Roll Up Strategies

Acquiring multiple businesses within the same industry is a dream for many searchers, but it’s far from reality in actual practice. While the acquisition process is very similar to Entrepreneurship through Acquisition (EtA), the additional skill of successfully integrating multiple businesses makes this strategy very complicated and with risk, as reported by searchers who have traveled this path. The primary basis of value creation is derived from multiple arbitrage as higher revenue businesses command larger valuations than what they were purchased for. However, it excludes small “tuck-in” deals where you may be essentially buying a customer list or a few employees in an “acqui-hiring” situation.

In a survey of 185 EtA businesses purchased by Harvard Business School graduates in the past decade, 14 (or 8%) have implemented a “roll-up” strategy of purchasing multiple businesses in the same industry vertical. These excluded franchises covered in another blog post, Buying a Franchise, and a micro private equity (PE) acquisition strategy in multiple industry segments to be covered in a future blog post. The industry verticals were medical, dental, and veterinarian practices; master insurance agencies and a variety of smaller industry segments that the searchers preferred not to disclose for obvious reasons!

In the survey, 10 graduates (or 71% of the 14) self-funded their search process and raised funds from investors for their first transaction; the balance raised funding from investors to support a salary upon launching their search. 10 graduates (or 71%) searched and operated with a partner, which is about the opposite for most searches, and the balance went solo. Only 2 graduates launched mid-career, with the rest launching immediately upon graduation (See Blog Post: Searching Mid-Career).

Their acquisition multiple averaged earnings before interest, taxes, depreciation, and amortization (EBITDA) of 4.5x with a range of 2.5x to 8.0x. These searchers had acquired an average of 15 businesses and a median of 4.0, with a range of 2 to 100. Total revenue averaged $15M, with a range of $3.5M to $150M. Total employee count averaged 227 with a median of 70, a low of 6, and a high of 1,500. Of the 14 searchers, 5 reported exits. In one case a 9x Cash on Cash (CoC) return and 15x in another. 

As with EtA, no one path is the best; each acquired search business is like a snowflake, unique in many ways. The survey of a dozen-plus searcher/CEOs yielded a variety of opinions, principles, and practices that worked well for them. Their comments can help you make a decision about whether this particular focused path makes sense for you at a unique stage in your career. This is their way of giving back to the EtA community and in many ways more valuable than my own opinions on the topic.

Having an up-front industry thesis or evolving into it

Paul Thomson at Scottish American reflected, “There was no primary thesis such that the investment only worked if it was a roll-up. Instead, we purchased the master insurance agency with the plan to prove we could operate it and grow organically. However, what we achieved in the first one with a personnel model, technology plan, and a brand were such that it was additionally scalable through acquisition.” Another searcher said, “We had not originally embarked upon our EtA journey having premeditated multiple acquisitions in the same space. However, we were seeking a business in a fragmented industry with a history of stable profitability. These two criteria naturally set the stage for further acquisitions in the same space: fragmentation means ample acquisition targets, and a stable history often means a relatively modest (i.e., nonexponential) future organic growth trajectory, such that supplementing organic growth efforts through M&A is very compelling.” Jay Davis at The Nashton Company observed, “We didn’t have a consolidation thesis in the PPM (Private Placement Memorandum). An opportunistic acquisition outside of our base business convinced us to concentrate in that industry.” Another CEO reflected, “It took us five years to see an optimal path for EBITDA growth in our extremely fragmented industry with many small players who have no good exit or succession options and lack professional management, which allowed us to establish footholds in new geographic markets.” One CEO said, “My first acquisition was purely opportunistic, but it did have potential for add-ons that could be executed in the fourth year, once I understood our industry dynamics.”

Brandon Halcott at TruFamily Dental and his partner had a general focus on the outset: “We wanted a very fragmented and low-technology service business without significant asset intensity and discovered that our top two, Fleet Refueling and Self-Storage, were too asset heavy. So we became very focused on dental practices, and it was nine months before we acquired the first practice that was part of an estate, which was the only way we could convince someone to part ways with their business since we knew nothing about dental! We grew to 27 before exiting.” Another looked at a variety of opportunities and said, “I had an investment thesis, not industry focused. When I raised funding for the first business, I zeroed in on the industry to match.” Two partners raised capital for a nontraditional EtA path with a very specific scope: “We’re very focused on rolling up direct-to-consumer e-commerce stores on the Shopify platform.”

One searcher/CEO cautioned, “It took a long time and many deals for us to actually have a thesis that is proven and not a hypothesis that is simply conjecture. We are becoming more theses driven as we learn from each deal. The first few were purely opportunistic geographically, and our exit to a PE firm helped us narrow our focus and step up the size of the acquisitions.” Echoing that evolution, Andrew Walker at Oak Lane Dental said the following: “As we’ve grown the group and have more resources to support underperforming target practices, we’ve expanded our thesis to include even smaller practices, as long as those practices can likely scale quickly with our approach.” One CEO reported a specific “build to exit” strategy, “It was not an original thesis and but more driven by how big we thought the remaining white space/opportunity was.”

Operating “in” the business and “on” the business

Jay Davis from The Nashton Company pointed out, “We were folding in our acquisitions to our larger company. So, in most cases, an acquisition had someone who ended up reporting up through either our regional director or even directly to the COO.” In a veterinarian practice roll-up, the CEO reported, “We either keep the seller on (who has rollover equity) or give a small amount of equity to the next level of management.” In a medical practice, the CEO said, “We inherited a very solid operator on our second deal, and she is now the COO.” For a very large operation, the CEO found that “Oftentimes we do need to recruit a new area director; in essence, these are CEOs of the local business operation. The COO helps execute the integration playbook. He has worked with me long enough to know what I look for in a deal and what I expect to happen.”

In a smaller size business, the CEO observed, “Our acquisitions are run as part of our platform business and become integrated into our own business, just located in another geography. The Covid pandemic helped us see how effective the management team can be with remote management and guidance.” One searcher/CEO pointed out, “Each business doesn’t need a CEO, I think finding one would be pretty tough, at least at the compensation we would be willing to pay. Instead, we split up the former CEO role, bringing high-level tasks to myself at the holding company, while distributing the other lower-level tasks to specialists in the business.” Another CEO commented, “We are now at our third acquisition, we act as the CEOs for our multiple businesses and have not yet crossed the threshold of span of control.” Andrew Walker at Oak Lane Dental projected, “When we move into tangential businesses (like laboratories, software, supplies, etc.), we will have CEOs for those unique businesses.”

A common theme for many CEOs is to be fully engaged in operating the business, not just active on the deal side. It may not last for a long time, but investors and lenders want to see them “in” the business. At early stages of the process, one CEO observed the following: “While I learn the ins and outs of the business and clarify the business model, I am the CEO of our companies, but there are very solid managers in place who run the day to day. At some point down the line, I will bring in a COO and revert to working ‘on’ the business.” Brandon Halcott at TruFamily Dental echoed the thought: “My partner and I filled all the roles for the first few units, then started hiring. We both provided the operational expertise even though neither of us had worked in the industry before, just relying on our prior experiences in other industries.” Adam Parker at Data102 found, “By being a CEO/operator, everything is your jurisdiction, which forces you to learn and understand all different parts of the business. You hone your operation’s expertise, which informs your acquisition strategy and better enables future execution and integration of acquisitions.”

Funding multiple acquisitions

Funds providers are attracted to a roll-up model because of the “proven” business model, relatively low multiples, and maturity of the businesses with an eye to reducing their financial risk/exposure. Banks with a national footprint often specialize in verticals. Live Oak, for example, has more than two dozen “Industry-Focused Teams.” Paul Thomson at Scottish American found, “Our bank specialized in the insurance industry. With our 80% repeating revenue, our model had demonstrated scalability, the lender looked at it as a good bet, despite a hefty personal guarantee. Our increasing revenue really mattered to them.” One CEO felt that their experience as an operator appealed to their bank: “Lenders and investors were excited to be involved, as our several years of ‘insider’ industry and management experience gave them confidence in the loans.” Jay Davis at The Nashton Company reflected, “We used cash and incremental debt. Our lenders and investors were very supportive of our program, especially after we had proved ourselves with the first one or two.” As did Alex dePfyffer at Heritage Holding, who said, “We typically finance our platforms with banks and investors. We have had good success doing bolt-on acquisitions off balance sheet with some additional debt. “However, another CEO cautioned, “Lenders in the home health care sector were generally skeptical about roll-ups because they have seen a lot go badly, especially with less experienced management teams, which ETA is going to be, almost by definition.”

CEOs recognize pretty quickly that cash flows are the cheapest form of financing, combined with smaller amounts of debt and expensive equity. Andrew Walker at Oak Lane Dental used a combination of bank leverage and cash flow as he evolved: “We initially used investor money combined with lender financing for our first three deals. For our fourth deal, we used pure debt financing. The next two practices used capital from our cash flow, and three additional practices utilized 100% debt financing due to their larger size. We anticipate using a mix of cash flow and debt financing depending on the timing and size of the deals.” Another CEO, who used a majority of both cash flow and debt with limited outreach to investors, said lenders were “very supportive as they saw the potential value creation.” Like many other EtA acquisitions, seller notes reduce capital costs, as pointed out by one CEO: “On each successive acquisition, we have used a combination of seller and investor financing. I believe that negotiating attractive valuations at a 2.5x multiple allows us to also create a high-yield debt financing structure that is appealing to investors on a deal-by-deal basis.” Max Wexler at EarlyBird Education Group utilized “A 25% seller note and SBA loan even in the midst of the pandemic. Also, there has not been as much consolidation in Midwest region of the USA and there is generally less competition than your major bicoastal cities like NY or Boston.”

Depending on the sector, venture-type funding may be available as reported by a CEO in the e-commerce space: “Our lender sees an opportunity to deploy a lot of capital. But they also have very high interest rates on these funds, which could be argued are ‘equity light’ return expectations.” By contrast, Brandon Halcott at TruFamily Dental found, “Less than 1% of dental practices fail on an annual basis, so many small and regional banks will lend for single practices in their community.” For the initial acquisition, some equity capital will be needed, especially for a self-funded searcher, as one recounted: “Investors saw a long-term consolidation play that allows them to see enormous capital appreciation over decades. Our lenders see steady, cash-flowing businesses with high recurring revenue. However, going forward, we are likely using only debt financing and cash flow for future acquisitions as I continue to learn the nuances of operating the businesses.”

Focusing on what more there is to learn

Just like compound interest Compounded Annual Growth Rate (CAGR), any incremental learning as each year progresses can be applied to all the businesses that are acquired. Whether its pattern recognition from so many similar businesses you acquire or the efficient application of new creative solutions across a variety of the same businesses, this is part of the value creation if executed properly. Jay Davis and his partner Jason Pananos at The Nashton Company noted their learning from each successive acquisition: “Integration is really hard, and therefore pacing has to match your resources. Also, discipline around targeting reasonable valuations is critical since, in some industries, the large players are acquisitive down to pretty small EBITDA levels, which tends to drive multiples higher. It is important to understand what multiples you have to pay. In some industries, you can still buy smaller ($500K – $1.5M EBITDA) for pretty reasonable multiples.” 

On the transaction side, one CEO summed it up as, “Building relationships with potential sellers is greatly improved. The fact that we are an industry insider, speak the language they speak, and have former sellers who can serve as references, means you are now viewed as a very qualified buyer! Our early experience using pricing as a means of value creation gave us confidence that we would see similar profit synergies.” Faraz Karbasi and Courtney Ellenbogen of Conant Capital felt they had learned “how to run a tight closing process and avoid losing deals which happened to us once. We also refined how to stage gate QoE (Quality of Earnings) and due diligence in a way to finalize valuation as early as possible and avoid deal breakups at the 11th hour.” Another CEO pointed out, “Our transaction costs declined with each deal as we became more skilled at structuring the deals and negotiating lower legal costs on each successive deal as our terms became more standardized and boilerplate.” Paul Thomson at Scottish American found, “The insurance carrier partners are all the same, so you know what their contracts should be. In addition, you know where to look for issues such that due diligence is very easy and is better than anything an outside firm will be able to do.” 

Adam Parker at Data102 observed, “What I value in an acquisition now compared to the beginning has been greatly refined. As you operate a business and get deeper within an industry, you hone in on the particular dynamics that would be unknown to a generalist.” Another CEO said, “Because we continue to hunt for businesses after our initial acquisition, our relationships with brokers, bankers, lawyers, and dealmakers are much deeper and long lasting. We all work better together knowing that we will likely work again in the short- and long term. We can get under Letter of Intent(LOI) within days and close on the deal within 6–12 weeks compared to many more weeks of diligence and closings that used to take took between 3 and 6 months.” A CEO stressed, “We carefully consider whether the internal culture of the company we are buying is already living our existing mission. Our least successful acquisition was falling short in this regard, and, in hindsight, this should have been a red flag to pull out of the deal.”

On the operating side, practice and repetition was often cited, as one CEO observed, “Every day I learn how to manage people better and practice dividing my time appropriately between day-to-day fire drills and long-term growth projects.” Brandon Halcott at TruFamily Dental reflected, “Over time, I learned what worked and what didn’t work around innovations in the business while trying new things. The most important accumulated knowledge was developing a great culture.” Andrew Walker at Oak Lane Dental put his accumulated lessons to use: “One core competency we needed to develop quickly was how to create and merge businesses efficiently and effectively. This key differentiation predicts a successful or poor roll-up outcome. We now have a near 700+ point checklist for each transaction. We codified every role and how they interact with every other role, every SOP, and best practice into operational manuals, etc. To ensure rave-worthy patient and team experiences is very difficult and critically important. These are rarities in small businesses and thus need to be created from scratch from internal and external sources, but [also] create value in consistent and efficient processes across our platform.”

Driving to achieve synergies and efficiency

Surprisingly, less than half of the CEOs reported significant back-office efficiencies as a major source of value creation. As Paul Thomson at Scottish American found, “We outsourced some overnight work to foreign countries, but it was not a great driver of margin uplift though. Revenue growth is really the value-add component—bigger businesses just trade for higher valuations.” Even at $75M of revenue and five units, one CEO felt, “Consolidation of back-office tasks like finance, purchasing and customer service can be very difficult and time-consuming. We used consultants to help with the process, and it was still very challenging. However, if you do not do this, as you grow, the company will become more and more complex to manage.” Another CEO with more than 2,000 employees said, “It can be difficult to integrate as quickly as one might like just with our focus on accounting. We are getting better at it after three years, but it still takes time to learn how to do and see any significant savings.”

Accounting and finance support generally are most common. One CEO made the following observation after two acquisitions: “I just hired a controller to oversee the internal finance/accounting at the various companies, but not replace any staff at the unit. It is more like overhead at the operating company than a cost savings.” Another CEO commented, “We targeted primarily the financial reporting and some initial vendor consolidation on materials. However, we want to maintain a decentralized approach to ensure that the businesses continue their entrepreneurial vigor and proximity to the front line’s customer dynamics that is critical to long-term success.” A CEO reflected, “We have reduced or eliminated many expenses from the acquired companies, including accounting, HR, and insurance. In the short term, these savings are offset by transaction costs and expenses associated with the increased complexity of our business.”

The dynamics of each industry segment are different and may lend themselves to economies of scale. Andrew Walker at Oak Lane Dental said, “Initially we were focused on learning the business and transactions. Now we have sufficient size and scope, we have been able to build out our centralized back-office team of centralized billing, finance and accounting department, marketing and social media team, compliance and clinical management team. We can now pick up speed in the acquisition process.” Adam Parker at Data102 found, “The back office is the first thing we integrate, specifically, HR, finance, and reporting metrics.”

Adding another level of complexity with roll-ups

There are good reasons why 92% of the searchers stay focused on a single business. While a consolidation industry thesis can be written down and may sound attractive to a large PE firm, executing on it is challenging and adds levels of difficulty, especially with EtA searchers who, by definition, have less-experienced operators with no prior industry experience, having only purchased a single business, and with zero practice at integration. Hunting for “synergies” is often more easily said than done.

Transaction costs related to each acquisition need to be accounted for and generally do not decrease with scale. One CEO said, “Smaller deals, while having attractive valuations, can be as much or more work than the larger ones. There is real cost in terms of your own time, your team’s attention and focus, and legal bills, just to name a few.” One CEO with more than 100 units warned, “Centralization is not easy and requires a pretty heavy investment; test the ‘nice to have’ against the ‘must have’ for each initiative. You really can’t afford a ‘deal team’ until about 50 units, so we were very busy early on.”

Negotiating better prices for consolidated purchases with vendors can yield savings, but having the central office take responsibility for purchasing decisions may not always be feasible. In the lawn-care services business, each unit has its legacy equipment, and one searcher/CEO says, “It did not make sense to ‘force’ the team to switch to Honda from Snapper for which they had spare parts, full training on, and—in some cases—better locally negotiated prices. If we were following a ‘greenfield’ strategy, it would be different.” On the other hand, after six acquisitions and more than $50M in revenue, one CEO reported, “We now have consolidated finance, customer service, and purchasing, saving ~$1 million per year.”

Another CEO related, “Our strategy relies on our ability to extract more value from the same customers than the previous owners could, primarily through price.” Cost synergy by itself is not enough to make it worthwhile.” Max Wexler at EarlyBird advised, “We immediately have each acquisition transition to an industry SaaS (Software as a Service) education center software package that each unit uses, and we can access from anywhere. It came with our first acquisition, and it scales well as we grow. It was challenging at first, but we become the IT champions.”

Brandon Halcott at TruFamily Dental resisted too much consolidation: “Initially, we did nothing, and after a dozen or so, began to centralize those functions that did not touch patients because the patient would not know the difference if this was being handled at the practice or centrally. The patient’s view was the lens we used to make the decision, even it was more costly at the practice level. We did make a mistake by renaming each practice and should have kept it with the original name or local reference.” Another CEO was also cautious about centralization: “We are focused on maintaining a decentralized approach such that the businesses maintain their entrepreneurial vigor and proximity to the customer-facing front lines that we view as critical to long-term success.” Finally, one pointed out the “time” factor: “Operations is harder and more time consuming. HR and financial reporting are the first to be integrated, but any operation is much harder and more time consuming.”

Preparing for unique challenges

Andrew Walker at Oak Lane Dental observed, “One challenge was learning how to build a platform business from scratch while conducting ongoing serial searches, securing new financing, and successfully transitioning and merging all of the companies into a single, cohesive team. Also, dealing with each new business’s acquisition and execution risks makes a serial search/roll-up considerably more challenging. Finally, the most challenging part of working in a ‘key man/woman’ dominated industry is successfully retaining team members and customers/patients. As the owner steps aside, the searcher faces the challenge of retaining key staff and clients/patients and instituting a new culture and systems that may be completely different than what some team members may have been doing for decades.” After his third acquisition, Adam Parker at Data102 said that when “merging businesses that have their own ambitious people who may see their new counterparts as rivals, there is also a lot of fear with M&A around change and job redundancy. I usually don’t make big changes for a year and communicate that going too fast risks ‘buy-in’ from the acquired group.”

Citing the more challenging elements of multiple acquisition growth, one CEO mentioned “determining who among our existing management team were capable of scaling their own roles to participate in a larger enterprise and having to move on from those who were great fits in earlier, smaller stages but no longer a fit for the new, larger stage.” One CEO also found, “Managing multiple seller relationships takes a lot of time. It is stressful to deal with the ups and downs of very small, people-intensive businesses when I’m not based in the same city.” Not surprisingly, Brandon Halcott at TruFamily Dental cited, “Going into default with the bank because of no cash flow was unprecedented and scary in the early stages of the pandemic.” Paul Thomson at Scottish American shared the emotional toll: “The travel is constant, and you are endlessly firefighting. Employees who are not on your side cause the problems the moment you leave, not when you arrive—at least in my case!”

A very important consideration in an acquisition is self-discipline around what you pay. One searcher pointed out, “Finalizing valuation and payout structure that is justified by the business performance and being cautious about overpaying for a business that you may want to rationalize is worth it, knowing the multiple risks it faces.” It is not surprising that so many have a partner, mentor, or strong COO, as one CEO said: “Economics don’t support a ‘deal team,’ and sourcing and closing acquisitions versus running/integrating a business are two very different skill sets. The former is 100% a sales role, so if you don’t want to fly around the country doing sales, you need to have a business partner who does and may talk you out of overpaying for a business!”

Advice for searchers investigating this path

One CEO pointed out, “Done right, this is one of the quickest paths to value creation. When you buy your first business, keep in mind the potential for acquisitions as one of your investment criteria. It also keeps the CEO job interesting, as each means your role will be changing.” Another CEO reflected, “Get a deal under LOI before you raise committed capital. Then select the right investors. More than one or two but keep it to a small group. Try to get at least one ‘lead’ who will be in the trenches with you in the early days. Finally, make sure everyone is generally aligned on your time horizon and strategy, not theirs!” Max Wexler of EarlyBird said, “I would advise those looking at this path to do it with a partner. There is a lot of work to be done on both the operations and M&A side. It is also challenging and lonely at times. I am very happy I decided not to do this alone.”

Adam Parker at Data102 pointed out, “You have to be disciplined with the multiples you acquire to make this work. This also most likely means you need to rely on direct sourcing for most of your acquisitions, which drive a lot of value. Spending time as a CEO operator is very important. It forces you to learn and understand all different parts of the business. You gain credibility and build a reputation that helps when you are courting the CEOs of follow-on acquisitions. Your pitch shifts from a traditional searcher to providing professional support for the business.” Another CEO urged taking time to understand the business model of your platform: “It is a great potential path once you’ve developed confidence that the original industry you’ve purchased into is a great one to be in. Momentum can build quickly as you begin to develop a reputation in the industry.” One CEO urged, “It really helps to have your own house in order before you start adding additional businesses. This may vary somewhat depending on the quality and sophistication of your management team.” 

Paul Thomson at Scottish American suggested “It will be rockier and more challenging than you can imagine. Do not lie to yourself about the timescale and do not always believe your spreadsheet. Make sure you have a set of trusted eyes and ears wherever you are not, that are loyal to only you.” Andrew Walker at Oak Lane Dental said, “Juggling the building of a platform while managing your multiple businesses and doing M&A while continuing to do search is much more complicated and challenging than the standard EtA approach, but also potentially more rewarding! If you don’t love the ‘search’ part of EtA, don’t do this. If you’re not excited by doing ‘deals,’ this is not the path for you!”

One of the searcher/CEOs said, “Generally I would not advise this path since there are easier ways to build a business. But, if you are going to proceed, have a staff operating position with someone who is good at authoring and executing the integration plan. There are a lot of details that you have to get right.” Another warned, “Do it if you’re excited about building a big company, the thrill of the journey, and becoming a great leader. Don’t do it if you’re simply looking for a finance-type career path or want a large paycheck and a stable gig. The economic payoff from this will take many years to produce, and the day-to-day stresses are incomparable to that of a typical finance/consulting career path.”

No discussion of this topic would be complete without referencing a report by McKinsey on M&A Value Creation. More recently, Professor A. J. Wasserstein at the Yale School of Management has written four excellent cases: “On the Nature of Programmatic Acquisition Strategies: Why Entrepreneurs Should Consider This Approach,” “How to Source Deals,” “Their Implementation,” and “Why Things Go Awry” .

Conclusion

Pursuing a roll-up acquisition thesis for value creation within the EtA ecosystem is neither a trend nor a significant portion of where searcher/CEOs are spending their time. From the “balanced” commentary above, as described by CEOs who have followed this path, you can make your own judgement as to whether this makes sense for you. As with many of the divergent EtA decisions, making an informed choice that is the right fit for you is most important. Hearing lessons learned from other searchers can help you decide your own path.

Search On!

Feel free to share some of your own best practices or experiences in dealing with these issues in the written blog comments below. I encourage this dialogue, allowing all to learn from both my own views and the views of others in a virtual learning cycle—so jump right in! In addition, I frequently update individual blog posts, so visit the www.jimsteinsharpe.com website regularly.