Investors tend to search for high profits, short time investment opportunities.  Securities markets, private equity markets also offer good options.  An industrial, trade or service business company may design different growth strategies, mainly two: (A) through a process to increase sales with its own sales efforts and broadening offer to displace competitive businesses, over time. which requires: TIME,(organic growth) or (B) external M&A growth, acquiring and generally merging various existing businesses in the same industry with the desired customer base and market, to create a consolidated company (build-up, roll-up).

Professional investors, like Private Equity and independent sponsors, wish to shorten time to exit from 5-7 years to shorterterms, depending on sectors and other circumstances or regulatory requirements.

Big deals, megadeals are no longer the only right strategy. Recently nowadays macroeconomy issues wit restrictive and more expensive access to bank financing opens competitive advantage to private investors, be it private equity funds, and private independent investors, sponsors alike. Targeting small add-ons with solid balance sheetsmay reduce the need for bank financing.  

Smart investors also realize that strategies pursuing a series of smaller deals in reasonable timeframe may generate equal or evenfar more value, so roll-up investments are increasing in M&A.

1) This is attractive for several reasons:

a)     To gain size, market share, territory, customers, and new or underserved customers to value creation: Consolidation in the sector. The market, esp. financial market, generally rewardsscale with a higher valuation, i.e. higher multiple of EBITDA are accepted toacquire a larger business, so the investor behind the roll-up is likely tobenefit from multiple arbitrage at exit – a strong value driver.

b)     Allows to increase offer: Combined companies with complementary product / serviceoffer a full-service business.

c)     Economies of scale: (e.g. increased buyingor selling power -e.g. distribution)

d)     Synergies (e.g. shared administration and marketing costs).

e)     Acquisition ofknow-how, technology and attract talent.

f)      Access to better opportunities (including capital,debt): Large companies have some liquidity premium that helps reduce their cost of capital and allows new opportunities (e.g. more acquisitions):  The combined scale allows the investor to complete acquisitions with debt.

g)     Increased exposure, gain audience and media attention.  

h)     Value creation and exit:  completing successfully initial and add-on acquisitions to the optimal size creates valuefor a profitable exit.

i)       Time to add value, and exit may be 3-4 years shorter thanan organic-growth project, and fits Private Equity and investors’ appetite.

2) This strategy must be based on good targets/project and the right team:

a)     The investors must identify a business /project and a sound team with prior expertise in the same business or sector.

b)      The initial, ideal vehicle is a “platform” that can be not only an existing, operating company to lead the rest of the acquisitions, but also, and quite often even better, a solid project designed by a top management team of consolidators with long experience in the sector.

c)      The platform vehicle must be well financed inorder to: (a) set the basic structure for the consolidators and management inplace and (b) start with the first 3-4 acquisitions according to the project size, type of targets, sector, businesses, etc.: If the businesses to acquireare highly profitable generating high EBITDA, sellers will set a price for acash -out – without prejudice that they may accept all or most frequently partof the price in the form of a minority stock of the platform.

d)      Businesses with important debt commitments – e.g.manufacturers- present additional, heavy finance needs rather than distribution businesses with finance needs for stock and working capital.

e)      After the initial acquisitions, the combined business value multiples increase and attract the interest the owners of other businesses to help better negotiation conditions in the acquisitions.

‍Challenges.

With the right management team, high-EBITDA targets with little or no significant debt (e.g. distributors) and sufficient funding, the challenges are, in essence: overpaying in the acquisitions and integration difficulties.

Keys for success.

The keys to successful roll-up acquisitions are:

a)      The right management team: a core organization management chart of consolidators, with in-depth knowledge of the sector, the industry, its driversand dynamics and prospects, and proven ability to create value, capable to design the plan, set up the platform vehicle, identify and evaluate targets,close acquisitions, implement operational and cultural integration, andcontinue with the following acquisitions processes, with smooth connection withowners of the targeted businesses..

b)      Planning: financial: e.g. maximum multiple of EBITDA tobe paid for the acquisitions, geographies to target, level of equity to offerto the owners of the acquired companies new hirings foreseen as the size grows,etc.

c)      Due diligence: business, financial, tax and legal due diligence procedures will be the core, almost day-to-day activity for the platformmanagement team throughout the years of the roll-up, so a sound team capable tooptimize this tool is a must.

d)      Closing: It will require sound structure deal, - often contemplating how non-business related assets or liabilities are segregated-and the appropriate legal instruments and structures.

e)      Systems: A mid-sized corporation needs more systems tooperate successfully than a small, local company not only for the platformadministration structure but most importantly, to select and uniform systemsfor the targets once integrated as part of the synergies. Basic systems to sustain the functioning of the platform and the businesses inside it are amust. The platform may not afford one single disruption especially at thebeginning.  

f)       Integration: The resulting, consolidated Group must become more than the sum of its parts. Post acquisition or merger integration, both operationally and culturally is a must and is not a simple task: quite often integrating a large corporation into another large corporation is easier than integrating small-medium businesses.

Management team will set KPIs to monitor the project on each acquisition and the platform as a whole like pre- and post-merger performance, debt/equity levels and costs of debt, operational costs at holding company (usu. less than that of combined firms), ownership distribution, etc.

‍How to identify a good roll-up?  

Suitable industries and sectors for a roll-up are whose with somecharacteristics, for example, highly fragmented markets, like transport andlogistics, food and the particularly profitable beverages distributors, withlittle consolidation, profile of businesses: e.g. family-owned, with elder managementpartner without clear succession, needing to sell in a few years before havingto liquidate without realizing value, with none or little experience in M&Adeals, not highly professionalized management, with goods profits inhigh-EBITDA industries  

Spain, a market to consider for roll-up strategies.

Spanish economy offers a good deal ofopportunities for roll-up projects because in a good number of sectors and industries the average size of businesses is quite small, becoming more difficult to be competitive, in highly fragmented markets, unable to expand abroad. Many existing, sound businesses are small-midsized, with low management professional standards, with elder owners without clear successors or without successors at all, needing to sell as the alternative to liquidate in a few years losing the value created.

As to deal structure, the legal and tax framework offers different characteristics, benefits and issues to address: foreign investments reporting / permit regulations, regulatory, tax, specialneutral(deferral)-tax regimes, asset depreciation, tax credits, losscarry-forwards, interests deductibility, redundancy costs etc.

Typically the major two ways to structure the add-on deals are:

-    Asset deals: advisable when the company includes certain activities or assets and esp. liabilities that are not the target, and when from a regulatory point of view the company is not subject to special requisites of licenses or permits. These deals require more detailed documentation and more complex procedures for the transfer.

-    Share deals: advisable when the company does not include untargeted items, and passes satisfactorily due diligence reviews, and /or is subject to special license or permit for the targeted activity which the company has in place and updated.

Detailed transfer agreement will be required including the appropriate representations and warranties and commitments e.g.confidentiality, non-compete, guarantees for price deferral, earn-outs,seller’s guarantees for contingent liabilities, and shareholder agreements incase the owners of the business acquired are to hold shares (e.g. minority stake) and perhaps positions in the Board of Directors.

Conclusion

Roll-up, buy-and- build strategies represent a high percentage of deals, as in the US, in Spain and may be particularly good strategy for investors in other markets like Spain.

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© amber legal & business advisors This document is a compilationof legal information for general use and should not be considered legal advice. For specific information andadvice you can contact us at info@amberbas.com andwww.amberbas.com

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