By Lou Sokolovskiy
In today’s market, where “roll-ups accounted for over 80% of all deals” in the lower middle market (over 2,000 deals) last year, independent sponsors have increasingly been turning to roll-ups to scale.
But with 60% of Private Equity (PE)-backed roll-ups failing to meet projected synergies within two years, the most important question becomes the simplest of all: what separates a successful roll-up from one that falters?
No one is better to answer this question than Andy Silverman of Parkway Capital. A longtime supporter of independent sponsors with a quarter-century career in investment, Silverman has seen his share of independent sponsor deals: around 250 per year.
A Common Roll-Up Challenge
Starting with a relatable scenario that many CEOs face in today’s uncertain economy, where interest rates remain high, Silverman shared some actionable insights for independent sponsors.
A sponsor has put money into a platform and feels good about the initial investment, he said, but a major concern arises: the CEO, the strategic visionary and thought leader, gets pulled away from the core business to look for new add-ons or integrate existing ones. What will you do?
“There’s nobody sort of at home to mind the farm,” Silverman said. “My poor CEO, God bless him, is flying around the country trying to herd all these cats.”
With 78% of PE-backed CEOs reporting burnout from juggling acquisitions and operations, this hits home. In this situation, Silverman added, what the business really needs is also COO to manage the day-to-day while the CEO focuses on growth.
Failure to do so results in more precious time being wasted and in a market where sponsors typically underwrite a 25-40% Internal Rate of Return (IRR) for their equity returns, delays can erode returns.
“Time is not your friend in an IRR context,” Silverman said.
Five Critical Factors for Roll-Up Success
Then what makes for a successful roll-up strategy? As a capital provider who refers to himself as “a mezz guy” (Mezzanine financing), Silverman outlines five critical factors.
- People: As highlighted by the CEO scenario, the depth of the management team is critical. There needs to be “scaffolding around the CEO,” he said, allowing them to be strategic while others ensure the core business runs smoothly. Acknowledging gaps in the team and addressing them is a must.
- Processes: Good processes must be in place, capable of working together and scaling with add-on acquisitions. Silverman warns that “putting in a new thing is always more expensive and takes a lot longer and is always a much bigger distraction than even the most conservative person underwrites.” Disparate processes from acquired companies can lead to laborious manual workarounds and a lack of scalability. Silverman’s insistence on the importance of good processes is backed by prominent studies suggesting that standardized processes lead to reduction in both operational costs and errors, by 20% and 50%, respectively.
- Systems: Working “hand-in-glove” with processes, systems are crucial for scale, Silverman said, adding that, for example, QuickBooks, a relatively simple accounting software, might suffice initially, but “ultimately everything needs to be on the same system” if building a national or regional platform. The inability to put everything on a unified system can make the platform unscalable for a future buyer.
- Capital Structure: Silverman stressed the prudent use of leverage, noting that for lower middle market businesses, once your debt is 4X your EBITDA, you are considered “highly levered.” With senior debt (priority loans with repayment preference) rates at 7-9%, cash flow constraints can hurt. While senior debt might seem cheaper, its cash flow limitations could become more expensive over time. Sponsors must consider the trade-offs between dilution (bringing in more equity) and being “over-levered.” Crucially, the capital structure must survive when “things [are] not going perfectly well,” especially since “more often not the first 18 months into an investment… That’s when most things tend to break.”
This factor also ties into choosing the right capital partner—one who is a “true resident” in the lower middle market, not a “tourist,” and will be a partner when things go sideways, not reacting roughly to a covenant breach - End Goal: Simply combining businesses without a clear exit strategy is a recipe for trouble. Silverman emphasizes the need for a “clearly elucidated strategy for some like us to want to execute on it,” such as building a regional leader or an actionable platform. The destination in three to five years must be clear. Sponsors cannot solely rely on the theory that “if I have a bigger EBITDA, I can get a bigger multiple and get you a bigger EV,” because “in practice it does not always play out that way.”
He uses a poignant example: putting an HVAC business in Dallas with one in Atlanta. While the EBITDA might combine, “how the heck does having an Atlanta Dallas-based business make any sense to anybody who’s trying to build sort of a regional or national platform?”
Without a clear strategic rationale and the ability to execute add-ons, you risk “just creating a museum of different assets that may not make a whole lot of sense together,” he said.
Additionally, veteran lender Bruce Lipian, co-founder of StoneCreek Capital, recently shared seven common pitfalls that emerging independent sponsors face this year, including underestimating the time required to close a deal.
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May 2025
