Roll-Ups: Lessons for Private Equity

Core Catalysts works with Private Equity (PE) firms across a broad range of types of engagement, from strategy to due diligence, through to integration planning and operational improvement. Recently we have worked closely with multiple firms on their strategies for industry roll-ups. From this, we have distilled several lessons we thought it would be worthwhile to share.

Lesson 1: Industry fragmentation is your friend.

Roll-ups work best in heavily fragmented industries: the fewer local, regional, or nationally dominant players, the better.

The first reason for this is simple: the more businesses there are in an industry, the more acquisition targets there are!

A less obvious reason is that acquiring “mom-and-pop” businesses can be far easier (and cheaper) than targeting even mid-sized industry players and is also less likely to lead to inflated valuations.

Focusing on mom-and-pops also capitalizes on one of the key challenges these kinds of businesses face: succession. The most stressful part of every “mom-and-pop business owners’ journey is achieving a successful exit, in particular if family members are not interested in carrying it on. PE firms pursuing roll-up strategies can make attractive offers that guarantee a successful exit while also ensuring the businesses that have been built will carry on and prosper.

Equally, once the roll-up has achieved some scale, it gets even easier to convince other sellers they are better off joining you than remaining stand-alone. This is only possible if there are no or few large players waiting in the wings to compete for deals.

Lesson 2: Boring and predictable is good.

Funeral services, car washes, waste management, and HVAC repair are all examples of boring and predictable industries that have proven lucrative for PE roll-ups.

There are multiple reasons why boring and predictable businesses work well for roll-ups. These include:

• They are easy to understand.
• They are easy to value.
• There is less competition for deal flow.
• They are simpler to integrate.

Put simply:

• Stable, reoccurring revenue is like catnip to PE firms. These businesses are easier to model and lenders can be made to feel comfortable with proposed levels of leverage, making financing easier.
• The investment case for a roll-up often includes achieving meaningful economies of scale (such as increased purchasing power, greater brand recognition, lower capital costs, and more effective advertising): simple businesses are easier to merge and integrate, making these “synergies” that much easier to achieve.

Bottom line: boring industries can deliver outstanding ROI.

Lesson 3: Having a great platform company really helps.

A platform company is the initial acquisition or “core company” that acts as the starting point for other roll-up acquisitions in the same industry.

Merging and integrating acquired companies is a lot easier when you have a high-quality platform company.

Why is this?

Well firstly, a high-quality platform company is a great educator: you quickly learn what works and doesn’t work within your original roll-up strategy and can hone and refine your entire approach (from target list to due diligence approach, all the way through to integration strategies and synergy targets).

More importantly, a great platform company gives you access to high-quality management and deep industry and operational experience, expertise, and know-how that can be leveraged to complement and enable your ongoing roll-up game plan.

Quality platform companies also have good systems, processes, and procedures that can be implemented, duplicated, or modified in acquired companies. Having a proven, replicable, operational blueprint and playbook is frequently an asset during the execution of roll-up strategies.

In summary: high-quality platform companies can lead to a proven operational formula that can be applied to acquired companies during integration.

Lesson 4: Don’t be too aggressive in your roll-ups.

Speed and driving (necessary) change are important in roll-ups, but too much change, too quickly, can be bad.

First, roll-up strategies must factor in people, and the fact that different companies (that you are trying to merge or drive synergies between) have different cultures and personalities.

Equally, change and uncertainty can paralyze organizations.

As mentioned previously, good roll-ups have a sound operational formula that can be repeated over and over during integration.

This formula should include robust communication strategies and an implementation plan that adopts a reasonable pace and cadence that is sensitive to people and change factors.

Practically, what this means is that initially, the roll-up plan should focus purely on rolling up financials into one entity (or achieving an effective enterprise level data view) while operationally keeping the businesses running separately and largely the same as they were pre-deal.

Then, gradually, back-office functions can be harmonized, integrated, and/or consolidated as applicable, focusing on delivering the most bang for the buck.

Only once this is done should front-office integrations (such as cross-training sales teams, centralizing company-wide branding, etc.) be considered.

Avoid the pitfalls:

• Doing it all at once will most likely not work out as planned, and could result in disgruntled staff, key employees quitting, and revenues falling far short of plan (endangering debt service).
• Think long-term (and don’t be greedy): loyal customers will sense that something is amiss if prices are increased too quickly and too much, new add-on products, services, and upgrades are suddenly aggressively marketed, or if service levels and availability are decreased significantly from what they’ve been used to.

In roll-ups, there are many sure-fire ways to damage and destroy the very brand equity and customer loyalty that made these businesses good acquisitions in the first place. The consolidated company should be a vast improvement for each individual company involved, and for the key stakeholders each company relies upon.

Making sure that any changes being implemented are actually improvements (versus taking advantage of potential reductions in competition), implementing them gradually, and focusing on maintaining and building employee and customer trust are all critical in roll-ups.

Lesson 5: If you don’t love integration, roll-ups are not for you.

PE firms are meant to deliver superior financial returns to their investors. PE firms are typically well-versed in all aspects of financial engineering and bring hawk-like focus to important considerations like cash flow and capital allocation.

However, success in roll-ups is often less about finance and more about operations. Folding companies under one umbrella (back-office, front-office, or both) effectively demands that the acquirer become a merger integration specialist. They need to be willing to roll-up their sleeves, get involved in the operational fundamentals, and drive the day-to-day blocking and tackling and front-line work required to drive change and deliver effective integration.

Even with good company level management in place, time and time again it has been proven that a strong appetite for operational challenges and a passion for integration (and doing integration right) are critical success factors for roll-ups.

If you don’t have the right integration resources in-house, make sure you contract with partners who can bring the experience, expertise, and knowledge needed.

Summary

• Lesson 1: Industry fragmentation is your friend.
• Lesson 2: Boring and predictable is good.
• Lesson 3: Having a great platform company really helps.
• Lesson 4: Don’t be too aggressive in your roll-ups.
• Lesson 5: If you don’t love integration, roll-ups are not for you.

If you need help with your roll-up strategy, or would like to learn more, please reach out!

–Mark Jacobs, Client Service and Delivery