be part of the planning process but deserves a mention of its own. It should go without saying that a mid-sized corporation needs more systems to operate successfully than would a small, local company. For example, if the manager of a recently acquired company were to abruptly up sticks and leave, how easily would the business be run in his absence? Systemization is required to ensure zero disruption in cases like this.
Understanding the industry: Some industries benefit from scale more than others. Likewise, certain industries aren’t fragmented enough to warrant implementing an acquisition roll-up strategy. Sluggish industry growth or less-than-optimistic future prospects are also important to understand. It’s crucially important to understand the industry, its dynamics, and its future prospects.
Due diligence: More acquisitions mean more due diligence. As a result, for any company implementing an acquisition roll-up strategy, due diligence effectively becomes a core part of the company’s operations - not unlike its finance or HR department. And as due diligence becomes bigger, the acquiring company will need to hire a bigger team to ensure that it’s being conducted with the same rigor for every single transaction.
Careful Hiring: Closely related to due diligence is the need for the team behind the roll-out strategy to ensure management competency. The bigger the company becomes, the more difficult it becomes to manage. Does the new entity require a level of middle management or regional managers? Who is responsible for overseeing the day-to-day management of its new branches?
Integration: All the businesses need to be well integrated to ensure that the new entity is more than the sum of its parts. Without post-merger integration and change management, the acquirer risks being left with nothing but a group of disparate companies (and disgruntled managers and staff) on their hands.
Timing: There is no standard ideal time to move with a roll-up strategy. As with any acquisition strategy, if the strategy can be implemented faster, then it’s better to do it faster. But speed itself is not the issue - rather one of a range of issues. It shouldn’t come at the expense of careful consideration, thorough due diligence, the right valuations, etc. One benefit of being faster directly related to the roll-out strategy itself is that there will be less chance that target companies are aware of the strategy, and as a result, will be less likely to demand higher multiples of EBITDA to sell.
Measures to look out for
It’s easy to lose focus in a roll-out investment strategy and to allow the acquisitions to become the goal in themselves rather than just the means to a much bigger end goal.
Putting in place a range of measures (or KPIs) enables acquirers to keep their eyes on the prize.
The following are just some of those KPIs (with operational KPIs varying by industry):
Ownership distribution
Pre- and post-merger performance levels at each company
Debt/equity levels at the holding company (and blended cost of debt)
The average acquisition EBITDA multiple
Time to close each acquisition
Employee turnover levels
Operational costs at holding company (should be less than that of combined firms)
Why folding companies under one umbrella isn’t simple
To use a crude example, all things being equal, integrating five companies, each with $5 million in average revenue, is easier than integrating one company with $25 million in revenue.
To fold companies under one umbrella effectively demands that the acquirer become a merger integration specialist.
And of course, there are external market issues that the acquirer has no control over, which can wreck any roll-up investment strategy, even if the integration processes have gone smoothly.
How to find the best industry for roll-ups?
In short, the best industry to implement a roll-up strategy is one where there is:
No clear industry leader.
Little industry consolidation.
Returns to scale.
Positive growth forecasts.
Owners willing to sell.
Aspects of finding the right industry for roll-ups (and how-to)
As mentioned in the sections above, before implementing a roll-out investment strategy, it is important to understand an industry’s dynamics (nationally, if the roll-out strategy is national, and internationally, if it is international or global).
The most common proponents of roll-out strategies are private equity firms. These firms can spend up to two years at a time establishing which industries are suitable for roll-outs.
An example here is useful. Consider the dairy industry. Although most countries tend to have at least one dominant player, there will also be a number of smaller regional players making milk and selected dairy products for their local market.
Perhaps some will even have a limited export component. As a steady but usually not fast-growing industry,
Now, if someone were to begin acquiring these companies, they would be able to offer an extended range of products (milk, powdered milk, cheese, artisan cheeses, etc.) across a much wider geographic area.
There would also be benefits of scale - for example, better bargaining power with farmers and supermarkets. The fact that the brand was now nationwide, means that it would gain stronger marketing power.
But also think of the value-adding potential of the deal. Perhaps some of the smaller dairy companies were only producing liquid milk.
What if the extra milk output could now be turned into higher-value products such as gorgonzola, camembert, or brie cheese by the new company?
Suddenly, the same inputs are generating 2x to 3x the value as before.
And you begin to see where a roll-up strategy can become so powerful when executed properly.
Why Roll-Ups fail
Silver bullets do exist in M&A, but they’re remarkably rare.
So much positive material has been written about roll-ups that it’s easy to be convinced that this is a strategy where it is impossible to fail.
That just isn’t the case.
A 2008 Harvard Business Review article states that more than two-thirds of roll-up strategies fail to create any value for investors.
The reasons for these failures usually fall under one of the following categories:
Integration difficulties: As this article states, all things being equal, five smaller integrations usually means approximately five times the integration challenges as a company five times the size. This needs to be accounted for at the outset.
Lack of benefits to scale: Not all industries have benefits to scale. The HBR article in the paragraph above mentions the funeral industry, where benefits to scale can only be enjoyed at a local level, and even then, they’re questionable.
Failure to account for economic downturns: Most roll-up strategies are based on conservative economic projections, but what happens when there’s an economic collapse, such as one wrought by a global pandemic?
Overpaying for acquisitions: In an effort to close deals faster as part of a larger strategy, acquirers may be forced to overpay. This is also an issue as target companies become aware of the roll-up strategy. Overpaying destroys value in the overall strategy, just as it does in a standard acquisition.
Conclusion
To paraphrase Warren Buffett, when answering a University of Florida audience about what steps they needed to take to be successful investors: ‘you don’t need to do anything really earth-shattering.
You just need to consistently do lots of small things right.
This is the logic that underpins a roll-up strategy:
Consistently make smaller value-adding acquisitions, and your company will almost certainly outperform the market over the long-term.
However, on balance, closing more deals means more pitfalls for acquirers. Anyone undertaking a roll-up strategy needs to conduct significant resources for planning, due diligence, and post-merger integrations.
DealRoom has already helped dozens of companies with their roll-out strategies. Talk to us today about how we can add value for you when looking at implementing your planned roll-out strategy.
What is a roll-up strategy?
A roll-up strategy is a focused acquisition strategy that involves the acquisition of multiple smaller companies (sometimes referred to as ‘bolt-on acquisitions’).
The roll-up strategy tends to be more common in industries that are fragmented but can happen anywhere that these bolt-on acquisition opportunities present themselves.
The end goal of a roll-up strategy is a company of much larger value that is more than the sum of its parts.
A study conducted by McKinsey over the course of two decades into successful M&A set out will disappoint followers of megadeals.
Pursuing a series of smaller deals, the total value of which is relatively close to the acquiring company’s market capitalization, rather than focusing on eye-catching ‘big bang’ transactions, tends to generate far more value.
In short, the research advocated a roll-up strategy for companies considering M&A.
In this article, DealRoom takes an in-depth look at the roll-up strategy, how to execute them, and the pitfalls to avoid.
Above all, we show how, in some industries, the leaders have gained their winning position through successfully executing roll-up strategies rather than being so-called disruptors.
So while McKinsey’s research refers to an M&A roll-up strategy as ‘programmatic M&A’, a far more accurate term may be ‘pragmatic M&A’.
What is a roll-up strategy?
A roll-up strategy is a focused acquisition strategy that involves the acquisition of multiple smaller companies (sometimes referred to as ‘bolt-on acquisitions’).
The roll-up strategy tends to be more common in industries that are fragmented but can happen anywhere that these bolt-on acquisition opportunities present themselves.
The end goal of a roll-up strategy is a company of much larger value that is more than the sum of its parts.
Why do investors love roll-ups?
The roll-up concept is attractive to investors for its value-generating potential. This value is achieved in a number of ways:
Economies of scale: The entity created from the roll-up strategy should enjoy economies of scale (e.g. increased buying power) well beyond any of the smaller companies that it is composed of.
Benefits of synergies: A well-executed roll-up strategy should benefit from a range of synergies that generate value at the margins. For example, shared administration and marketing costs.
Increased exposure: By virtue of being a bigger company, the entity created from the roll-up strategy will have increased exposure, giving it access to a larger audience and making it the focus of increased media attention.
Access to better opportunities (including capital): Bigger companies, as a rule, tend to enjoy a liquidity premium that lowers their cost of capital and allows them to access opportunities (e.g. more acquisitions) than smaller companies can.
Importance of having a disciplined roll-up strategy
A roll-up strategy doesn’t generate value on its own.
As DealRoom is constantly at pains to emphasize, acquisitions are complex projects that require diligent project management.
This means excellent planning, ensuring cultural and operational fit, thorough due diligence, and sound deal structure for each one of the acquisitions.
By extension, when there are many acquisitions, this workload should increase. Just because the companies are smaller, it doesn’t mean that you can take shortcuts in the process.
Best practices in Roll-Up strategies
The nature of an acquisition roll-up strategy is that most strategies are implemented over a period of three to four years.
Here is what can be found amongst best practices:
In general, the more diligent about roll-up and its strategies your business is, the higher your chance of achieving a successful outcome.
That said...
Here is a detailed overview of key steps to start with when you're considering roll-up as a strategy for acquisition:
Planning: Lots of it. Nobody should consider a roll-up strategy without planning five years ahead. At this stage, the team should be considering the maximum multiple of EBITDA that will be paid for the acquisitions, the geographies that the company is interested in, and the level of equity that it is willing to hand over to each of the acquired companies owners.
Develop systems: This should be part of the planning process but deserves a mention of its own. It should go without saying that a mid-sized corporation needs more systems to operate successfully than would a small, local company. For example, if the manager of a recently acquired company were to abruptly up sticks and leave, how easily would the business be run in his absence? Systemization is required to ensure zero disruption in cases like this.
Understanding the industry: Some industries benefit from scale more than others. Likewise, certain industries aren’t fragmented enough to warrant implementing an acquisition roll-up strategy. Sluggish industry growth or less-than-optimistic future prospects are also important to understand. It’s crucially important to understand the industry, its dynamics, and its future prospects.
Due diligence: More acquisitions mean more due diligence. As a result, for any company implementing an acquisition roll-up strategy, due diligence effectively becomes a core part of the company’s operations - not unlike its finance or HR department. And as due diligence becomes bigger, the acquiring company will need to hire a bigger team to ensure that it’s being conducted with the same rigor for every single transaction.
Careful Hiring: Closely related to due diligence is the need for the team behind the roll-out strategy to ensure management competency. The bigger the company becomes, the more difficult it becomes to manage. Does the new entity require a level of middle management or regional managers? Who is responsible for overseeing the day-to-day management of its new branches?
Integration: All the businesses need to be well integrated to ensure that the new entity is more than the sum of its parts. Without post-merger integration and change management, the acquirer risks being left with nothing but a group of disparate companies (and disgruntled managers and staff) on their hands.
Timing: There is no standard ideal time to move with a roll-up strategy. As with any acquisition strategy, if the strategy can be implemented faster, then it’s better to do it faster. But speed itself is not the issue - rather one of a range of issues. It shouldn’t come at the expense of careful consideration, thorough due diligence, the right valuations, etc. One benefit of being faster directly related to the roll-out strategy itself is that there will be less chance that target companies are aware of the strategy, and as a result, will be less likely to demand higher multiples of EBITDA to sell.
Measures to look out for
It’s easy to lose focus in a roll-out investment strategy and to allow the acquisitions to become the goal in themselves rather than just the means to a much bigger end goal.
Putting in place a range of measures (or KPIs) enables acquirers to keep their eyes on the prize.
The following are just some of those KPIs (with operational KPIs varying by industry):
Ownership distribution
Pre- and post-merger performance levels at each company
Debt/equity levels at the holding company (and blended cost of debt)
The average acquisition EBITDA multiple
Time to close each acquisition
Employee turnover levels
Operational costs at holding company (should be less than that of combined firms)
Why folding companies under one umbrella isn’t simple
To use a crude example, all things being equal, integrating five companies, each with $5 million in average revenue, is easier than integrating one company with $25 million in revenue.
To fold companies under one umbrella effectively demands that the acquirer become a merger integration specialist.
And of course, there are external market issues that the acquirer has no control over, which can wreck any roll-up investment strategy, even if the integration processes have gone smoothly.
How to find the best industry for roll-ups?
In short, the best industry to implement a roll-up strategy is one where there is:
No clear industry leader.
Little industry consolidation.
Returns to scale.
Positive growth forecasts.
Owners willing to sell.
Aspects of finding the right industry for roll-ups (and how-to)
As mentioned in the sections above, before implementing a roll-out investment strategy, it is important to understand an industry’s dynamics (nationally, if the roll-out strategy is national, and internationally, if it is international or global).
The most common proponents of roll-out strategies are private equity firms. These firms can spend up to two years at a time establishing which industries are suitable for roll-outs.
An example here is useful. Consider the dairy industry. Although most countries tend to have at least one dominant player, there will also be a number of smaller regional players making milk and selected dairy products for their local market.
Perhaps some will even have a limited export component. As a steady but usually not fast-growing industry,
Now, if someone were to begin acquiring these companies, they would be able to offer an extended range of products (milk, powdered milk, cheese, artisan cheeses, etc.) across a much wider geographic area.
There would also be benefits of scale - for example, better bargaining power with farmers and supermarkets. The fact that the brand was now nationwide, means that it would gain stronger marketing power.
But also think of the value-adding potential of the deal. Perhaps some of the smaller dairy companies were only producing liquid milk.
What if the extra milk output could now be turned into higher-value products such as gorgonzola, camembert, or brie cheese by the new company?
Suddenly, the same inputs are generating 2x to 3x the value as before.
And you begin to see where a roll-up strategy can become so powerful when executed properly.
Why Roll-Ups fail
Silver bullets do exist in M&A, but they’re remarkably rare.
So much positive material has been written about roll-ups that it’s easy to be convinced that this is a strategy where it is impossible to fail.
That just isn’t the case.
A 2008 Harvard Business Review article states that more than two-thirds of roll-up strategies fail to create any value for investors.
The reasons for these failures usually fall under one of the following categories:
Integration difficulties: As this article states, all things being equal, five smaller integrations usually means approximately five times the integration challenges as a company five times the size. This needs to be accounted for at the outset.
Lack of benefits to scale: Not all industries have benefits to scale. The HBR article in the paragraph above mentions the funeral industry, where benefits to scale can only be enjoyed at a local level, and even then, they’re questionable.
Failure to account for economic downturns: Most roll-up strategies are based on conservative economic projections, but what happens when there’s an economic collapse, such as one wrought by a global pandemic?
Overpaying for acquisitions: In an effort to close deals faster as part of a larger strategy, acquirers may be forced to overpay. This is also an issue as target companies become aware of the roll-up strategy. Overpaying destroys value in the overall strategy, just as it does in a standard acquisition.
Conclusion
To paraphrase Warren Buffett, when answering a University of Florida audience about what steps they needed to take to be successful investors: ‘you don’t need to do anything really earth-shattering.
You just need to consistently do lots of small things right.
This is the logic that underpins a roll-up strategy:
Consistently make smaller value-adding acquisitions, and your company will almost certainly outperform the market over the long-term.
However, on balance, closing more deals means more pitfalls for acquirers. Anyone undertaking a roll-up strategy needs to conduct significant resources for planning, due diligence, and post-merger integrations.
DealRoom has already helped dozens of companies with their roll-out strategies. Talk to us today about how we can add value for you when looking at implementing your planned roll-out strategy.
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