- What a roll-up acquisition is.
- How to use roll-ups to improve brand loyalty.
- How to grow a company’s valuation without ever touching its operations.
- How to couple a roll-up strategy with effective systematization.
- How roll-ups can allow a business to take advantage of economies of scale.
- How to properly integrate a business following a roll-up acquisition.
In Part One, we discussed why a good company needs systems, regardless of size, but a company making between $700,000 and $1.2 million in annual profits is more able to support the cost of implementing those systems. In Part Two, we looked at the buying universes: Private equity firms and individual buyers. We discussed their motivations and why targeting a specific price point helps avoid competition and allows us to find businesses valued at 3x its annual EBITDA, grow that business and sell it for a much higher multiple.
Now we need to look at one of the most effective ways for growing a business post-acquisition so that we can sell it for a much higher price and make the best exit possible. Namely, roll-up acquisitions.
What Is A Roll-Up Acquisition?
A roll-up – sometimes referred to as a “tuck-in” – is when a business buys another company in the same market and merges it into its own operations. These mergers combine multiple small companies into a single large entity that can take advantage of its larger size.
The roll-up strategy is typically used to reduce costs through economies of scale while increasing valuation multiples by achieving greater scale.
It’s not uncommon to see an uptick in roll-ups as certain market sectors begin to mature. It’s also used as a strategy when investors want to bring together complementary businesses in order to achieve vertical integration. A good example is an HVAC company acquiring a plumbing business.
Traditionally, roll-ups were the domain of private equity firms, but they are becoming increasingly frequent for individual business owners as well.
Reasons For A Roll-Up Acquisition
Increased Purchasing Power and Brand Recognition
Over time, industries will mature. This causes the number of competitors in a sector to shrink as businesses begin combining to reduce overhead and gain more purchasing power. Once the business is acquired and folded under the buying company's name, the buyer's brand recognition increases.
However, as that business grows inorganically, it can (and should strive to) maintain the goodwill that the acquired company has built up in the community. This will ensure that customers continue to be loyal and workers remain happy in their jobs.
When a company with a higher Price/Earnings (P/E) multiple buys a business with a lower P/E, it results in what is known as an arbitrage of earnings multiples.
Also known as “multiple arbitrage,” this practice is used to increase the value of a company without making any operational improvements to it.
This is especially useful when it comes to EBITDA (earnings before interest, taxes, depreciation, and amortization) – if a company making $2 million in EBITDA acquires a company making $1 million in EBITDA, it now has $3 million in EBITDA. It’s a strategy that has been used by large firms for decades to increase the value of their companies.
There are 5 companies each doing $1 million earnings
Buy each for 3x = $3 million/business
5 businesses at $3 million = $15 million
Sell the holding company at 10x profit = $50 million (5 companies, each making $1 million x 10)Your profit = $35 million ($50MM – $15MM)
Economies of Scale
A roll-up acquisition is sometimes used to take advantage of economies of scale in a given industry. By combining companies, the acquirer is able to boost output with a minimal increase in its operating costs. When average costs begin to fall as output increases, economies of scale are created.
The best way to picture this is to imagine a factory running at less than maximum capacity. The factory has a fixed cost to operate, but is not being used to its full potential. If the factory owner is able to increase output, then the factory’s revenue grows without increasing its costs, leading to a higher profit margin. This is known as “achieving scale.”
There are many benefits that can be gained from creating a regional brand and taking wins from one company and applying them to all of a business’ operations.
As stated above, a classic roll-up strategy involves buying smaller competitors in order to achieve greater scale. This is especially true in fragmented markets. If a certain home services sector in a region is particularly fragmented, it can often be lucrative to make horizontal acquisitions where there are a number of family-run companies to buy.
These acquisitions are usually relatively inexpensive, with profit multiples of 3x or 4x. The strategy should involve a strong emphasis on integration in order to reduce friction between the business methods of the acquired company and the buyer.
Traits Of A Successful Roll-Up
Manual Processes Are Automated
As businesses begin to grow more rapidly, manual processes become more cumbersome. We have seen this first hand at many of the home services companies we’ve worked with.
It’s not uncommon to find a very successful, family-run HVAC company that still does most of its accounting on paper. It’s simply how they’ve always done business and it’s worked for them so far. At Acquira, we’ve helped many companies implement the systems necessary to help them grow organically, and this systematization becomes even more important when dealing with roll-up acquisitions.
Bear in mind that these types of manual processes usually evolve over time, organically, and are very specific to the people doing them. Processes like these often don’t make sense to outside observers. When looking to automate manual processes, first investigate how and why each process evolved and clarify the requirements of the process.
Once a full understanding of the process has been reached, you can begin to automate the workflow capabilities through an ERP (enterprise resource planning) platform.
Back Offices Replaced
The back office consists of things like accounting, administration, IT/tech, marketing, and Call Service Representatives (CSRs).
Many smaller companies simply aren't large enough to support, for example, a full-time finance person or a full-time marketing person. By “replacing the back office,” you're typically able to streamline these operations and reduce a large cost of that business. Or you can add a function that the business never had in the first place, thus increasing its value.
As we’ve said ad nauseam at this point, systems are the key to growing a business. When it comes to inorganic growth through roll-ups, it’s vital to ensure that the systems are universally adopted at all levels of the organization.
At Acquira, we’ve seen the chaos that can bubble up when two companies are merged, but systems have not been properly integrated across the organization. This is why we’re preaching systematic excellence as often as possible. A large portion of our training is dedicated to ensuring that everyone understands why certain systems are in place and how those systems can help everyone succeed.
Efficient Reporting Relationships
One of the greatest cost-saving endeavors that result from roll-up acquisitions is clearing the clutter at the top of the org chart. Following a roll-up, there will be redundant positions. This is why it’s vital to ensure that the right people are in the right seats, and anyone who isn’t in the right seat either needs to be reassigned or let go.
However, this process can lead to inefficiencies in reporting methods as employees become unsure about who their direct superiors are. From the beginning of the merger, the owner should endeavor to create well-defined routes for reporting. Goals should be established, expectations explained, and the appropriate reporting methods should be communicated.
A Note On Operations
If your goal is to simply roll up disparate businesses in order to take advantage of multiple arbitrage, you'll likely only be able to sell a business like that for 6x its consolidated annual earnings.
However, rolling up businesses and then implementing homogeneous systems that lead to organic growth, will create a company that is valued closer to 10x its annual profit.
As we said in Part Two, Private Equity wants to buy a business that is already growing under its own weight. It takes the same amount of work for a firm to analyze the financials and re-do the operations of a company making $1 million in profit as it does for one that's making $10 million in profit so it might as well bet on the bigger company.
An unsystematized company would only attract buyers who are willing to get their hands dirty and grow the business themselves so it won't attract the higher multiples. If you're able to roll up a group of companies and systematize them, you can demand a higher price from private equity buyers.
Making The Exit: Selling At A Higher Multiple
As we discussed in Part One of this series, effective systems are the best way to organically grow a business.
As mentioned, small family-run companies usually sell for multiples of 3x or 4x of their EBITDA. If you’re able to systematize that company and truly optimize its operations, it wouldn’t be uncommon to exit that business by selling it for a 6x multiple.
The next easiest way to grow a company is through roll-up acquisitions. This strategy will increase your earnings multiple rapidly. If a business owner can buy, for example, six businesses that are each making $1 million in EBITDA and apply the systems they’ve already built at their first business to each acquired company, the combined company suddenly becomes much more attractive.
In fact, these are the exact types of businesses that private equity buyers are attracted to, as we discussed in Part Two of this series. It wouldn’t be unheard of to sell a company like that for as much as $60 million.
Acquisition roll-ups have been an effective growth strategy employed by some of the biggest companies on earth. Facebook didn’t invent Instagram – it bought it. Google didn’t invent Google Docs, it bought the company that invented the software.
Roll-ups allow you to grow the valuation of a company without even touching its operations. However, for a business that couples roll-ups with an effective systematization strategy, the upside potential is incredible.
Many people have experienced a roll-up acquisition from the employee side. What’s your story? Let us know in the comments!
Acquira’s ecosystem has been specifically designed to connect eager buyers with motivated sellers. We offer off-market sourcing, systems training, leadership coaching, and more. If you’re a business owner in search of a roll-up acquisition, schedule a call with us today so we can begin finding you the perfect complementary business.
- Roll-ups are a way to increase value without touching a company’s operations.
- A roll-up strategy, coupled with effective systematization, offers immense upside potential.
- Roll-ups allow a business to take advantage of economies of scale.
- For a roll-up to be effective, it’s imperative to pay attention to the integration process.
Acquira is a business acquisition in a box service. We help entrepreneurs buy businesses and we invest in them and their chosen businesses. We are here to help ensure that each business we work with is posed to make the biggest positive impact possible for its owners, employees, and community.