I recently wrote about how to set your strategies around mergers and acquisitions, but I wanted to go into more detail about one type of M&A strategy: the roll-up. A roll-up is when you plan to buy multiple businesses within one industry. And, there are many potentials ways to implement a rollup, which I will detail herein.
You need to figure out exactly what your goal is from the roll-up, much more than simply growing revenues and market share. For example, you may be rolling up geographies for an expanded footprint of boots on the ground: taking you from Chicago alone, into New York, Los Angeles and Miami too. Or, you could be rolling up products: taking you from a one product company (e.g., search marketing agency) to a multiple product company (e.g., adding email marketing, digital advertising and social media marketing). Or, you could be rolling up industries to sell into: adding automotive, retail and consumer products, to your original insurance focused business. Or, you could be rolling up talent: if your marketing driven business is able to add a strong sales team or strong technology development team into your arsenal. Whatever is most needed for your business, and positions you for long term success when you are done.
One way you can finance a roll-up is simply using your company’s equity as a currency. For example, you own 100% of one business today, but you might own 25% of the company, after four businesses are rolled-up, with the shareholders of the other businesses owning the other 75%. Although most sellers like to see some cash at the time of sale. The other way to finance a roll-up is by finding a private equity fund to help you with the needed cash, with the fund making an investment in your company. Not all private equity funds do roll-ups, so you need to find the funds that prefer roll-up strategies in your industry (and can guide you through the typical pitfalls to avoid, which they have learned over the years). And, assume the fund will not be financing the roll-up entirely with equity, so make sure the rolled-up businesses will have at least $3MM of cash flow with which to pay any debt-related payments which may be involved.
My number one mantra from a roll-up of businesses is to “Do No Harm”!! Do not try to fully-integrate these businesses day one, given the various personalities, company cultures and skillsets involved. I try to think of it in three sequential phases: (1) phase one is simply rolling-up the financials into one entity, keeping the businesses largely running the same as they were before the deal; (2) phase two is integrating all the back-office functions across all companies (e.g., payroll, insurance, overhead); and (3) phase three is integrating the front-office functions (e.g., cross-selling products, cross-training sales teams, centralized brand). Don’t try to do it all at once, as it will most likely not work out, as planned, and could result in disgruntled staff quitting and revenues falling far short of plan. Phase it in over a couple years.
There are a lot of potential pitfalls with any single M&A transaction, which I won’t repeat here. But, when you are rolling-up multiple M&A transactions, the opportunities for pitfalls are multiplied and compounded. For example, merging two company cultures is hard enough, yet alone merging ten company cultures. And, although the growth is exciting, the employees may not like the combined Newco company ,as compared to how things used to be at the stand-alone Oldco company. So, get ahead of those issues and start pre-selling the future vision and culture across the organizations from day one, and make sure each company is involved in the creation of whatever plans are discussed. And, often times, small businesses are dependent on their founders, so make sure they are locked-up as employees of Newco for some mutually agreeable transition period (e.g., at least one year), to ensure a smooth transition and limited impact to revenues post transaction.
I have previously talked about shooting for 1+1=4 economics from M&A transactions. For example, two complementary products, selling into two different industries, gives two $10MM revenue businesses the chance to get to $40MM together, after they start cross-selling their products into the other company’s clients. But, those economics don’t hold up when only rolling-up geographies, as example, where 1+1=2 in a best case scenario of nothing going wrong. And, as we learned, the opportunity for things to go wrong is quite high. So, build in cushions into your combined company revenue plans. Perhaps build in a 50% haircut on the target company’s revenues when building your models and negotiating your deals (giving the seller an earn-out if things go to plan, but not overpaying if they don’t).
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