How to Start Executing the Roll Up Strategy in M&A

Transitioning from Corporate Development to CFO

In corporate development, you're very focused on one or two deals at a time. In the CFO role, you take on a different kind of responsibility and scope of thinking. For me, it was a natural progression. I grew up in finance, moved into corporate development, and then stepped into a leadership role in finance and M&A.

What made it interesting and exciting for me as an opportunity is that we are very acquisitive. Our strategy was to grow through acquisitions. So, not only do you execute deals, but you also develop strategies on which deals to pursue.

Once you get the deal done, the hardest thing for me is to stay away and let the M&A guys actually do the deal. Then, how do you handle integration and what happens afterwards? Often in corporate development, you do the deal, nibble at integration, and then hand it over. 

Down the road, you're not responsible for what happens to the deal. But in my seat now, I'm very responsible. Even your perspective on looking at deals is very different than just executing them.

Also, the biggest difference is the ownership of success. You have to live with a P&L afterwards. It's a very different perspective and what you're looking for because as M&A professionals, you want to get the deal done. You just want to get as many check marks next to the deal as possible. 

But being in a different role as an operator or head of finance, you want to get the right deals done. You want to make deals that can make you look great afterwards. You're ultimately responsible for what that looks like after a year, two, three, four. Your baseline is very different. You do diligence as you look at it very differently. All those things are just approached with a grain of salt.

Setting up the roll up strategy

When you think about it, you have to break it down.

What do you really need for the foundation of a roll up? One thing is, you need a good network within the industry. You need to know the product and the industry to be successful. Second, you need a team of people who are industry experts. 

This helps build trust with potential sellers quickly. You have to identify the gaps and opportunities, and what will be your differentiator. If you're just doing a roll up without differentiating yourself, it won't add much value.

Back office synergies alone won't yield the maximum return on investment. You need to select a capital provider that is willing to go through your ups and downs. Someone who is resilient and is able to identify your differentiating factor. 

You have to build a strong pipeline. Years ago, a McKinsey study identified building a reputation as an acquirer as one of the top four success factors. When people know you as a reliable acquirer, they want to do business with you, knowing you'll treat them fairly and make the process as simple and painless as possible.

References are valuable as industries are interconnected. This brings me to my next point: build a strong pipeline. It’s all about numbers and the flow of deals. You need a certain number of deals to start with and you might execute 10, 20, 30 percent of them, or even 50 percent if you're really effective. There must be a ready pipeline so when the capital arrives, you can move immediately.

Be diligent about execution. Create a plan and stick to standard operating procedures. It's easy to get lost in the art of the deal, but there is also a science to M&A. Following these processes will ease the burden on the team, the seller, and help plan deal cadence.

Finally, invest in the right tools. After many years, we started using Deal Room, which changed the game for us. It allows you to plan and monitor progress, and It's hard to manage M&A without the right tools. Invest in tools to ensure smooth deal flow.

Importance of industry expertise

There are a couple of things that really drive the importance of understanding valuation, identifying what constitutes a good or bad business, and the fundamentals that make a business in the industry successful or, conversely, just a façade.

Getting there involves building an understanding of what each team member brings to the table. Whether one is an operator, an M&A valuation expert, a procurement specialist, or a sales professional, these are the critical components of assembling the right team. Once people see that you have the right people in place, they will trust you. Investors will recognize that we have the right team.

Another important aspect is dealing with private sellers, especially those whose families have built their businesses over years, sometimes generations. For example, we purchased a business that had been in operation for 115 years. 

That's a generational asset. They are not going to hand it over to someone they don't trust to promote their name, legacy, customers, and product. Having that reputation and a team of experts is crucial.

Proactive approach to expanding industry expertise

Yeah, absolutely. When you start a rollup from scratch, as we did, initially there are no revenues. You start from zero and gradually build your team.

Often, what you find very valuable is that when you acquire companies, you discover individuals within those organizations who are knowledgeable and valuable. 

For example, you might acquire a company where an HR person from the operations you purchased becomes the head of HR for the entire rollup, or a marketing person might emerge as a key player. 

It's important to evaluate not only the operations but also the talent that comes with them to see how they can be utilized beyond just that one acquisition.

What you often discover is the dedication of these people is very high because, naturally, in any rollup, when being acquired, there's always the concern of job security.

By demonstrating that they will not only retain their jobs but also have prospects for future opportunities that they never had in their original organization, you become a very attractive acquirer. This adds significant value and makes your company appealing to potential acquisitions.

Valuation on roll up strategy

Yeah, there are several factors to consider in valuation. Going back to my corporate development role at Goodyear, the approach in a large corporate environment often involves multiple valuation methodologies like DCF, multiples, and comps.

In roll-up strategies and in the private equity world, EBITDA is typically the main driver of all valuations. It’s simple enough, serving as a proxy for cash, and that’s what people focus on. 

However, there are exceptions because reported EBITDA on the P&Ls of privately held companies can be misleading. This requires making EBITDA adjustments, both good and bad, and you need to discern which are viable post-acquisition.

Another critical aspect of valuation in roll-ups is paying attention to EBITDA multipliers—what you buy at and the potential market you can exit at. The spread needs to be large enough to be forgiving because if it isn’t, getting the valuation right on some deals can be very challenging, especially when working with limited and sometimes anecdotal data.

Furthermore, we look at the potential to grow the EBITDA organically and the valuation spread or multiple arbitrage opportunities achievable by consolidating.

There are also lessons learned and unusual findings, like why an automotive shop’s owner expensed an airplane because he moved further away and needed it for commuting. These are humorous adjustments you encounter. 

But there are also significant adjustments, like owners who claim not to be involved in the business, yet no financial decisions are made without their approval. When a larger company takes over, these costs need to be accounted for, even though the owner may not have considered these tasks as work.

In a consolidation play, depending on the industry, EBITDA multiples can start anywhere from four to eight for single operations and can go from 15 to 20 when consolidated. This multiple arbitrage can be two to three times.

We don't tend to offer large amounts right away and overpay. The reason we approach it this way is because it's extremely difficult to consolidate and integrate mom-and-pop shops that have been in the business for 30, 40, 50 years.

For example, we once asked for an inventory report, and the owner pulled out a pen and paper and wrote it down on a yellow sticky note, claiming that it was his balance sheet or his fixed assets registry. 

You look at that and wonder, 'Are you serious? How do you integrate that?' You can't directly integrate it. You have to have someone inspect everything, try to ascertain when the assets were acquired, and so forth, which becomes really challenging. Therefore, you don't pay a premium because there's an arbitrage opportunity.

Each time you pay a premium, it's usually because you'll end up spending a lot more money on integration than if you were to buy operations of 25 stores that have annual audits and systems in place. Those are the differences you see in the marketplace.

Building the operating strategy

You know, in our industry, as well as many others, businesses are built on trust. In a consolidation plan, you often lose that trust from the perspective of a customer. For example, people choose their barber or hairstylist because of the personal trust they have, not necessarily the name on the building. They trust the person who makes them look great.

The same principle applies in many other services, like automotive, where customers may not know what's hidden under the hood. They need to trust the person they are dealing with, and that trust can diminish when the business is sold. 

To compensate, you must offer something that replaces the value of why customers come to you. This might be ease of purchase, introducing technology, or providing some other unique value they can't get elsewhere.

Moreover, what differentiates your approach? What parts of the operations will make you more efficient and where will you pick up synergies? While back-office synergies are beneficial, they have their limits. 

If you cannot grow the top line or expand the margins compared to previous operators, it will be extremely difficult to improve EBITDA and achieve organic growth.

And this builds into a playbook, and you have to revise it every year or two. Because you have new players, competitors and technology come into the industry. So, it's always an ongoing, kind of a live document that you have to manage.

But you also need to know what your core is. For us, the core was technology. We wanted to ensure that we introduced technology that wasn't present in those areas prior to our acquisitions. We also aimed to offer a level of customer service that was unprecedented in the industry.

These are our key strategies, and we are executing very tightly against them. How this takes place varies and will likely change a year or two from now. But these core strategies are crucial, and the differentiators I mentioned are what you want to make sure you have going in.

They will set you apart from previous sellers or any competitor that might undertake another roll-up strategy in the industry.

Dealing with capital providers

It was an interesting process, different than I expected, being much more operationally focused.

When we sent them the decks and all the financial modeling, we asked, 'What questions do you have about the financial modeling?' The biggest compliment we received was, 'Nope, we're good with financial modeling. You guys did a good job.'

So, there were no questions about that, but the real questions were about execution. 'This all sounds great on paper, but why do you think you can execute better than the next guy?' Those were the things they were really focusing on. It was important for us to demonstrate our capability to execute.

We had a good story and a solid strategy, supported by robust financial modeling. The main focus then turned to execution. What is our execution risk? We probably spent more time discussing the execution risk than the other aspects.

We are a bit more traditional at this point because we were very much a piece-by-piece kind of acquirer. If you had a platform that you start acquiring, you can probably utilize debt a lot sooner than we could. 

But yes, you start thinking about it. We didn't have those lined up. We had a network, my network of professionals, that I've stayed in touch with throughout the years. I was not worried that we wouldn't be able to find somebody, but we didn't have anyone particularly lined up.

The equity piece of it was really the important part because a lot of the debt providers also ask, 'How committed are you guys on equity?' and 'Do you have enough cash flow to service the debt?' Those are the two key questions. As long as you secure the first one, ensuring you have enough cash to service the debt, then finding debt will be easier. 

Those are the things we also consider when we do an equity roll. Not too many people depend on it when they decide to get out; most of them would prefer cash than equity. But we do offer both and are open to it. As we move to larger acquisitions, that becomes more of a play, and it's something you want to entertain and engage in.

We don’t do many earnouts. And the few we've done, I've learned to probably stay away from them. I love them from a conceptual perspective but hate them in practice because there are so many factors that affect earnouts, from the deal structure to the accounting methodologies. 

It can cause conflicts, like when we switch from cash to accrual accounting, which is always a debate. How you account for manufacturer rebates, for example, every single thing becomes a debate. So, although earnouts sound great in theory, they are very challenging in practice.

Building your pipeline

So, I'll tell you, that was probably one of the most interesting parts of our roll-up strategy in the beginning. There were a lot of questions about managing and reviewing the pipeline areas.

Once we started rolling and executing on the pipeline, we didn't get any questions from PE firms anymore about whether our pipeline is strong or not. We have probably 50 to 100 targets in the pipeline right now and we've demonstrated that we could close about 50 percent of those.

It's only up to us how fast we want to go. Once you demonstrate the execution of it, those questions will probably die down. But yes, pipelines are a huge risk for consolidators. 

You need to list down 20 to 30 potential deals because the expectations of the funnel are probably 10 to 20%. So, you have to have around 30 candidates for acquisitions in order to be able to close three to five. That's how the PE firms or our experience have looked at it.

We were fortunate enough that we had a different and much better story about that. So that is no longer a discussion, but in the beginning, it was all about pipeline and that was the number one thing. But once we demonstrated execution, it was a much easier conversation.

Pitching to the PE firm

Maybe it's a cliché to say it again, but it's one of those things you've got to really think about: What is in it for them? So, when you're pitching, don't just talk about your strategy. 

Talk about why it benefits them, and that was a lesson I learned early on as I transitioned from corporate to the private equity world and advised on other deals. Much of the pitch was around building a great company or product, but not enough about what's in it for the investor. How can the investor get their money back? What are the numbers, the ratios? 

Because everyone loves a great company, but there are countless examples of great companies that never made money and went under. For an investor, a great company or brand doesn't do everything for them.

You really need to speak to what's in it for them. How solid or sound is your model? For the sellers, it's slightly different, but not by much. Many of these people have built their family's history on these businesses. 

You need to reassure them that you will take care of it. For private sellers, the number one concern for many of them is what's going to happen to their people like Joe, Sally, or Megan who work in their business. Will they be secure? 

That part of their legacy is crucial because these sellers are involved in their communities; they see these people at grocery stores, churches, and community places.

They don’t want to be seen as walking away with millions while their employees struggle. So, when you pitch, you must also articulate how you will take care of their business, their people, and their lives.

Just be prepared, get your stuff ready, but also don't be overly scripted. The best conversations we've had were more informal, like over dinner or a few drinks, where you can talk about things in a relaxed setting. 

It doesn't have to be super formal. Being too scripted can make you come across as less genuine, and investors might become skeptical, wondering what you're hiding.

They're looking for the genuineness of your pitch and your story. If you're too scripted, they might think you're just presenting the parts you want them to hear, rather than the true story. So know your material and how to present it, but also be yourself. Be natural and honest.

Does alcohol help close deals? I wouldn’t say that. I’d recommend against it, though I’ve never done that. But you bring up a good point about networking. Whether it happens over a glass of wine, at a golf club, or during a hike, networking can indeed help close deals.

Explaining your M&A process to investors

No, you have to start with a certain knowledge and the process of approaching it. That was one thing that evolved the most for us because there's always the balance of whom you are trying to please: is it the finance team, the investor, the seller, or the operations guys? You really have to fine-tune it. 

Also, you need to understand the seller support process. When dealing with highly sophisticated sellers, it's different. I believe mom and pops are extremely sophisticated operators, but they may not be the most sophisticated sellers of businesses.

When dealing with corporate development, where people do this for a living, you might say, 'Let's go to term sheet,' and everyone understands. However, if you mention a 'term sheet' to a small business owner, they might not know what that is, so you have to be very careful.

Another significant difference between corporate development and small roll-ups is the timing of transactions. In corporate development, we might sign and then close a month or two later to prepare for the transition. 

In roll-ups, everything happens at once. The owners are very sensitive about confidentiality and letting people know they are selling their business.

To help them through the process, having a simplified structure reduces a lot of emotional anxiety because they know what's coming next. So, create steps like, 'We'll ask for this, then create an LOI, then conduct due diligence or a quality of earnings report,' and explain what each step involves. 

It’s much easier when you have a clear process. Do we use consultants? No, not really, except for legal teams and third-party quality of earnings, but we don't hire consultants for other aspects.

Building your M&A team

You want to start with key people in each department. Begin with a strong CFO. Then, of course, you need a good operator, like a GM, who can really drive the business. Following that, you need a solid finance person who will help grow the pipeline and manage the deals. One of the lessons I learned is that I would bring on a skilled IT head or CIO much earlier than we did because in the consolidation play, integration, especially data and system integration, is crucial. Without someone effectively guiding this, you'll end up paying for it for years to come.

Then you start building the teams, including someone who can direct your strategy. This doesn’t necessarily have to be a full-time strategy person, but someone who ensures we are on track with what we planned to measure and achieve. This role can often be filled by either the CFO or the CEO.

From there, you build your team gradually. You don't need to hire a head of corporate development or financial analysts right off the bat. You can get the momentum going and scale from there. Initially, we started with more of a 1099 structure, but we did have a head of corporate development to build that pipeline, which is important. The GM or CEO can handle a lot, but having someone dedicated to it is beneficial.

So, the key roles you want to have in a roll-up strategy would be the GM, head of finance, head of operations, IT, and M&A. These are the core components of a strong team.

Monitoring cost

Especially when you're doing a very aggressive roll-up, you never have a really good base to compare to, like how you did last year, because last year someone else was managing most of the business.

So, you really need to stick to your KPIs. Determine what you need to do to be successful and manage your business effectively within the framework of KPIs. As you look more into it, you must understand where you will extract value. Will your value be in cost savings, or will it be in pricing or volume?

Wherever you decide to create value, you must closely monitor it. Are you actually deriving the expected value? If not, ask yourself why. Did you make wrong assumptions? Did the market change, or are you simply not executing well? These are crucial aspects to focus on. Additionally, ensure you conduct thorough due diligence to prevent any unforeseen costs from creeping up.

Success metrics

That's such a different approach in corporate development or corporate finance when dealing with roll-ups. You always look at what is referred to as LTM, last 12 months. We create a pro forma going backwards. This will show what the earnings and cash flow would have been if we owned these companies for the last 12 months. 

It's an interesting and tricky situation for monitoring where you are at, but it's the only way to measure whether you're doing better or worse than what you acquired.

You always look at the LTM at acquisition or the LTM number to see if you're doing better. Sometimes, you have to pay for the sins of others. They had a good month, and now you have to live with it.

Or if there's a gap between the LTMs at the time of acquisition and when you did the valuation, and the business sinks during those two or three months, you're paying for it because you have to make up the difference. You can't walk back and it becomes part of your numbers.

For private equity, there are two main concerns. First, they want to see the performance of the overall consolidated company. How are you doing now that we've consolidated everyone? Are you covering your extra overhead? 

But they also worry about how you are doing compared to what we purchased, what we paid for. If you paid 10 times EBITDA for a business and the EBITDA erodes, all of a sudden the valuation might be 12 times.

If your exit was estimated at 13 times, you've just eroded 66 percent of the differentiation of that arbitrage. You have to be careful not to go backwards because as soon as you do, your deals become much more expensive as you're always measured against the effective multiple today.

If you buy a business with a million dollars of EBITDA at 10 times, that means 10 million. If you erode the EBITDA from a million to 500 thousand, all of a sudden you paid 20 times for it. You have to pay attention to that. As long as you're moving up, you're doing really well.

You track it for 12 months, but you also track on an aggregate basis from what you bought at acquisition versus where you are today, and then you track that until you sell.

So, in those 12 months after purchase, you're validating your original purchase, and then it becomes part of the overall operations.

At the same time, you're always measuring yourself against what was my invested capital? What did I pay in the beginning, and how does that compare to my expected capital at the exit?

Rolling it into an IRR figure is key. That's what everyone wants to know. But there's a nuance, which I find interesting, if not funny, in the PE world. PE's don't necessarily deal with IRRs. They only deal with, say, four times earnings, five times earnings. 

What you earn on your invested cash makes a big difference whether you earn four times in one year or four times in five years. That reference point is rarely discussed. It's only like, well, it was a four times exit. That's great. But if it took 10 years, it's really not that great.

The assumption is that private equity firms usually hold a company between three to five years and aim for a two to three times exit within that timeframe. However, there is a noticeable difference if you hold a company for two and a half years compared to five and a half years, even if you achieve the same exit multiple.

The exit multiple for the invested capital is always key. The EBITDA valuation multiple is a crucial KPI that's measured. The third piece is cash generation for servicing debt. The way you multiply your returns is by leveraging up the companies and using borrowed capital to make money and purchase new companies without spending your own equity. You must have enough cash flow to service that debt.

If you can maintain these three aspects, everyone will be very satisfied.

Utilizing technology 

I've been the longest non-paying customer, and we've known each other for about eight years, maybe six years before we actually went with a product from DealRoom. Just for clarity, there was no usage of Deal Room for free.

We chose DealRoom for one specific reason: it was the only platform tailored to M&A processes that combined multiple features such as data room, process management, and pipeline management. We couldn’t find these features integrated anywhere else.

While there were many data rooms and products focused on deal or project management, none offered a comprehensive tool specifically for M&A project management that combined all these elements. That was the attractive part of Deal Room for us, and why the team actually liked it.

From my perspective, when discussing tools, I suggested that our M&A team take a look at DealRoom. I completely left the decision to them, and they evaluated several products and chose Deal Room without even informing me beforehand, which I was very pleased about.

Importance of a unified platform

What it does, from three different points of view starting with the seller, is set expectations. Building trust and setting expectations are crucial, especially since for many sellers, this is their first and possibly only time selling a business. They learn the components of the deal they need to follow through on and what to provide for the deal to happen.

It's much easier than being told, 'Hey, Monday morning, give me these documents,' and then on Wednesday being told, 'You didn’t provide X, Y, and Z, and I need A, B, and C by Thursday morning.' That can frustrate people. When they understand the structure they need to follow, it eases their emotional ups and downs throughout this process.

The second point is that it serves as a data depository. There's always one place to go to, which is really great. But the third aspect is that it keeps the internal team on track by monitoring whether things are submitted or not and whether people are following up on items. 

If you see an empty folder for two weeks and it's past due, you can follow up with the person supposed to populate it and ask, 'Why is this still empty?' If that folder were just sitting on their computer, you wouldn’t know whether it’s there or not. You'd expect it to be done, but it might not be.

This structure allows you to really monitor the process of the deal and the project, which is extremely helpful and can significantly reduce the time of the deal cycle. We've cut our deal cycle time from about 9 to 12 weeks down to 6 to 8 weeks.

Biggest lessons learned doing roll up strategy 

Any startup will tell you this, but rollups are particularly unique in their approach, especially if you're starting from ground zero. It's crucial to ensure it is well-funded. Constantly seeking or begging for funding every time there is an acquisition is not ideal. 

That frustrates those involved in the process, especially the sellers, and it can ruin the company’s reputation. Also, it's important to build a strong platform early on that you can build upon going forward.

That brings me to the second point: invest in IT. This is probably the biggest lesson I've learned through our journey. Your system integration and synchronization are critical for everything you do later on, from running operations to achieving pure synergies and efficiencies. 

It's essential to have your IT in order from the beginning. In a rollup, it's much easier to start with the right solution and then incorporate other acquisitions into it, rather than trying to synchronize everything after you already have a hundred different locations or divisions.

The third thing I want to touch upon is hidden costs, which are particularly tricky. The less sophisticated the sellers, the more hidden costs there will be. Almost every acquisition we've made has involved unexpected issues. 

For instance, when employees meet the new HR personnel, they often ask about raises they were promised. Whether or not these raises were actually promised is almost impossible to verify, but the expectation is set, and suddenly you're failing to meet it or you have to absorb higher labor costs than anticipated. This can be particularly damaging if you're in a labor-intensive business.

Another key point I've discovered, specifically in our case, is data integrity. The less sophisticated the sellers, the bigger the data integrity issues you're likely to encounter. I want to clarify that you're not necessarily buying businesses with false data; rather, you're buying businesses with inadequate data. 

What was sufficient for mom-and-pop operations isn't adequate if you're trying to build a multi-million or hundred-plus million dollar company that needs to be audited in the near future. These are two very distinct issues that you'll need to address.

Future trends in the roll up space

Roll-ups are becoming somewhat stale in many ways, and while many industries have been targeted, there are still tons of opportunities remaining in numerous industries.

I would say we're in the second half of the roll-up craze. We have plenty of time left before the game is over. At this stage, it's crucial to identify why you're engaging in a roll-up. In the early phases, you could choose almost any industry and derive value primarily from back-office synergies. 

It was a new and exciting approach that everyone appreciated. Now, you need to be more strategic. You must consider what technology you will introduce, how you will change your processes to improve, and what additional value you will provide to customers.

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