M&A Series – Roll up, Roll up…. growth through acquisitions

The strategy of growth through the acquisition of multiple companies within a sector is often referred to as a “roll up” strategy.  It is a pretty simple concept although I hasten to add not necessarily that simple to successfully implement! But if you get it right, the growth and returns can be outstanding.

The idea is that by buying multiple companies within the same sector you can achieve more rapid growth than you can organically, consolidate some costs (though centralising certain core functions and/or introducing improved management processes) and increase sales (through cross-selling or bringing in an overarching brand to the group of companies to enhance the customer experience).

Clearly improving sales and reducing costs will drop down to improved profit. This benefit is then amplified yet again in the valuation of the group as the EBITDA sale multiples of companies are higher for larger businesses.

Typically entrepreneurs target highly fragmented industries where there are lots and lots of small (or “mom and pop” if you are in the USA) operators. This has the advantage that the vendors probably don’t have any succession or exit plan and there is plenty of target companies out there with little competition for them.

In the SME space, two current examples in the UK which are interesting as they have taken two different strategies regarding integration/branding. The first is The Clean Space – a corporate cleaning company which has made nine acquisitions and brought them all under a single umbrella brand united by a strong vision and values.  The second is The Hakim Group (founder by Imran Hakim of iTeddy / Dragon Den’s fame) who are rolling up independent opticians but keeping them operating under their original branding.

The above examples are of private companies but the roll up strategy takes on a new level of growth opportunity when you have a listed company doing the acquisitions.  (This is something I am involved with via The Recruitment Group which will be listing on the Nex Stock Exchange and rolling up recruitment companies). There are two key advantages to doing this with a listed company: firstly, the listed shares are liquid (i.e. can be sold much more easily than a private company shares) so this is attractive to the vendors. Hence the acquiring company’s shares can be used as currency to make the acquisitions which saves cash. Secondly, the listed company will typically trade at a much higher multiple than the private company they are acquiring. So there is immediate value gained from the acquisition due to this difference in private and public valuation. Of course, Martin Sorrell pioneered this strategy with WPP back in 1985 and built one the largest global advertising and comms groups in the world.  Now he’s at it again…

Here at Caribou Capital, we are looking at various opportunities for doing roll ups and I thought I’d share some of the things I consider important to consider. Whether you are an SME owner looking to grow your business via roll ups, or an entrepreneur seeking to enter a market with a first acquisition to build a roll up business, here are a few points to consider:

• The sector – unlike the classic business investment opportunities, it’s best to steer away from the glamourous, high-tech, or “next thing” industries. Unloved, established, predictable industries with recurring revenues work well.  Easier to value and less competition for deal flow. It’s no co-incidence the successful rolls up have been in sectors such as funeral providers, office supplies, waste management and so on
• Acquisitions are notably challenging, particularly when it comes to merging operations and issues around company culture. Rolls ups can multiply this issue ten-fold. Make sure you have a system to follow. Strong leadership with a clear vision and values will help to implement the strategy.
• What bits of the business do you want to integrate (and when) is a key determinant of the success of this strategy. Will you keep the current brands in place or create an overarching brand?
• A strong platform company (i.e. business number 1) is ideal as it’s this company that you will build out the roll up and use as the best practise for all the business processes (this doesn’t necessarily mean it’s the biggest though).
• What will you do with the current owner-managers? If you are buying them out, how will you replace them. If they are staying on, then structuring the deal to keep them motivated is vital.
• How will you finance the acquisitions? Your answer to the previous question will dictate this to some extent but your 3 options are obviously: equity, debt & cash flow. I heard a nice quote recently from the founder of The Clean Space, Charlie Mowat: “Debt is cheap but unforgiving, while equity is expensive but supportive”.
• Deal origination – having a constant deal flow is vital for this strategy. You need to systemise this process to keep the time and costs down of finding and evaluating target companies. This also applies to the transaction costs – developing standardised templates for the legal documents will help keep costs minimised.

There is no right or wrong answer to many of these questions. Each industry or situation will require a different approach but being aware of what the options are and making an informed decision should help reduce the risk of things going wrong, and more to the point, increase the chances of building a great business!