Roll-Up Investing (Combining Finance and Entrepreneurship)
After the traditional path of IB, PE or consulting, many people decide to do something more entrepreneurial. Of the people who pursue entrepreneurship, many will try to apply their existing finance and deal knowledge by buying businesses.
I’ve talked about search funds and they are indeed a very popular route for people to raise money and buy a small cash flow generative business. To review, search funds typically focus on buying a single business and improving its financial profile.
But there is another related strategy that has grown substantially in visibility and popularity over the past few years: roll-ups.
The goal of a roll-up is to buy and combine several small businesses in order to unlock synergies, drive multiple expansion, and derive benefits from scale.
What is a Roll-Up?
A roll-up is when an investor buys up a bunch of similar companies and operates them under the same corporate umbrella, essentially merging several small businesses. The idea is that you can build scale, derive cost improvements, and replicate best practices across each business.
For example, it might be unprofitable to purchase and operate a single fruit stand. But if you own a dozen fruit stands in Manhattan, then you’re able to secure better prices from suppliers, diversify your risk across locations, and understand consumer trends better.
Like any private equity deal or search fund acquisition, the typical process for smaller-scale roll-ups involves:
Outlining an investment scope (e.g., a specific geography or type of business)
Raising money from investors
Finding an operator to manage the businesses
Buying the businesses (could be one site at a time)
Integrating the businesses together
The key difference here is the volume of deals that you need to do in order to perform the roll-up strategy. M&A is the main engine of the roll-up process and your ability to buy businesses at a cheap multiple will drive your overall return.
The main reason this works is that private equity and growth equity firms often aren’t able to invest at such a small scale. Most private equity firms won’t have an investment mandate that allows them to invest in a single dental office.
But if you roll up twenty dental offices and put them under the same branding, then you’re able to sell it at a much higher multiple and higher price. On the flip side, most roll-up investors don’t expect the same kind of multiple that private equity firms offer and are thus able to buy at a cheaper multiple and employ some arbitrage.
Common Roll-Up Strategies
Below are a few common roll-up strategies that have active buyers and sellers in the marketplace.
The e-commerce roll-up (or aggregator) has quickly gained traction with the advent of Amazon and Shopify businesses. Additionally, online marketplaces like Flippa and Exchange Marketplace have made buying and selling online businesses much easier. The typical e-commerce roll-up searches for third-party seller on Amazon or Shopify that sells consumer products. Most operators of these e-commerce businesses don’t have the capital to scale their business to the next level, which is where the roll-up steps in.
Roll-up companies use their domain expertise, supply chain operations, and marketing knowledge to grow these e-commerce brands. There are many major players in the space, but e-commerce brands can still be purchased at low single-digit EBITDA multiples.
Example Players: Thrasio, Branded Group, Elevate Brands, Unybrands.
Healthcare Services Roll-Up
Rolling up healthcare service providers is a proven, profitable strategy commonly employed by private equity firms. Most healthcare services are relatively stable businesses, have inelastic demand, and hold very niche skills, thus creating information asymmetry between customers and practitioners.
Virtually every kind of specialty healthcare provider has been rolled up by private equity over the past decade, including family doctors, vets, physiotherapists, dentists, and opticians. Many healthcare practices are operated by just a few physicians, which makes them the perfect target to roll up.
Example Players: dentalcorp, Altus Health, Varsity Healthcare Partners
Another notable industry for roll-ups is software. Many small software businesses serve very specific niches that are extremely logical acquisition targets. The growth of big tech platforms like Apple, Google, Amazon and Shopify have allowed for small businesses to be developed specifically for their platforms.
Software developers often develop a tool or useful application that addresses a specific need and build a business out of it. In turn, investors can purchase these small businesses at low multiples and integrate them into a diversified portfolio of software companies. Marketplaces like Microacquire and AcquireBase have made this strategy more accessible to buyers.
Example Players: Constellation Software; most technology private equity firms like Vista Equity and Thoma Bravo apply this to some degree
Roll-Ups as a Career
The roll-up concept has been around for a long time. Companies like Constellation Software, all the CPG brands, and Waste Management have been doing it for decades at the large-cap level.
However, I think pursuing the roll-up strategy has recently become more viable at a smaller level and thus more accessible for individuals to pursue. Raising capital is easier now than ever. Plus, the popularity of roll-ups in market private equity means that there will be many buyers once you decide to exit your roll-up business, and new online marketplaces will help to facilitate deals by automatically pairing buyers and sellers.
I think the roll-up is just as viable a career path as search funds and in some cases, can be pursued simultaneously.
Below are some pros and cons I would consider when evaluating roll-ups as a career:
Get to utilize your prior finance / dealmaking experience in a tangible way.
If you’ve worked in IB and PE and you’re thinking of ways to apply your new-found skills, well… most career paths involve going back into PE. I think people tend to like search funds, roll-ups, and other related strategies because they allow you to improve your dealmaking skills in a much more entrepreneurial environment.
Value arbitrage generally exists between middle market PE and small-cap deals. Middle market private equity firms are often unwilling to invest in individual units.
You can apply more financial leverage to a portfolio of companies than you can to a single business.
Your portfolio is inherently going to be diversified if you own a collection of businesses.
You don’t have to apply any creativity to come up with a business idea.
Buying an existing business is the easiest way to become an entrepreneur without having to do any of the legwork for launching.
Finding an effective operator who can scale a group of businesses is fundamental for roll-ups and can be extremely difficult. You need to find an operator who knows how to implement profitable changes and will likely have to give this person a large chunk of equity.
Doing one deal is already a lot of work, but for roll-ups to work you typically need to do a large volume of deals. This means that you’re constantly looking at new opportunities, filling your pipeline with prospects, and reaching out to new potential sellers. Over time, this can become very tiresome.
Geographic opportunity may not line up with where you wish to live.
Raising capital is stressful and time-consuming.
I think the roll-up strategy is an intriguing way to be an investor and an operator. It’s a great way to combine your financial skillset with an operating skillset while also being able to learn about a specific industry.