What is a Roll-Up, and how does it work?

We often get new clients who come to us with an offer. Many, if not most, business owners are receiving buyout offers via mail or email fairly regularly. Many of these offers come from Search Funds, or Private Equity backed Strategics. Let’s unwrap both of these buyers.

Search Funds are usually staffed by one or two recent MBA grads who have associated with a sponsor and are looking for companies to buy and run. The searchers may or may not have real-world experience and are industry or verticalagnostic. They are looking for a relatively bulletproof business with a long history and low volatility. Typically, they are fund less – meaning they will need to raise funds to purchase the company at the time of an offer, IOI, or LOI. Once the LOI is executed, Search Funds begin a parallel track of due diligence and a frantic search for the funds required to close. More on that process in a later article.

Private Equity backed strategics are the most common source of Roll-Ups. This strategy is essentially pairing a platform investment (the initial strategic firm that is already performing) with the backing of a Private Equity fund to grow through acquisition. New acquisitions are funded through either the fund’s equity component or combined with private and commercial debt. The dual goals of a Roll-up are providing a required Internal Rate of Return (IRR), and achieving a windfall through an exit, often leaning on a concept called Multiple Arbitrage.

Most acquisitions by Roll-ups will be trying to achieve an expansion in geographical footprint, service or product offering, or improvement in the share of wallet from the existing client base. All Roll-ups will be searching for two synergies: revenue and cost. Revenue synergy can be accomplished by selling more products to the same customers through cross-selling or up-selling. If a company that sells bats also gets into a ball and glove business, then you can see how one client can quickly lead to more revenue. Similarly, if instead of three sales reps or account managers, the same client can be managed with just one, the costs go down.

Multiple arbitrage is when a firm buys companies at a lower multiple (5x) and exits at a higher multiple (10x). As most Private Equity funds have a time limit whereby funds must be invested and returned in a pre-set window (usually 5-7 years), exits are generally mandatory. Knowing how this process works and the underlying requirements of each PE fund will allow the sellers to evaluate and prepare for an exit to a PE backed Roll-up.

Why is this important? If a seller is interested in an offer from a PE backed Roll-up and is willing to stay on through the second exit, they may participate in both the synergies (through an earn-out) and the multiple arbitrage (through retained equity in the Newco). While not appropriate for every seller, this can quickly add up to a significant upside and lead to what we, in the business, call a “Second Bite of the Apple.”

As a personal note, most folks I know who get second bites of the apple play lots of golf and seem quite happy.

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