🏴☠️ ⚡️ Are roll-ups an optimal strategy in Micro SaaS? (Acquisition Concept)
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TABLE OF CONTENTS:
What are roll-ups (the result of multiple add-ons), and why are they so prevalent in Private Equity Buyouts?
Biggest risks and points of failure
Industries where roll-ups are most common
Roll-ups in Micro SaaS?
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Let’s start with a strangely unknown fact: the VAST majority (~78%) of US Private Equity buyout transactions in recent years are add-ons (aka the acquisition of a smaller firm as part of a roll-up strategy).
But what is a roll-up?
Let’s start with a simple example…
WHAT ARE ROLL-UPS (THE RESULT OF MULTIPLE ADD-ONS), AND WHY ARE THEY SO PREVALENT IN PE BUYOUTS?
Think of roll-ups like collecting and combining puzzle pieces to form a more valuable picture.
BigCo is like a beautiful, large puzzle that people love and value highly.
SmallCo's are smaller, less valued puzzle pieces.
When BigCo collects these smaller puzzle pieces (SmallCo's) and adds them to its already impressive puzzle, the combined picture becomes even more valuable. The market sees the larger, more complete picture and values it much higher, even though the individual small pieces were not as valuable on their own.
This strategy is super common in boring, service-based industries (HVAC, plumbing, towing, carwashes), where players buy a solid ‘platform’ business to then acquire all the competitors in the region to form a larger, more valuable business.
“I’m rolling up towing services in the Pacific Northwest,” is what you’d hear in conversation.
Here’s an example with numbers to bring this to life - pre-acquisition:
BigCo (Acquirer):
Profit (EBITDA):$20M
Valuation EBITDA Multiple: 10x
Valuation: $200M
SmallCo (Target):
Profit (EBITDA):$2M
Valuation EBITDA Multiple: 5x
Valuation: $10M
The combined value of these independent entities is $210M…
Now, by the numbers - post-acquisition:
BigCo + SmallCo:
Profit: $22M
Valuation EBITDA Multiple: 10x
Valuation: $220M
The total valuation of the combined entities is now $220M!
Put simply, SmallCo is now worth 10x (instead of 5x) because it’s part of BigCo, which commands a 10x. The example here demonstrates $10M of instant value creation as a function of the add-on per a roll-up strategy.
Here’s a concise summary of why add-ons are attractive:
Cost Efficiency: Smaller acquisitions typically require less financing, making them more attractive when credit is expensive or hard to obtain.
Synergies: Integrating smaller firms can create operational efficiencies, improve market reach, and realize cost savings.
Valuation Arbitrage: Buying smaller firms at lower multiples and consolidating them into larger entities that trade at higher multiples creates immediate value.
Challenging Economic Conditions (higher interest rates and tighter credit conditions): These conditions make larger leveraged buyouts (LBOs) less feasible, leading firms to focus on smaller, more manageable acquisitions that can be financed with less debt.
BIGGEST RISKS AND POINTS OF FAILURE?
Of course, anything that creates significant value comes with its fair share of challenges. Add-ons, indeed M&A in general, is littered with failures. Here’s the quick scoop on biggest challenges:
Integration Challenges: Integrating different company cultures can cause productivity and morale issues while combining multiple systems and teams can disrupt operations and create inefficiencies. Additionally, ensuring seamless integration of various technology platforms is often complex and costly.
Overestimation of Synergies: Overestimating potential cost savings and revenue enhancements can lead to disappointing results, and successfully realizing projected synergies requires effective execution, which is challenging.
Financial Risks: Financing acquisitions with significant debt can be risky in volatile markets or with rising interest rates, and the need to service this debt can strain cash flows, particularly if the combined entity underperforms.
Market Risks: Acquiring too many companies in a saturated market can limit growth opportunities, and increased competition can erode the consolidated entity's market position and profitability.
Legal and Regulatory Risks: Navigating different regulatory environments is challenging, especially across jurisdictions, and large roll-ups can attract regulatory scrutiny and potential antitrust issues.
Talent Retention: The departure of key employees during or after integration can undermine the roll-up's success, and maintaining employee satisfaction and retention during integration upheaval is difficult.
INDUSTRIES WHERE ROLL-UPS ARE COMMON
Let’s now take a closer look at the usual suspect categories for this strategy:
Healthcare Services: The healthcare sector, including medical practices, dental offices, and healthcare IT companies, frequently sees roll-up strategies due to its high potential for operational efficiencies and fragmented nature.
Consumer Services: Industries such as HVAC, pest control, and landscaping are common targets for roll-ups because they consist of numerous small, localized businesses that can benefit from centralized management and economies of scale.
Technology: The technology sector, particularly in software and IT services, is attractive for roll-ups as smaller tech firms can be integrated to create comprehensive solutions, enhance innovation, and expand market reach.
Financial Services: Financial services, especially insurance agencies and wealth management firms, often undergo roll-ups to consolidate expertise, streamline operations, and enhance customer offerings in a highly regulated environment.
Manufacturing and Industrial Services: Manufacturing and industrial services see roll-ups as companies aim to enhance production capabilities, reduce costs through bulk purchasing, and expand their geographical footprint.
Real Estate: The real estate sector, including property management and real estate brokerage firms, use roll-ups to achieve greater market penetration, enhance service offerings, and increase portfolio value through strategic acquisitions.
ROLL-UPS IN MICRO SAAS?
Micro SaaS companies typically operate in highly specialized niches, which are often underserved by larger software companies, leading to a proliferation of small, independent providers. This fragmentation presents an excellent opportunity for roll-ups, as acquiring and consolidating these smaller players can create a more comprehensive and competitive product suite.
The result is better retention (aka stickier product) and a broader share of wallet (aka the percentage of a customer’s total spend within a particular category that is captured by a specific provider).
Conversely, Micro SaaS firms are typically bootstrapped and come with their fair share of technical debt, legacy programming languages, etc. This can make technical integration VERY HARD and immediately kill add-on opportunities. It also limits add-on candidates because you are beholden to a product tech stack or language.
As is always the case, this strategy involves hard-core trade-offs, and it isn’t viable in a wide range of scenarios.
That said, theory suggests that Micro SaaS is conducive to a roll-up strategy, and we must all inform our thinking accordingly…
That’s a wrap!
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