From Mergers & Acquisitions Magazine (March 2001):
TO DO WHEN A ROLL-UP GOES BAD
By Dennis I. Simon (as told to
Here you sit, holding the bag.
A few weeks ago, or even days, you were the fair-haired
boy (or girl) in charge of a $200-million roll-up. A number of companies in your industry were combined into one giant firm.
Expectations were immense. Buying power. Economies of scale. Shipping discounts. Ever larger acquisitions and buyouts. The
promoters promised everyone the moon.
Now, suddenly everything has gone sour.
Cash flow is down. Expenses
are rising until they threaten to go off the Richter Scale or the Beaufort Scale, depending on which you use. The information
technology systems won’t merge; hell, they won’t even talk to each other. Leadership is lacking. Six of the former
visionaries who founded and ran these 10 enterprises from day one have flown the coop and are nowhere to be found. Ask not
for their advice, for they are in the wind.
These missing leaders are among the happy few. Several former owners
have cashed out, and many former executives have strapped on their golden parachutes and floated away from the plane before
it developed engine trouble, to mix metaphors outrageously. Now the plane is losing altitude and headed for a crash.
The rest of the former owners are suing the new company. Their piles of gold weren’t big enough. So while the plane
is losing altitude, they’re demanding that it fly higher and faster, and when it won’t they’re manning the
anti-aircraft guns and trying to shoot it down.
The promoters have stood at the turnstile and collected fees for
each person who got on the plane. Now they, too, are in the wind. The banks, law firms and accountants you rely on are angry.
They are threatening to call in a turnaround firm to clean house.
How did things get so bad? And, more important,
what can you do to clean it up?
Lesson No. 1: Most roll-ups are doomed.
I hate to say that, but it’s
true. The reason is that most roll-ups are not done to create a more efficient business, a long-term money-making machine.
They are done to create the illusion of synergy, the promise of a bigger gorilla in the marketplace, and to create the aura
of success, allowing a select few to cash in for short-term gains. They are done to create a favorable sale. The owners and
executives have slaved long and hard and now they feel it’s time to reap their reward. Boom, it’s time to cash
out and go on an extended vacation.
Remember the last scene in “The Shawshank Redemption”? The two
convicts are lazing on a beach somewhere near Puerto Vallarta with enough money to last forever. That’s what some owners
and promoters had in mind.
They took advantage of an arbitrage system that rewards roll-up fantasies while the
public stock market goes up. As long as the public market will pay 10 times cash flow for a larger company instead of four
times cash flow for smaller entities, these roll-ups will keep on rollin’ up. As long as the market keeps rising, another
risk-taker will come along to buy the stock on speculation. But when the market goes down, or when the stock falls because
the newly rolled-up company isn’t performing, someone is left holding the bag.
This time, it’s you.
Next time, it’ll be someone else. It’s like musical chairs, only more painful.
These roll-ups are
a good idea for the Wall Street banker and for the seller, but can be a bad idea for the lender, the stockholders, and the
manager who has to make the new company work.
Roll-ups are a lawyer’s and a turnaround specialist’s
paradise. Everyone sues everyone, and then they call in the operational experts. Stockholders sue brokers and promoters. Turnaround
specialists make their living off these mistakes, which are products of an over-valued stock market and the result of 18-carat
greed. But this is a free-market economy, and these transactions are to be expected. Some people would rather take big risks
and go after big rewards. If there were not an exaggerated multiplier in the public market place, there would be no roll-ups.
When a roll-up goes bad, it exhibits the same characteristics as any other failing business. Sometimes
you can sense the failure, the lack of energy and direction; you can smell it. In one moribund manufacturing business, we’ve
seen too many empty offices and people walking around in a daze. In another, there is a sense of hysteria, with people running
around willy-nilly as if the place were on fire.
The proof is in the pudding, which in this case can be found
in the financial reports. Lack of adequate cash flow can be disastrous. Early warning signs include unexpected buildups in
inventory or receivables, unusually late financial reporting or bloated G&A expenses, failure to meet income projections,
a sliding position in a dynamic market place, low or vanishing profit margins, and working capital shortages or low cash flow.
Somehow managers find a way to ignore these signs. People who are used to running one business may now be running
two, or five, or even ten unassimilated organizations. They don’t do the metrics – they don’t count the
beans every day – they don’t know which products, services or divisions are making money and which ones aren’t.
They don’t have clear-cut goals, so they don’t know if they are running on empty or building up a reserve.
If you are on a management team or board of directors left holding the bag, what can you do?
You can call
in a turnaround firm to help, which may be advisable, or you can try to do it yourself. Realize that the longer you wait,
the more blood is going to be let, the more expensive it’s going to be.
The best time to call a turnaround
expert is any time your company is not meeting its own business plans and projections, and your management has not risen to
the challenge by implementing decisive and even radical changes in the way the company does business.
In a normal
one-of-a-kind business, the early warning signs are not so readily overlooked. But in a roll-up, with five or ten business
units that are being integrated (or not being integrated, which is usually the case), the picture can be more confusing and
the signs harder to read.
a faltering roll-up, a reporting system should be put in place to count the beans every day, so the flow of red ink can be
stopped, so that managers can identify which personnel and which business units are performing and which ones are not.
Someone needs to rethink the entire business, asking whether it makes sense, whether it has the potential to be a
thriving competitor, and what form it should take.
Remember, the roll-up was formed so that certain people could
take advantage of a market arbitrage opportunity. The newly integrated business didn’t grow like a normal market-driven
business, to efficiently meet the demands of its customers better than its competitors. So it will have certain inherent weaknesses.
Four major issues determine the success of any roll-up:
• Information technology;
• Executive compensation and various employment contracts;
• Direction, focus and leadership;
• The motivation of key personnel.
is a greater factor than many people realize. An I.T. system that doesn’t work can cripple a business, especially a
growing business or a roll-up; some I.T. systems we’ve seen were unable to track inventory or produce accurate financial
statements. Making an I.T. system work can cost millions.
I.T. systems integration has become a major factor in
roll-ups and other business integrations. Managers from the old school who are not familiar with new technology may need to
call in a consultant to avoid major unforeseen expenses.
Here are four ways to recognize poorly integrated information
A. Extended workflow cycle-times caused in part by too many handoffs among personnel. Often, in a post-acquisition
environment, people use remnants of systems that may contain inaccurate information. For example, an engineer may use parts
numbers from a data base that is no longer supported by the central system. The resulting workflow can be chaotic, expensive
B. Late deliveries caused by uncoordinated efforts between departments or across functional areas.
In a complex manufacturing environment, many tasks must be processed in parallel with predecessor/successor relationships
clearly established and well coordinated. Obviously, I.T. system failures here can be costly.
C. Erosion of data
integrity from downloading data to spreadsheets and increased reliance on desktop tools for day-to-day management execution.
For example, people may download schedule data from the central system and create their own schedule controls, using spreadsheets
or other applications on laptop or desktop computers. Since they are processing work outside of the central system, any changes
to the work in process go unnoticed, resulting in wasted time and materials.
D. Reduced productivity and increased
rework resulting from unnecessary time spent tracking, researching, expediting or otherwise manually intervening in the processing
of the workflow.
If you have any of these problems, you know you are in trouble.
The cost of integrating
multiple I.T. hardware and software systems can be so high that it may make sense to sell off several of these businesses
instead of integrating them together. This may not be what the roll-up promoters promised, but the profit picture may not
be what they promised either. You may be faced with a choice between closing the larger, freshly rolled-up business or selling
off a few business units. An experienced turnaround firm should have a special division that can help solve these complex
and costly I.T. problems. (For example, at Crossroads, we created our own I.T. company called Solutions Enabler Technologies,
to work with healthy companies and to help us solve difficult integration problems. At times we use it as a triage unit, with
our turnaround clients.)
The other three major problems have to do with the efficacy of your management team.
You may have too many executives who cost too much and who may lack the incentive to produce and who may be pushing the business
in too many different directions.
Employment compensation contracts, signed to entice entrepreneurs to participate
in the roll-up, may turn out to have a crippling effect on a roll-up that’s in trouble. You may need to cut salaries
at the top. Suppose you’ve brought in several companies that have CEOs with base salaries of $750,000 per year, who
on termination are each owed a year’s salary, plus benefits. And suppose further that these companies arrive with even
more baggage, i.e., several other costly executives. You may have acquired a CFO from one company with a compensation package
worth $500,000, plus a COO from another firm, a CIO from another, and a CTO from yet another. All these people add up; pretty
soon you’re talking real money.
Before the roll-up, these ten companies were run by ten independent leaders.
They no doubt had ten different visions of the future. After the roll-up, these visions may be wildly incompatible; management
meetings may look like bouts put on by the World Wrestling Federation.
Heads may have to roll to solve this problem.
Concentrating the decision making into the hands of a few competent leaders can help unify the direction and focus
of the company.
Usually, in a large-scale integration of multiple businesses, two or three leaders rise to the
top, like wrestlers who survive the fight. These competent leaders deserve to be in charge; the rest should be eased out the
plane door into thin air without their golden parachutes, if that can be done without breaking the bank (to mix metaphors
even more). Sometimes the only way to cut the golden parachute expense is by taking bankruptcy, which allows the company to
reject these obligations. Chapter 11 can be useful here.
Often, an experienced turnaround firm can provide objective
guidance; these matters may be personal and delicate and can be hard to manage for those with longstanding personal relationships
The motivation of key executives also may be a problem. Your owners were formerly entrepreneurs accustomed
to running their own companies. Full of the entrepreneurial spirit, they worked from 6 a.m. to 9 p.m. for 20 years. But they
are not sole proprietors any more. From our experience, we can almost guarantee that you will have problems in this area.
A newly integrated and reorganized business requires motivated entrepreneurial leadership. Sometimes new leaders have to be
brought in from outside or brought up from inside the organization. Performance-based compensation is critical in this area.
A roll-up that is reorganized still faces challenges, but with the I.T. systems integrated; focus and
direction established; competent, motivated management in their proper places; and market position clear, success is often
Holding the bag may not be so bad, after all.
You can be the fair-haired boy (or girl) again,
• Shoot the sacred cows that
chew up cash;
• Do the metrics and protect cash-flow;
• Raise prices, if necessary;
operations, if needed;
• Integrate and maximize collections;
• Seek out and cut hidden, unnecessary
• Question and perhaps sell non-strategic assets;
• Focus first on saving, not growing, the
• Examine inventory practices to reduce SKUs (stock keeping units);
• Cut non-performing product
lines and personnel;
• Hold everyone accountable for what they do, every day;
• Get the most from your
• Compensate the right people based on their performance.
Often, it’s an advantage
to bring in turnaround experts for their objectivity and experience.
If done right, some roll-ups can work, and if turnaround efforts begin early enough and are done right, many
of the doomed ones can be saved.