Should more search funds do roll ups?

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10

Reply by a professional-advisory
from University of Pennsylvania in Dallas, TX, USA

Thank you, Luke. Hello. Yes, I have been involved with PE and roll ups for many years. Please feel free to contact me at redacted

Reply by a searcher
from Athabasca University in Kelowna, BC, Canada

I would argue against it for a while as well, and for many businesses, permanently. Roll ups can be a powerful strategy, but mostly to leverage the valuation multiple increases at larger company sizes. It doesn't necessarily generate real value in terms of increased EBITDA margins (it's often the reverse). From an integration perspective, many roll ups fail to realize the operational improvements they set out to. There are a combination of reasons for this, but primarily it's because not every acquisition is a good fit for the group, with too much work to align the business models/culture/operations/etc. But when roll up is the strategy, a couple of things happen that don't match the search fund model: 1. With the goal of adding more revenue/companies to the group, buyers get less picky over time and start acquiring less appetizing businesses to roll up. Backwards justification kicks in - we're buying this, let's find the reasons why this is a good buy. 2. Purchase valuations start to get too rich to close deals. Enough sellers are wise to the fact that this is happening, and there may be competition among buyers, so the valuations start to get out of hand. That makes generating positive ROI harder. It's a marginal expansion issue, which is a foundational challenge for businesses. Expanding in any way often leads to lower marginal returns. The speed of that expansion is inversely related to the marginal returns (move faster, get worse results). For more on this, look up any of the publicly listed companies that execute roll up models. You will see a few things that have happened over time: - Sellers get paid richer and richer multiples. - Unadjusted EBITDA gets squeezed to smaller and smaller margins. - Adjusted EBITDA, where they "normalize out" all of the actual costs of the strategy, is used to justify that it's working. - Investors end up paying too much for a stake in ownership. Because the buying might happen at say 5-7x and the company might end up with 25x valuations on the public market, it looks like instant value creation. But it is a house of cards, and somebody gets left holding the bag if the company can't properly integrate, operate and maintain industry appropriate cash flow margins. But the professionals who run the deals get well rewarded.

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