Roll-Up’ Firms Want You
Dale D. Buss
There are pluses and minuses to Selling your firm when an investment group is buying up independent businesses in a market segment.
Two years ago, Deborah Cross was feeling overwhelmed by the demands of managing Hearing Dynamics Inc., a chain of San Diego-area audiology clinics that she had built lovingly over 14 years. She was frustrated by the lack of capital for expansion and for improved marketing. She also wanted to spend more time at home with her young son.
Then Sonus Corp. came along, buying Cross’ company in late 1996 as part of its “roll-up” of dozens of local and regional audiology clinics nationwide. The Portland, Ore.-based consolidator took ownership responsibilities off her hands, infused Hearing Dynamics with big-company resources, and gave Cross, who joined Sonus as regional administrator, more time to spend with her family “I absolutely believe in what the company is doing,” says the 42-year-old former entrepreneur.
But Sonus’ bid for Mark Toscher’s California company, Audiologic Associates of Santa Barbara, which provides services similar to Cross’ company, faltered on reservations he shared with his partner.
“There was going to be a little too much looking-over-the-shoulder stuff for us to swallow,” Toscher says. “And the amount of money upfront wasn’t enough that if it didn’t work out, we could say, `We’re out of here.'”
Like Toscher and Cross, an increasing number of small-business owners are finding themselves in the path of a roll-up these days. Also known as “build-ups,” “buy-and-builds,” or even “poof” companies because of how quickly they materialize, roll-ups involve an investment group’s rapid-fire purchase of a number of independent businesses in a given market segment and their consolidation under a single, new corporate umbrella.
Closely related are sudden acquisition sprees by existing companies that become consolidators as they seek a new competitive critical mass.
The Meaning For Main Street
The rationale behind a roll-up is to reap economies of scale by centralizing functions such as purchasing, accounting, and human resources. Because roll-ups take root in highly fragmented markets, they don’t necessarily threaten the survival of the remaining independent businesses. In fact, many independents worry more about missing a great selling opportunity if they say no when a roll-up comes knocking. Typically the businesses that are bought maintain local management while the parent company focuses on building the regional or national entity.
The payoff for investors in the roll-up comes when the consolidator takes the new company public with an initial public offering (IPO). Stock in the new public corporation becomes part or all of the currency for buying out owners.
Roll-ups, in fact, have become the most popular way for Wall Street to make money from America’s mom-and-pop multitudes-and vice versa.
“Main Street is not putting up much of a fight; in most cases, it’s putting up a ‘For Sale’ sign,” says David M. Scharf, an analyst for San Francisco-based Montgomery Securities Inc. He calculates that roll-ups have raised more than $8 billion in investor capital in the United States since 1994.
A few public roll-ups already have unraveled somewhat. such as TeleSpectrum Worldwide Inc., based in King of Prussia, Pa. Last fall, a year after trumpeting its entry into the Boston market, the telemarketing-services consolidator shut down its four Massachusetts sites and cut 400 jobs as its stock price plummeted from a high of about $18 a share early last year to as little as $3 a share in December.
Actually that torrid pace may be cooling a bit this year. In recent months, far example, several roll-ups in Houston-a hotbed for consolidators-failed to complete IPOs.
“Some roll-ups won’t last because they’re being put together without a lot of thought,” says Carl Thoma, a partner in Thoma Cressey Equity Partners, a Chicago-based firm that has financed more than 45 roll-ups and other consolidation plays. “It’s like getting married after one date: The odds probably aren’t as good as they’d be if you had a longer relationship.”
A Broad Phenomenon
Although the jury is still out on the roll-up phenomenon as a whole, many small-business owners can’t wait until the final verdict. They’re being approached now with opportunities to sell, and some even have a choice of roll-up suitors.
Roll-ups already are active in dozens of industries-services as well as goodsranging from temporary-staffing companies to coffeehouses, candy makers to automobile dealers, nostalgic-collectibles companies to floral wholesalers, and limousine services to funeral homes.
“And I don’t even think we’ve scratched the surface in terms of the number of industries that are subject to roll-ups.” says Howard Ross, a partner in Arthur Andersen & Co.’s Philadelphia office and architect of the TeleSpectrum roll-up as well as many trouble-free consolidations. “Every time I turn around, I’m amazed that there’s another industry that no one ever thought of-court reporters, for example. There are now four of those [roll-ups] going on around the country.”
A common roll-up scenario involves owners who founded their companies after World War II and now are looking for a strategy to exit the business. Cash and stock yielded by a rollup agreement suddenly makes these entrepreneurs’ stakes in their companies very liquid.
A roll-up can be the salvation for a family business facing a management vacuum in the next generation. It can be an antidote to poor estate planning. Or it can be a welcome solution for a founder seeking an exit strategy, as it was for Mike Nothum Sr.
Nothum founded his heating, ventilation, and air-conditioning firm in Tempe, Ariz., in 1962. By the time the roll-up offer came, his son, Mike Nothum Jr., had spent 19 years building the firm’s revenues from $2 million a year to $35 million, making it one of the strongest companies in its market.
Meanwhile, the son had slowly built his stake in the company to about 50 percent with the intention of buying out his father completely in the next few years.
“But the detriment of having a rapidly growing company, without having 100 percent ownership of it, was that it became more difficult to buy extra pieces of it every year,” says the 43-year-old Nothum.
So he decided to become a charter member of a Houston-based roll-up, signing on as chief operating officer of the company that is now called Comfort Systems USA while his father sold most of his stake for cash.
“It was great for him: Here’s a man who already had devoted most of his life to building a business but who now was at the tail end of his career,” says the younger Nothum. “Instead of waiting five to 10 years to get paid off by me, he got his money within 24 hours.”
As you make your own decision about roll-ups, consider these suggestions that have emerged from the comments of people knowledgeable about the trend:
Know your suitor. Jonathan Karp, a shareholder in Reish & Luftman, a management consulting firm in West Los Angeles, says to keep in mind that the transaction consists of two parts: investing in a business and selling your company. If you take stock in a roll-up and join its management team, your livelihood and financial security now will be largely tied to that company
Especially if the roll-up protagonist is not a well-known local player in your industry make sure you know with whom you’re dealing. Consult your regular advisers but also, perhaps, broaden your sources of advice to include investment bankers or venture capitalists. Talk to roll-up architects.
“The main thing is to team up with people you respect, who understand your business and with whom you can enjoy working for the long term,” Chicago financier Thoma says. “Don’t get caught up in the euphoria of the moment.”
Search yourself. There’s no better time to decide whether you really want to be a business owner, to become just an active participant, or to go fishing for a while and live off your proceeds.
“It’s one thing to run a mom-and-pop business because everything you do is added to your own net worth,” says J. Del Walker of Pannell Kerr Forester of Texas PC, a Houston-based consultant to closely held businesses. “But just being the general manager of a division of a transportation company, say, isn’t too sexy. You may start thinking, ‘I don’t get paid enough to do this stuff'”
Steven Weissman chose not to pursue a roll-up bid for Kinetic Information, his three-person high-technology marketing and consulting company in Waltham, Mass. “It’s very important to understand what you’re looking to get out of it, whether it’s financial gain or personal growth,” he says. “Those two are not always joined at the hip. If you can find a circumstance where you can get both, that’s the one you grab.”
Prompted by the roll-up bid, Weissman did a lot of introspection that led directly to a decision about how to improve his company instead of selling out.
“It became apparent that in order for us to continue to grow, what we really needed was resources to boost sales,” he says. “So we ended up hiring a salesman, which was a stretch at our size. But we decided it was something we couldn’t afford not to do.”
Examine terms carefully. Make sure the valuation of your company is fair, reflecting not only a multiple of your earnings but also your expenses, growth prospects if you stayed on your own, the quality of your management team, and the outlook for your industry.
Carefully consider the cash-versus-stock balance: While cash is a bird in the hand, the roll-up likely will discount an all-cash offer by 15 to 25 percent, Walker says, because prospective IPOs prefer to use their shares as currency
And, of course, many cash sellers have been gnashing their teeth over what might have been-how much more valuable the stock in their roll-up is now than it was then-because of the bull market.
Ty Dickinson, 37, had envisioned expanding his $12 million floral distributorship, Johnson’s Roses in Woburn, Mass., under his ownership until USA Floral Products Inc. approached him last year. He and coowner Pamela Dickinson, his wife, sold out to the roll-up, and now he is on the board of Washington, D.C.- based USA Floral while still running Johnson’s Roses.
Dickinson accepted 70 percent cash from USA Floral. “I was being risk-averse when it was formed,” he says, “because it didn’t have Morgan Stanley as our investment banker at that time, or Bankers Trust as our senior bank. I was pretty much trusting the ‘story’ that it would work. As it turned out, I would have been better off taking the 100 percent in stock.” The company’s shares recently traded for about $19, up from the $13-ashare price of last October’s IPO.
Read the employment terms’ fine print. Employment terms make up another crucial aspect because corporate ownership and the strong will of a former entrepreneur working in a collective environment, even with a lot of autonomy, “are guaranteed to clash,” says Reish & Luftman’s Karp. And employment contracts, he says, typically are finite.
For example, once Philip Starr looked at the paperwork accompanying a roll-up bid for his Los Angeles-based vocational-rehabilitation concern last year, his view of the deal soured. “We got a three-year contract, then at the end we were ‘at-will’ employees, so we could be terminated anytime,” says the co-owner of MCS Rehabilitation Inc. “That was on top of finding out that the principals of the company were going to get a whole lot more stock than I was.” Ultimately, Starr chose not to sell.
Get in early. Terms likely will be more liberal the earlier you’re approached, and often the founding members of a roll-up- like Nothum of Comfort Systems-enjoy the most-privileged positions.
“The founding companies get money out of the deal when they first go public and they still own their own companies,” says Donald McKay, CEO of Tougher Industries Inc. in Menands, N.Y. The company is a large regional contractor that is competing with the proliferation of roll-ups in the heating and air-conditioning industry.
Project your status a year from now. The bull market won’t last forever. And roll-ups as a whole are still such a young phenomenon that it isn’t possible to answer definitively the $64,000 question: Do the entrepreneurs who have sold out become happy in their new roles as managers?
Walker says that he’s encountering former owners who are finding themselves being marginalized. “They’re first told to focus on operations and less on strategy” he says. ‘Then they find out that some of what they want to do is not consistent with company policy … Soon they are told that they don’t even need to worry about growing their business anymore, because the roll-up is going to make its stock grow by continuing to acquire more companies.”
Consider your customers. Audiologic Associates’ Toscher says one reason he turned down Sonus was that, based on watching another roll-up in his industry he concluded that remote ownership “can alienate customers” in a hands-on business such as audiology.
National ownership and coddling local customers aren’t necessarily in conflict, says Jonathan Ledecky, architect of USA Floral and of one of the first major roll-ups, U.S. Office Products, also based in Washington. He explains that U.S. Office Products’ more than 200 local companies use their own identifies in local promotion but note that they’re “a U.S. Office Products company They’re getting the benefit of a brand as a marketing tool, and they can go to the customer and say, ‘We’re part of a larger company’ hut the people they’re dealing with-the customer care and contact- haven’t changed.”
Consider your employees. The specter of becoming part of another Tele-Spectrum Worldwide-where a rollup faltered quickly and slashed the jobs once provided by a local owner-is one of the worst nightmares of entrepreneurs who are considering selling out to a roll-up.
Yet allowing more career-advancement opportunities for their employees is one factor that attracts many business owners to a roll-up. That weighed heavily for example, in the decision by Stephen Schramka to sell his two-location, 106year-old, family-owned funeral-home company in suburban Milwaukee. He sold to Equity Corp. International, a company in Lufkin, Texas, that owns nearly 300 funeral homes across the country.
“Family members now have a chance at some career opportunities-such as management or stock ownership-that there’s no way they would have had as long as we remained a small, independent company, Schramka says.
Keep the door ajar. Circumstances change, your competition toughens, rivals sell out, deals sweeten. Even Kinetic Information’s Weissman says he has never said never to the roll-up that approached him last year. “I’m proud of myself for not rushing in, and I’m certainly more circumspect now,” he says. “But they’re still expressing some interest, and so am I. The conversations aren’t over.”
Leaders of The Roll-Up Charge
While consolidation mania is partly about making hired managers out of autonomous business owners, the flip side of the trend-where the roll-ups actually are born-is producing plenty of new entrepreneurs. Meet a few of them’
Jonathan Ledecky is one of the poster boys for roll-ups. Ledecky founded one of the big originals, Washington, D.C.-based U.S. Office Products, in 1994 and has fostered its growth to a $3 billion company today.
Now, also from Washington, he’s nurturing USA Flora, and he’s launching his biggest roll-up effort ever, Consolidated Capital, a sort of catch-all concept that intends to roll up whatever businesses seem to make sense.
He emphasizes an approach that he calls “corporate democracy” to satisfy owners and their employees who join his company. “You have to be tremendously sensitive to the owner who’s selling his or her baby to you,” says Ledecky. “And if you tell them you’re going to do ‘A,’ you must do ‘A.”‘
It seems to work. Ninety-five of the first 100 floral-trade companies that he approached turned him down initially, but 72 of them eventually joined, he says, and 96 percent of his original employees at US. Office Products companies are still with him.
Steve Kerrigan, chairman and CEO of Coinmach Laundry Corp. in Charlotte, NC., was part of a group of investors that acquired the 48-year-old regional coin-laundry company in 1995 and used it as the vehicle for a roll-up.
The company had made two major acquisitions by the time it went public in 1996, giving it control of about 240,000 machines and 7 percent of the national coin-laundry market.
Now, Coinmach Laundry has made 50 acquisitions, has 19 percent of the market, and is on its way to a projected 30 percent in the next few years.
“I like to say that we’re only in the fifth inning of our consolidation,” says Kerrigan, who got his start with the company as the chief financial officer of its predecessor for seven years. “We’re a successful roll-up because we’re integrating companies, not just accumulating companies. There’s always a customer at the end, and we believe you have to be able to deliver service to them that is at least as good as what they got before.”
Kurt Swenson is proof that roll-ups really are a cradle-to-grave concept. Swenson is busy building his 115-yearold, formerly family-owned company into the nation’s premier roll-up of the grave-marker industry.
Rock of Ages Corp. in Graniteville, Vt., formerly operated only on the quarry and manufacturing side of the business, but Swenson-the firm’s chairman, president, and CEO- is working to integrate companies in that sector with memorial-retailing companies to create an entity that’s new to the industry in size and scope. Revenues in 1984 were $24 million, but they rose to $54 million last year, and Rock of Ages went public last October.
“Reaction has been very good” from buyout targets, Swenson says. “I think the reason is that our company has a long history in the business, and [retailers] we’re talking to have been our customers for a long time. They know who we are.
The next major element of his strategy, he says, is to build Rock of Ages into a national brand.
Steve Harter, president of Notre Capital Ventures II in Houston, is one of the few legitimate contenders for the title-now held by Ledecky- of “father of the roll-up.”
Harter already has taken seven companies public, including Comfort Systems, US Delivery, Coach USA. and Metals USA. He sees today’s consolidation trend as serving the same sort of useful, rationalizing purpose for America’ economy that the creation of Standard Oil and U.S. Steel did a century ago.
Harter still seems a bit taken aback by the idea that he runs a company that is leading the roll-up charge. “I went from being an accountant with a local environmental-services company that was part of one of the early rollups to being a [mergers-and-acquisitions] guy,” he says. “We had [representatives From] 250 institutions show up for our recent conference.”
Besides spawning and cultivating rollups, what most concerns Harter about the phenomenon is the rise of financially oriented roll-up architects who, he says. don’t know what they’re doing.
“I’ve got some concern about guys who have never operated in consolidating companies,” Harter says. “A lot of bad deals are going to get done because of it, and we may end up with the same black eye as [financiers] did during the junk-bond era.”
COPYRIGHT 1998 U.S. Chamber of Commerce
COPYRIGHT 2000 Gale Group