Oddball roll-up

June 29, 2023

by an investor from Boston College - Wallace E. Carroll School of Management in Darien, CT, USA

Most acquisition-led industry consolidation ('roll-up') theses are predicated on majority ownership stakes###-###-#### % buyouts) of acquired companies in order to maintain the control needed to drive top- and/or bottom-line synergies, implement best practices across the acquired businesses, change management, set compensation, etc.

At the same time, many business owners who aren't at retirement age don't want to sell a majority of the equity in their business. Has anyone seen a roll-up that was comprised of 30-49% ownership stakes in businesses where the founder rolls 51-70% into the NewCo (roll-up entity) and cedes 100% voting control to the acquirer/NewCo?

Everyone's familiar with the roll-up/consolidators of dental, HVAC, fire protection services businesses, but it strikes me that this alternative offering might be extremely differentiated in those respective markets (and other industries undergoing consolidation too). It benefits the founder that wants to monetize a small portion of their business but retain economic upside and bet on themselves, while also giving them the potential benefit of significant multiple arbitrage when the NewCo acquisition entity is sold in the future. It also benefits the sponsor because he/she retains all the control rights associated with governance/voting decisions, while at the same time ensuring that the founders that just want to retire or cash out and lose motivation self-select out of this offering.

I'm sure there are reasons I haven't seen this in the past but it strikes me as a uniquely aligned offering for investors and business owners, and quite different from other roll-up strategies in the market. Would love any thoughts or criticisms anyone can share! This is more of a thought experiment than anything else.

Reply by an investor
from New York University in New York, NY, USA

It’s an interesting idea but I see a few issues that might come up. The current owner is not really betting on themselves as they have fully lost control to the acquirer. So they have to get comfortable that (1) the acquirer is going to run their business at least as well as they would have, (2) the other targets in the roll-up are also good businesses and (3) the acquirer can pull this all together. As you note, the current owner does gain the opportunity for multiple arbitrage down the road. However, they have to be comfortable on points 1-3 above, and that multiple arbitrage will not be realized for X years, so there is a big time value consideration as well. I’m also not sure what the ideal seller profile would be for such a strategy - retiring founders might find it too complicated and unappealing to lose control, while younger sellers might just want to cash out completely and move on to their next venture. Please keep us posted if this idea gets traction - very interested to hear how it goes!

Reply by an investor
from Boston College in Darien, CT, USA

All good points. Let's speculate that sub-scale businesses trade for 5x in an industry that otherwise trades at 7-8x and scale assets trade for 10x+. It might worth the hassle for an owner to sell 30% at a minority discount (5-6x) if they believe the 70% will ultimately be sold for a substantially higher multiple (10x) if they are one of 5, 7, 10, 15, etc. other owners who've also rolled into the NewCo in the same way and can all sell what is now a much more diversified, larger/scale business. Maybe, maybe not. But all those rolling owners would accelerate their ability to sell their remaining economic interest for a 'scale exit' valuation by many years rather than trying to grow to that scale on their own.

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