Roll-up Strategy – What Is It and Why Do Private Equity Firms Do It?

FAQ

What is a roll-up strategy

A roll-up strategy is when an investor (typically a private equity firm) buys one relatively large company called a platform and then several smaller companies (called bolt-ons) in that same industry to combine with the platform.

The result is one larger, more valuable organization with streamlined operations and a single management team.

The best industries for roll-ups are fragmented industries with a high degree of recurring or re-occuring revenue.

This fragmentation allows for there to be a high number of bolt-on targets and the recurring and re-occuring revenue component means that they can typically be integrated successfully without losing much (or any) value.

The difference between a platform acquisition and bolt-on acquisitions is that the platform is a single, relatively large business that is acquired.  Bolt-on acquisitions are typically greater in number and much smaller than the platform acquisition they are being integrated with.

The 101 On Private Equity Roll-ups

The buy-and-build strategy entails making an initial investment in a business identified as having significant potential to serve as a foundational ‘platform’ operation. 

This platform is intended to serve as a base for incorporating other businesses (typically called bolt-ons) within the same industry, ultimately forming a larger enterprise. 

Through multiple acquisitions, the newly formed business is anticipated to benefit from economies of scale and increased value due to its stronger position within the industry, cost synergies, and an increased valuation multiple by moving up-market.

Roll-up strategies are also frequently referred to as industry consolidation strategies within the alternative investment community. This is one of the most common levers that private equity investors will pull to increase investor value. 

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4 Steps To A Successful Roll-up

1. Find a Target Industry and Acquire a Platform Company In It

This strategy involves identifying a target company to serve as the central investment for future acquisitions. 

The chosen target should also have the capacity to support a business that will incorporate additional acquisitions in the future. Therefore, the private equity firm that is implementing the buy-and-build strategy seeks specific qualities in the initial target, such as a strong, tenured and competent management team and a strong reputation.

Having a strong management team makes the integration (step 3) much easier as the team knows their business inside and out, and can quickly identify strong investment opportunities and implement them into their own business.

In addition to a strong management team, an industry with several dominant competitors is less desirable than one that is fragmented and lacks dominant players.

Additionally, there should be identifiable acquisition opportunities within the industry that can enhance the core business when merged. This is common in fragmented industries.

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2. Source and Acquire Bolt-on Acquisitions

Bolt-on acquisitions are the smaller strategic purchases made by the platform company to increase its size.

These acquisitions are within the same industry and have a similar business model. The aim for the private equity-backed platform company is to leverage its skilled management team to seamlessly integrate these bolt-ons into the business.

Additionally, some of these bolt-on acquisitions will be able to add new capabilities or service offerings to the acquiring platform.

It is not uncommon for private equity groups to add 4+ bolt-on acquisitions to their platform companies over the course of their holding period.

3. Bolt-on Integration

Integrating bolt-on acquisitions with the platform company involves a systematized process of evaluating the team, changing their current processes and technological infrastructure, and getting the new team members up-to-speed with new operating procedures and reporting expectations.

Culturally, efforts are made to foster collaboration and unity between teams from both entities, facilitating a cohesive organizational culture. Operationally, processes, systems, and workflows are streamlined to optimize efficiency and eliminate redundancies. Typically this means that the bolt-on company inherits the processes and technology of the platform organization.

Additionally, talent management plays a crucial role, with a focus on retaining key personnel and integrating talent from both companies to leverage expertise and drive growth. Customer integration efforts involve harmonizing relationships and service offerings to deliver enhanced value and capitalize on cross-selling opportunities.

Financial integration is also prioritized, involving the consolidation of financial reporting and management systems to facilitate decision-making and achieve economies of scale. By executing these integration steps effectively, private equity firms can unlock synergies, accelerate growth, and enhance overall value across the integrated entity.

4. Exit

Assuming the private equity acquirer was able to acquire and integrate smaller bolt-ons into the larger platform company successfully, the result should be a larger, more profitable business.

As companies become larger, they are generally seen as being safer and less reliant on a single operator or CEO. This higher degree of safety combined with moving up-market (where there are fewer investment opportunities) means the business should sell at a higher valuation than the sum of the parts of which it was constructed.

It is not at all uncommon for a private equity group to buy a platform with $5M EBITDA for 5X ($25M), then buy 5, $1M EBITDA bolt-ons at 3X each ($15M).

The Roll-up Outcome

It is not at all uncommon for a private equity group to buy a platform with $5M EBITDA for 5X ($25M), then buy 5, $1M EBITDA bolt-ons at 3X each ($15M) for a total of $40M in invested capital.

The result of this is a single business that generates $10M in EBITDA (assuming no other growth initiatives)

This $10M EBITDA business was constructed at a cost of $40M (4X EBITDA). However, it should sell for ~7X EBITDA ($70M).

The result of this is a 75% total return to investors.

Further Considerations of Roll-ups

While there is a 75% total return for investors, this is not taking into account a number of key considerations:

  • The acquisition(s) will likely be financed with some debt, so there won’t be a need for the full $40M capital outlay from the private equity firm.
  • The 75% enterprise value growth will take years to materialize
  • There will be other fees such as financial diligence and investment banking that will eat into the return.
  • The private equity firm will take a percentage of the profit as a performance fee.

When accounting for all of these factors, it is still not uncommon for a good private equity investor to be able to drive 25% annual returns to their limited partners by utilizing a roll-up strategy.

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