Volume 6, No. 1, Spring 2001

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The "Roll-up": Look Before You Leap

By William C. Herber, CBA, Senior Vice President & Scot A. Torkelson, CBA, Vice President

In its simplest sense, a roll-up is the term used for the combination of several smaller-sized businesses into a single, larger entity. The larger entity can be either a private or a public company, and typically the purchase of the smaller companies’ stock is accomplished with the stock created by the resulting larger company. In effect, the smaller companies are "rolled up" into one entity. The expected benefits to the owners are realized when the larger entity reaches the size necessary to conduct an IPO, thereby bringing liquidity - and cash - to the transaction. The companies that roll up and proceed immediately to an IPO are called "poof IPOs" - as in poof, a $300 million company is created out of a number of smaller entities with much less value on a standalone basis.

WHAT ARE THE BENEFITS?

One of the main benefits of the roll-up is that it brings about the economies of scale produced by larger companies by combining and centralizing the administrative and overhead functions. These costs can include accounting, accounts receivable and payable departments, management, utility and other costs for office space, human resources, computer systems, etc., etc.

WHO REALIZES THE GREATEST BENEFIT?

The most likely candidates for roll-ups include sectors which are larger, but highly fragmented among the "mom and pop" operations. These may include repair services, telemarketers, auto dealers, construction companies, telecommunications, or any industry or sector that can combine into a more effective entity were it larger, unified, and able to spread its overhead costs more broadly. In fact, the trend in roll-ups continues to rise, with an estimated $8 billion raised in investor capital from roll-ups since 1994.

WHAT ARE SOME DANGER SIGNS TO LOOK FOR BEFORE I ROLL UP MY COMPANY?

• Chief among the danger signs are either over-optimistic valuations for the rolled-up entity, or an uneven valuation of the various participants. Either way, poor execution in this area can rapidly unwind a deal.
• Excessive debt of one of more members can unnecessarily hamper the success of the rolled-up entity. The excess debt of one becomes the debt of all, and this can hurt the final entity.
• Not having a plan in place to realize the synergies before the companies are rolled up.
• Participating in a roll-up involving third parties with no prior experience. Remember, a roll-up is more than just a holding entity or conglomerate business. The goal is integration - becoming one company with higher sales and margins than a single, smaller company could achieve on its own.
• Participants in the roll-up who are not clear with one another about their roles after the roll-up can damage the success. Some members would like to continue their management roles; some want to be bought out. If a roll-up occurs and it is followed by a distribution of cash to the members, subsequently followed by everyone retiring, this clearly leads to a rapid unwinding or loss of the potential to go public.
• Combined with this is the absence of skill sets at the top executive position of the newly enlarged company. The skills needed to run a national or regional company are considerably different from those needed to run a small business. Therefore, fresh talent, properly selected, may need to be hired to manage the rolled-up entity.
• Finally, remember that you are transitioning from a 100% owner to a minority owner. This means a loss of control, and a very different environment from what you may be accustomed to when decisions were yours alone.

STILL SOUND GOOD? HERE ARE SOME STEPS TO GET STARTED

1. Determining the Participants - Select parties with experience in roll-ups. Review the role of each participant after the roll-up. Identify managers with the skills necessary to run a rolled-up entity.
2. Find Venture Capital - Generally, some source of additional funding is necessary to be able to move the project forward at a rapid pace.
3. Creating the Consolidating Entity - Once a roll-up is decided upon, and members are determined, a consolidating entity is created. This will be the company which will acquire the smaller companies, retain the senior management, and remain after the roll-up.
4. Purchase the Smaller Entities to be Rolled Up - The consolidating entity will buy a majority stake in each of the companies to be acquired, or it may acquire the smaller companies in their entirety. If the smaller entities are not purchased with cash, the individual companies as well as the final entity, in its rolled-up configuration, need to be appraised, as the smaller companies are typically purchased using the stock of the consolidating entity.
5. Determining the Timing of the IPO - The first three steps are reported to take one year to accomplish, and it is then not uncommon to delay and IPO for one year or more so that the consolidated entity can develop a track record and be able to show the economies of scale to the marketplace. Also, each of the steps leading to a successful IPO takes time.
6. Successful IPO = Cashing Out of Acquired Owners - who entered into the roll-up in the first place and wanted to try to maximize their value by acquiring stock in the rolled-up entity rather than simply selling their companies and taking the cash. The receipt of cash for their newly rolled-up company, which is realized by the liquidity of the newly public stock, is, hopefully, at a much higher value than the owner would have achieved if he sold his company as an individual entity.

CONCLUSION

If you are in an industry that is more efficient centralized than operating on its own, if being larger will enhance buyer power, and if having a presence throughout the United States, rather than in one or two major cities, would enable you to obtain customers that you would not be able to retain on your own, then a "roll-up" may be good for you. However, we tracked nine roll-ups which went public in 19997 or early 1998, and only one stock is trading above its initial IPO price; the other eight were at least 50% below the IPO price. This means either that the IPO price was too high or that the rolled-up companies were not able to enhance profits and growth as anticipated. Sometimes smaller is better.