MM M&A 011: Empire Building Through a Roll-Up Strategy

In this episode, Gina Cocking and Jeff Guylay continue their discussion on deal structuring.
Today, the focus is on roll-ups. Key takeaways from this episode are:
• Highly fragmented industries are ripe for roll-ups
• A roll-up is an attractive exit alternative for companies that are subscale or have an incomplete management organization
• Transparency from both the buyer and the seller leads to the most successful outcomes

Other episodes in our series about deal structuring include price and terms, earn outs, rollover equity, and reps and warranty insurance. 

Later in this episode, Gina is joined by our guest Rob Humble, Chief Revenue Officer at Innovative Aftermarket Systems ("IAS"), to share his insights from executing a roll-up strategy for IAS as the Senior Vice President of Strategy and Corporate Development.
In this episode, Colonnade Advisors addresses the following questions as related to roll-ups:
What is a roll-up? (01:02)
Gina: "A roll-up is when an owner, which could be a private equity owner or a strategic, starts with a platform company. The roll-up adds other companies in the same industry, and they're typically smaller companies than the platform. The add-on companies are rolled into the platform."

What is the purpose of implementing a roll-up strategy? (01:34)
Gina: "It's a way for a company to increase in size inorganically, quickly, and while doing so, they are recognizing both expense synergies and perhaps revenue synergies."

Jeff: "It plays on the themes that we've talked about in other episodes, which is bigger is better, in many respects. Generally, bigger companies are more attractive to a wider audience of investors or buyers."

What industries typically do roll-ups? (02:42)
Gina: "One industry that comes to mind is the insurance agency industry. We have seen this time and time again, where a private equity firm buys an insurance agency, a large insurance agency, and then they start making smaller acquisitions."

Jeff: "The insurance distribution sector is perfect for the roll-up strategy. It's low capital intensity, recurring revenue, and highly fragmented market."

What type of companies implement roll-up strategies? (04:29)
Jeff: "This strategy works for large public companies, private equity firms, and independent companies."

What is the rationale for roll-ups? (05:34)
Gina: "One is geographic. Number two, it might be because of specific product knowledge. Number three, it can be to get a specific customer.

What is the financial benefit of roll-ups? (06:49)
Jeff: "A large platform company is going to trade at a higher multiple than a smaller company. There's arbitrage if a large platform company acquires smaller add-on acquisitions and integrates successfully."

Why is integration important? (07:56)
Gina: "Sometimes, acquisitions fail because they fail to integrate properly. That is not just making sure everybody is on the same technology system, but integrating cultures, integrating client relationships, and integrating product sets. That is the real challenge in an acquisition."

Jeff: "The integration is key to a lot of things, certainly to value maximization over time."

How do add-on companies benefit from roll-ups? (10:23)
Jeff: "The add-on companies benefit from the resources of the parent company, the larger enterprise. Add-on companies can grow their business, which probably will have some contingent consideration involved in the transaction, and be a part of the success."

Gina: "The smaller company, ideally, will have some rollover equity or earn outs that are structured on growth in the company, so you get to participate in the upside."

When Colonnade represents a seller into a roll-up, what diligence is done on the buyer? (12:10)
Jeff: "We do diligence on the parent company and the financial sponsor. We talk about their track record and history in doing roll-ups. We do diligence on the acquisitions they have done already and the outlook of the combined entity. Part of the consideration to our client is likely going to be equity in this new entity, so we will think about how much to rollover, what's it worth, what are all the conditions around it, and who is in control."

What is one of the challenges for sellers in a roll-up? And what are the trade-offs? (13:23)
Gina: "One of the challenges for entrepreneurs when they go through a sale process is the sudden realization that they're going to have a boss. Entrepreneurs are entrepreneurs for a reason. They like running the show. It can be a challenge to be part of a larger organization and not be in charge."

Jeff: "There are the trade outs with control. Being part of a larger organization, the add-on company benefits from the growth of the larger organization, increased size, and resources for future acquisitions."