Creating value when acquiring and combining companies is not easy. In theory, the sum of the parts will be more valuable than each part individually. However, there needs to be some cohesion to a roll-up. Alternatively, you end up with a disjointed company that does not command a valuation premium, but rather should be discounted to its peers. How do financial buyers generate additional value when they combine companies?
Here are some value creation techniques used in roll-ups. As a seller, you need to be aware of them if you are considering selling to a buyer executing one.
#1 A Cohesive Investment Thesis
Scale for the sake of scale is not good. Diversification of services and products makes sense, but only if there is commonality amongst the services. When exiting, the combined entity has a much better chance of attracting sophisticated investment capital if it can prove how its services and/or products relate to each other, and how they can be leveraged to increase market share within the common theme. This cohesion is key to the roll-up's investment thesis. The quickest way to destroy value in a roll-up is to have a "hodge podge" of products and services without any rhyme or reason.
Yes, scale is good and necessary as long as it makes sense. In most industries, significant value creation occurs when companies grow to a certain critical mass. These companies are better able to support the infrastructure and capital intensity required by its customers and price services and products accordingly. Larger companies have a better ability to be a price leader, rather than a price taker. When we deploy buy and build strategies, we work extremely hard at increasing our companies' scalability, so we can take advantage of pricing power, services and products integration, buying power, and a common infrastructure.
#3 The Right Management Team
Founders make great partners, but it is often hard to promote one of them to CEO of the combined entity. This is simply because founding partners / entrepreneurs are the life blood of roll-ups, but their skills often don't match the combined entity's strategy. If the combined entity is now looking to re-brand itself, integrate services, promote its expanded geographic footprint and showcase itself to investment bankers, a more "sales oriented" CEO is required that is influential with these different stakeholders. A CFO is needed, too. Trying to promote founders and their accountants to these roles is challenging, because running a $30 million business is very different from running a $300 million business.
#4 A Succession Plan
Roll-ups may be exited at a premium, but shortly thereafter they lose significant value when the founders all leave. Sometimes, a lack of a succession plan eliminates any chance of an exit. The problem with roll-ups without succession plans is that they are "one generation" businesses. Once the founders leave, the second tier of management is incapable of handling the new entity unless they have been properly identified and trained well in advance. The strategic plan needs to include taking inventory of the talent across all companies, and matching it with all the key positions in the combined entity. Each key role must have a backup that is at least two people deep. Any hole identified must be immediately recruited for, so proper training can commence.
#5 The 'Boards Around the Hockey Rink'
Roll-ups don't work without a proper succession plan. They also don't work without a playbook to work off. Founders are good at intuitive value creation. However, intuition can sometimes fail and is risky. Any business, but particularly a roll-up, should be managed with standard operating procedures that govern all key business activities. Having a process infrastructure is like putting "boards around the hockey rink." You still want your founders to play and be entrepreneurial, but you need to make sure the puck stays in play when their slap shot sails wide. Ultimately, value creation in roll-ups is enhanced when the company becomes "process driven" rather than "founder driven."
It is easy to put deals together. The real fun for both the buyer and the seller starts after the closing date when it's time to integrate the businesses in a roll-up. How does the buyer realize the returns they modeled? How does the buyer generate the real value creation in the roll-up that will lead to a higher exit multiple?
For sellers, it is imperative that they understand these value creation elements in a roll-up so they are prepared for the change that occurs post-transaction. However, when the change is properly executed and the roll-up well integrated, the additional value generated may make up for the change management challenges and stress experienced throughout the process. This may mean another significant monetization for the seller when the roll-up gets sold.