A roll-up M&A is where you combine two or more small enterprises to form a much larger business.
They can be a useful way to grow your business quickly, but pose certain issues for entrepreneurs.
This guide walks you through the pros and cons of roll-ups, and gives some pointers for executing a successful strategy.
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What’s a roll-up acquisition?
A roll-up acquisition is where several smaller companies are rolled up to form a much larger entity.
Private equity firms sometimes use roll-ups to move a business into a new market sector, access new customers or assets, or grow and scale. Because large companies are often more valuable than smaller ones, they can make money by selling the rolled-up company or floating it on an exchange via an Initial Public Offering (IPO).
How can I benefit from a roll-up acquisition strategy?
Larger businesses often dominate their market sectors because they can offer a wider range of products or services and make economies of scale.
Some market sectors are quite fragmented, with many smaller businesses operating in particular niches. Some examples are the restaurant and furniture industries. This fragmentation can attract investors who see the potential for ‘rolling up’ individual companies thereby leading to greater profits and increased value.
Here are some reasons roll-up mergers can be useful:
Economies of scale
Companies can become more efficient when they merge by distributing their production costs across larger volumes, bringing down unit costs and becoming more profitable.
Sometimes companies execute a ‘vertical’ merger where they buy up smaller companies in their supply chain, saving costs that way. Or they merge across their sector ‘horizontally’ by buying up smaller businesses in different markets or locations. This way, not only can they make economies of scale they can also enter new markets.
Market influence
If enough companies in a sector roll up, they can become a dominant player in a market. As such, the resulting business can raise prices more easily and increase profits. It can also get better deals from suppliers and financiers like banks.
Cross-selling
By gaining access to new customers and broadening its product range, a roll-up company can scale without acquiring these organically.
Better financials
Sometimes a merged company will improve its financial position such as its price-to-earnings ratio, or being worth more overall, without changing anything about its business.
What are the negatives of a roll-up acquisition strategy?
Although roll-up mergers can be very beneficial, they are also highly risky. Here are some of the downsides:
Challenges from market regulators
The UK Competitions and Markets Authority (CMA) has recently identified roll-up acquisitions as a potential target for investigation and enforcement, particularly in the veterinary, dental and medical sectors. If you are considering a roll-up, it’s essential to take advice from competition lawyers pre-deal.
Integration problems
Mergers and acquisitions are complex transactions that need much negotiation and paperwork. Often the acquired companies have very different cultures, leadership styles and ways of doing business. When leaders’ styles clash, this can hinder integration and delay the benefits of the merger.
In addition, changes at the top can negatively affect morale, increase staff turnover and lead to a loss in productivity. The new company will have to find a way to bring teams together to ensure success.
Misalignment of merged companies
Sometimes, the merged companies are so different that it’s simply too difficult to roll them up. Maybe their assets are mismatched so they can’t be combined to make savings. Another example is where consumers prefer to buy from smaller, local businesses rather than a merged and distant business.
Financials
While merged companies can improve their financials by merging, this doesn’t necessarily mean that the company’s financial position has improved; rather it now has the potential for improvement. If it fails to take advantage of the roll-up, its value can rapidly deflate.
In addition, a company may need substantial finance to execute its roll-up and will have to service this debt increasing the pressure on cash flow. It may also find itself with a lower credit rating leading to worse financial terms, and the combination of these two factors can tend to snowball, leading quickly to difficulties.
If the new company uses equity rather than debt to finance the deal, this can also cause problems such as loss of control over decision-making and dilution of founder holdings.
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What key things do I need to consider before executing a roll-up merger?
One of the first things to consider if you’re thinking about a roll-up merger is whether you understand the market sector you’re targeting. The most successful roll-ups have been in fragmented sectors with no real dominant players. Highly regulated sectors can offer attractive pickings when market conditions change. For example, the Covid-19 pandemic gave rise to the emergence of small companies offering testing products, offering opportunities for successful roll-up mergers.
You also need a proven formula for extracting value from the merger, and a clear plan to consolidate employees, management structures, assets, sales channels and IT. As with franchise businesses, a tried and tested process-driven approach is the best guarantee of success. You’ll need a organisational discipline to maximise your chances.
Finally, make sure you have the money to finance the deal. If you’re planning an IPO, have you considered the additional complexity and regulatory scrutiny involved, post-IPO?
How can I finance a roll-up acquisition?
One of the trickiest parts of executing a roll-up strategy is funding it. You can use your company’s capital, take on more debt or look for funding from private or public equity. Either way, you’ll likely need more cash than you’ve got at hand. The most common source of funding is the private equity market.
Using equity funding
If you choose private equity to fund your roll-up, you should choose a specialist firm. Roll-up mergers tend to need more capital and can be more difficult, so you’ll need a team that knows what it’s doing.
Using your company’s equity as currency
Another way to fund a roll-up is to give away some of the company’s equity as part of the deal. While your share of the company might fall, you could achieve gains overall.
How will I integrate my roll-up acquisition?
The most important thing is to have a strategy and clear objectives for your acquisition. Decide your goal, for example, expanding into new territories, expanding your products or gaining a new customer base. Be realistic about how tough the negotiations can be. Getting expert help is essential and using experienced mergers and acquisitions lawyers is one of the keys to success.
While you may see the advantages of a roll-up in theory, realising that hidden value can be tricky in practice. A good advisor can help you work through the financial implications of the deal and point out potential flaws in your approach, leading to a more successful roll-up.
For more advice on mergers, acquisitions and roll-ups, consult our corporate solicitors. Get in touch on 0800 689 1800, email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
