Roll-up mergers and acquisitions can be beneficial, but they can also be difficult to pull off. Mergers and acquisitions are often complex, and roll-ups in particular face certain obstacles that can be difficult to surmount.
This guide walks you through the pros and cons and provides some pointers as to how you might successfully execute a roll-up acquisition strategy.
- What is a roll-up acquisition?
- What are the benefits of a roll-up acquisition strategy?
- What are the negatives of a roll-up acquisition strategy?
- What key things do I need to consider before executing a roll-up merger?
- How can I finance a roll-up acquisition?
- How will I integrate my roll-up acquisition?
What is a roll-up acquisition?
A roll-up merger is a consolidation process whereby smaller companies are rolled-up to form a much larger entity. They are sometimes pursued by investors like private equity companies. They are often used in new market sectors and are a way for businesses to grow and expand. Because large companies are often valued more highly than smaller ones, they enable private equity firms to drive value from a sale of the new business or a flotation via an Initial Public Offering (IPO).
In a roll-up merger, the owners of the companies being merged get cash and shares in return for their equity. These companies are then transferred to a holding company and combined. The advantages to the new business’s owners can include better market placement, improved access to new customer, technology and markets.
What are the benefits of a roll-up acquisition strategy?
Larger businesses are often more successful than smaller ones and can dominate the sectors in which they operate. This is because they offer a wider range of products or services, are able to make economies of scale and also profit from improved brand awareness. Think Apple, Microsoft and Facebook for example.
In contrast to markets with a few, major players are more fragmented, with lots of smaller businesses operating in particular niches. Some examples are the restaurant and furniture industries. This fragmentation can lead to opportunity for investors who see the potential for ‘rolling-up’ individual companies and creating a larger one, leading to greater profits and increased value.
Some examples of successful roll-ups include the American giants, Waste Management, Inc. and Blockbuster Video. These businesses were the result of smaller companies being combined into a single player that dominated its respective market sector.
Here are some particular benefits of roll-up mergers:
Economies of scale
One potential benefit of a roll-up merger is that a company can make economies of scale by becoming more efficient, distributing its costs of production across larger volumes, lowering its unit costs and becoming more profitable.
A company (newco) could execute a series of ‘vertical’ mergers and acquire a number of smaller companies that produce products that are vital its supply chain. By acquiring these companies, it can save costs and consolidate its business. Or, newco can pursue a ‘horizontal’ merger, where it buys a number of small companies operating in the same sector but in different markets, perhaps in different countries. By making economies of scale, it can cut down on costs as well as gaining access to new markets.
A company can significantly increase its share of a market by acquiring companies. If it makes enough acquisitions to significantly increase its size, it can become the dominant player giving it the power to increase prices and therefore profits as well as reducing costs through economies of scale.
Because it’s now large and influential, it can get better deals from suppliers, negotiating for lower prices as it’s buying larger quantities. It can also gain better to finance on more attractive terms as it’s a lower risk proposition.
By increasing its access to new customers, or by increasing the numbers or types of products it sells to existing customers, a company can scale without having to acquire these customers by its own marketing efforts.
Sometimes a new, merged company will gain improved financial status by gobbling up smaller ones. It may have a better price to earnings ratio, or higher overall value than before 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:
Mergers and acquisitions are complex transactions and require a lot of negotiation and paperwork. Often the companies being acquired have very different cultures, leadership styles and ways of doing business. When leaders clash, this can hinder the progress of integration and making the changes that are needed to take advantage of the merger can become protracted.
In addition, changes in leadership can lead to drops in morale, the departure of talent, and falls in productivity. The new company will have to find a way to bring teams together to ensure success.
Mis-matches in merged companies
Sometimes, the companies being merged are so different that it proves too difficult to make a success of the roll-up. Maybe the companies’ processes or assets are so different that it’s hard to make economies of scale. Or customers may prefer to buy local. For example, buyers may prefer to buy a car from a dealership in their local area, rather than from a large and distant consolidated company.
Merged companies can improve their financials by merging. However, since these improved financials are not tied to any real improvement in the company’s financial position, but rather the potential for improvement, if the company 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 its financial position. It may also find itself with a lower credit rating that can add to worse financial terms, and the combination of these two factors can tend to snowball, leading quickly to financial difficulties.
If the new company uses equity rather than debt to finance the deal, this can also lead to issues, including loss of control over decision-making and dilution of founder holdings.
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, Covid-19 has given rise to the emergence of small companies offering testing and track-and-trace technology. Consolidating smaller companies in this market could offer opportunities for a successful roll-up merger.
A second thing to consider is whether you have a proven formula for extracting value from the merger. You’ll need a 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 great deal of organisational discipline to maximise your chances.
Thirdly, have you finance in place to do the deal? Or, if you’re planning an IPO to finance it, have you taken into account the additional complexity and regulatory scrutiny that will be 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 firm that’s a specialist in this kind of deal. 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?
As well as generating finance for your roll-up, you’ll need to have a plan in place to manage the integration because this is the factor most likely to lead to success – or not. Think about whether you want to take things slowly or move quickly to build a new brand and keep talent on-side.
The most important thing is figuring out what your goal is, whether that be expanding into new territories, expanding your products or gaining a new customer base. You also need to 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 trusted 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.