Aggressively pursuing acquisition opportunities in a downturn is by no means a new or novel strategy in the world of M&A. There’s a big difference, however, between those who strategize and those who actually pull the trigger. Now is the time for private equity buyers to be preparing diligently and acting decisively in completing roll-up acquisitions.
Before COVID-19 arrived in the U.S. triggering a recession, any targets of substantial size and quality were disappearing quickly as buyers looked to achieve economies of scale in highly fragmented industries. The yearslong seller’s market has given way to an altered landscape; one in which buyers will be rewarded for maintaining a pipeline of targets and acting during a brief period of opportunity.
Data from the 2007-09 downturn suggests buyers that make significant acquisitions during an economic downturn outperform those that do not. Deal premiums come down and some companies may feel pressured to put assets up for sale. There is a small window in which to capitalize, and buyers can do so by adequately preparing and then moving quickly.
In this deal environment, buyers must continually procure targets in new and existing geographies, building out a robust pipeline of proprietary acquisition opportunities to avoid being left empty handed.
The Timeline of a Roll-Up
Here is the timeline for how aggressive roll-up processes typically progress:
- Strategy Formation: Discuss acquisition strategy, expectations, communication, and goals
- Marketing Documents: Develop marketing materials to distribute to targets
- Identify Targets: Complete extensive research and explore potential targets
- Build the Pipeline: Outreach via mail, phone, email, and inbound sourcing
- Maintain the Pipeline: Perform follow-up efforts
- Discussions with Targets: Conduct an introductory call with all interested targets
- Offer Preparation: Organizing target documents, valuation, LOI, and negotiations with the target
- Due Diligence and Closing: Keep the diligence process moving towards an efficient closing
Benefits of Being First
Being the first acquirer to approach a target can be beneficial. To determine whether there are independent operators of significant size to be rolled up, buyers can conduct market surveys well in advance of communicating with prospective targets. We advise buyers to think about the revenue estimates and geographic distribution of those qualified opportunities, as well as how auction processes are unfolding in the industry.
Prepare for Down Funnel Activity
Private equity buyers should determine a streamlined set of information required for a Letter of Intent. Roll-up deals too often fall through due to excessive diligence demands as buyers attempt to collect additional data to validate a purchase price for an LOI. The purpose of the Letter of Intent is to agree on a purchase price and structure in order to get to the stage of negotiating exclusivity. Streamlining the preliminary analysis portion helps buyers submit LOIs quicker and ensures more pipeline opportunities become closed deals.
Roll-up buyers should be open to the idea of looking further down market at smaller companies. Only recently are middle market buyers showing a willingness to pursue platform targets as small as $4 million EBITDA, as they seek to deploy their target level of capital and grow the business. Going down market is an effective way for buyers to build a platform and then pursue several smaller add-ons. For example, a buyer may acquire a platform company that is doing $4 million EBITDA, followed by 5 add-on targets that are doing only $1 million EBITDA. By starting smaller and building the EBITDA to over $10 million, the buyer will have a strong chance to see significant multiple expansion at exit and perhaps additional value creation through professionalizing smaller businesses than starting with a larger established platform.
Industries Primed for Consolidation
Buyers need only to look at one particularly active and quickly consolidating industry: facilities services, which includes HVAC and refrigeration, fire and security, elevator service and commercial landscaping, among other trades. Buyers must always maintain a pipeline of targets lest they miss out on an appealing opportunity. If a buyer envisions expansion into another geography in the next three or four years then, based on the pace of recent deal flow, today is the time to act. When completing roll-ups in facilities services and other quickly consolidating industries, buyers need to expect to be competing with other acquirers and should respond with a sense of urgency.
Because roll-ups can be completed relatively quickly, these transactions tend to be efficient and inexpensive ways to supplement a platform’s organic growth.
Preparation and speed are becoming increasingly important in completing roll-ups amid the uncertainty caused by COVID-19. Private equity buyers that are able to execute on an aggressive strategy quickly and efficiently will come out the other side better positioned.
Michael Shaw is a Partner and Managing Director at Copper Run. He specializes in private equity buy-side advisory.