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RESOURCES

Team

Equity Sponsor

Because a rollup strategy requires strong financial backing, the most important part of the team will be the equity sponsor. The sponsor will provide the initial capital to position the platform for acquisitions, is likely to have contacts with many investment bankers, sources of financing and other sources of acquisition opportunities and will be well represented on the platform's Board of Directors.

Once you have determined that your industry and company fit the criteria for a successful rollup, you must create an offering memorandum which will explain in great detail why this is such a compelling investment opportunity. The memorandum should contain detailed information regarding the existing platform, the management team, the strategy, the industry and its competitive dynamics and valuation analysis for typical acquisition targets. Obtaining the backing of a sponsor is an arduous process because the sponsor accepts the most risk for buying into the idea and will therefore perform rigorous analysis of the proposal. Although many sponsors see hundreds of investment ideas each year, there is a lot of capital out there looking for good opportunities.

Choose a sponsor based on the terms of their investment and their ability to add value to the business. You will obviously need to address the amount of the initial investment, the percent of ownership they will receive and the terms of add-on investments. Other issues include how much, if any, equity investment is required from the management team and the composition of the Board of Directors. As important as the economics of the deal is the sponsor's experience in the industry. Because the sponsor will probably have control of the Board, his or her knowledge of the industry's dynamics is very important.

You may also want to consider whether the investor has a specific timeline for exiting the investment. Equity Sponsors are usually private partnerships which have raised a fund of capital from institutional investors such as insurance companies, universities, pensions, etc. Funds are often raised with a five- year targeted lifetime and an internal rate of return of 30 percent or more. Because of the targeted lifetime, Sponsors often try to liquidate their investment in three to five years.

Investment Bankers

Because a rollup strategy consists of numerous transactions, it will be important to maintain relationships with a number of investment bankers who will be valuable sources for acquisition ideas. Investment bankers may have relationships with companies in your industry and will facilitate acquisition discussions. Your lead investment banker may change between deals if different ones initiate acquisition ideas. This is likely to be the only member of your team who may change from deal to deal.

Choose an investment banker who has been involved in dozens of acquisitions and who is familiar with rollups. It is not critical that the investment banker is associated with a large or well--known firm as much as it is important that he or she has the right experience. If possible, choose from investment bankers who have invested equity capital in other acquisitions. They should know how to underwrite and value a private company. You can also select investment bankers who have represented the buy-side of acquisitions, even though they have not invested capital in those transactions. Try not to select investment bankers who have only represented the sell side of corporate mergers and acquisitions.

Review the background of these bankers carefully and do not be shy about discussing the details of prospective bankers' backgrounds. There are thousands of investment bankers who fit the criteria above. Do not settle for second best.

The following is a list of the areas in which your investment banker may need to have experience:

  • Building comprehensive financial models of the historical and future projections of companies in the context of a change of control transaction.
  • Valuing private companies.
  • Preparing bids in the form of letters of intent for the purchase of private companies.
  • Negotiating the terms of purchase agreements on behalf of buyers of private companies.
  • Preparing financing memorandums for raising capital for private companies going through a change of control transaction.
  • Negotiating supply agreements between the sellers and buyers in change of control transactions.
  • Negotiating the terms of financing with sources of senior debt, subordinated debt and equity.
  • Negotiating shareholder agreements among the equity investors in a change of control transaction.
  • Negotiating employment agreements for senior management of the Target, if they are joining the Combined Company.
  • Orchestrating the close of buyouts on behalf of buyers.

Corporate Attorney

Selecting the right attorney and law firm is a very important decision. Unlike the selection of an investment banker, it is important that the attorney you select is with a law firm that has the right set of capabilities. Whereas the lead investment banker on the deal may change, you should have an attorney who is familiar with your strategy and who knows how to structure your transactions. This way, you won't have to reinvent the wheel during every acquisition, which will expedite the process and lower transaction fees.

Select an attorney and law firm that are highly experienced in corporate transactions, preferably representing the buy side of acquisitions. The attorney should be a specialist in corporate transaction work. The law firm should have a substantial corporate transaction practice, benefits practice and environmental practice.

The following is a list of the areas in which your attorney and law firm may need to have experience:

  • Preparing bids in the form of letters of intent for the purchase of private companies.
  • Negotiating the terms of purchase agreements on behalf of buyers of private companies.
  • Negotiating supply agreements between the sellers and buyers in change of control transactions.
  • Negotiating the terms of financing with sources of senior debt, subordinated debt and equity.
  • Negotiating intercreditor agreements.
  • Negotiating environmental indemnities.
  • Negotiating shareholder agreements among the equity investors in a change of control transaction.
  • Preparing incorporation documents for the company.
  • Negotiating employment agreements for senior management.
  • Orchestrating the close of buyouts on behalf of buyers.

Accountant

It is important to select a reputable accounting firm that provides a wide array of services. This is because several individuals will be performing the financial due diligence. The more reputable the firm, the more weight their opinion will carry in the event of accounting disputes with the seller.

Choose an accounting firm with experience performing financial due diligence for acquisitions. The following is a list of the areas in which your accounting firm may need to have experience:

  • Reviewing the Target's audited financial statements and providing a "Quality of Earnings" report
  • Issuing reports focused on key deal issues
  • Advising on indemnities required in the LOI and adjustments to the Purchase Agreement
  • Creating partial-year audits upon close of the transaction
  • Advising on a tax efficient deal structure
  • Analyzing employee benefits
  • Analyzing risk management (Insurance)
  • Assessing the Target's Information Technology systems (generally only larger accounting firms do this work)

Environmental Auditor

It is important to assess any environmental liabilities the target may have. When a corporation purchases the stock of another company, all the target's liabilities transfer with the stock, including environmental liabilities. If the transaction is an asset purchase, an environmental audit becomes less of an issue, although it's still relevant.

Like your financial auditor, choose an environmental auditor with a solid reputation who's opinion and analysis you can trust. The environmental auditor must perform a Phase 1 analysis and issue a report of his findings. If potential problems are discovered during in the Phase 1, by law a Phase 2 must be completed.

Senior Lender

Because a rollup strategy involves multiple acquisitions, it is important to arrange for debt financing with a lender who is willing to commit a pool of capital to financing your deals. There are a number of ways to structure debt commitments for rollups and the Sponsor should be able to help you formulate one which works with your strategy and the terms of the equity investment.

The easiest way to choose a senior lender is to distribute an information memorandum and financial model and request term sheets from them. Your Sponsor will know lenders who will be interested in your type of deal and will handle the process of receiving and analyzing their term sheets.

Choose a senior lender based on the competitiveness of the terms they are proposing. While it is important to have a relationship with your senior lender based on mutual understanding and respect, the differences between term sheets are easy to quantify. The key issues to analyze include:

  • Amount of committed capital
  • Terms of financing each add-on acquisition relative to additional equity investments
  • Interest rate
  • Length of loan and maturity
  • Amortization schedule
  • Prepayment penalties
  • Financial covenants

Subordinated Lender

Subordinated lenders include a variety of institutions, including banks, mezzanine (another term for subordinated debt) funds, pensions, insurance companies and wealthy individuals. The process of raising subordinated funds is quite similar to raising senior loans. Potential lenders will require an information memorandum and financial model in order to do preliminary analysis and gauge their interest in the deal. They will want to meet the management team and perform the same sort of due diligence as other investors. The sponsor or investment banker should handle the process of contacting subordinated lenders and receiving and evaluating term sheets from them.

Subordinated debt may not be required in your strategy or may be necessary to finance only some of the acquisitions. A lot will depend on the financing available from senior lenders and the health of the acquisition targets.

Key considerations when sourcing subordinated debt include:

  • Interest rate
  • Warrant position (if any)
  • Length of loan and maturity
  • Amortization schedule
  • Prepayment penalties
  • Financial covenants