Private equity (PE) in the U.S. has had a decades-long love affair with the roll-up strategy, a tactic involving mass acquisition and consolidation to achieve industry dominance.
The lucrative market emerging around artificial intelligence and its new capabilities – such as generative AI and blockchain – is irresistible to PE acquirers. While this approach can be used by established companies, PE has overtaken the practice, strong-arming its way into growing or crowded sectors.
But a new player wants in: venture capitalists (VCs). They are looking to apply the practice to AI, including a new brick-and-mortar variation: vertical AI roll-up – where investors and acquirers buy mature, people-intensive businesses to scale them with the latest tech.
However, risks remain. At the moment, VC firms lack the required acquisition expertise to effectively use debt as commerce. There is also the pitfall of inflated expectations – accustomed to tech-style valuations that clash with the realities of lower-margin investments.
Only time will tell who comes out on top with AI expansion, but the roll-up strategy has been extensively studied, offering insights into the short- and long-term repercussions of serial acquisitions. Some are optimistic about the potential for mass adoption, while others firmly oppose the approach.
VCs champion these deals as innovation goldmines – extolling synergy and efficiency. But for founders who cash out, who really wins when the hype fades?
Roll-Up and Conquer
The flood of investors and acquirers to the space has created a frenzy and fueled this strategy’s resurgence. Roll-ups happen when a firm entering a fragmented industry begins to amass businesses in the local market. The assets are then consolidated to secure the firm’s position as the area’s top economic force.
When aggressive acquisition and commercially successful technology collide, you get: vertical AI roll-ups, (not to be confused with vertical SaaS, or VSaaS) – essentially a shortcut to enter markets with proven or foreseeable profitability.
The goal is to acquire and integrate traditional service businesses (e.g. law, HR, service, etc.) and apply industry-specific AI tools to solve each sector’s unique challenges. Another major appeal is acquiring customers that can be integrated into an existing AI business, rather than building a single entity from scratch.
Now the “renowned ‘solo’ VC” is increasingly focused on the revived practice for profits.
“If you own the asset, you can [transform it] much more rapidly than if you’re just selling software as a vendor,” Elad Gil, a startup investor, told TechCrunch. “When you take a company’s gross margin from, say, 10% to 40%, that’s a huge lift. Suddenly you can buy other companies at higher prices […] you gain enormous leverage relative to the business, enabling roll-ups others can’t execute.”
How’d We Get Here?
Roll-up strategies have not only caught the attention of VCs, but also publicly traded firms and startups as they pursue higher returns. But this was not always such a common practice, especially once these types of companies caught regulators’ attention.
At the turn of the 20th century, a handful of large U.S. corporations began engaging in predatory pricing, exclusive dealings and mergers designed to destroy competitors. The 1914 Clayton Antitrust Act sought to prohibit such serial acquisitions with a standard for “incipient monopolization.”
However, over time, changes to the legal and regulatory landscape weakened incipiency enforcement. In particular, the Hart-Scott-Rodino Act fueled the trend, creating new merger filing thresholds, which only required investors to report acquisitions to the Federal Trade Commission (FTC) if valued above $101 million. (For scale, in 2021, the total number of U.S. mergers reached 21,994, yet only 4,130 – or 20% – were reported.)
As regulations were gradually eroded, serial acquisitions grew in popularity. Multiple studies show strong, positive correlations between serial mergers and acquisitions (M&A) and both total shareholder returns (TSR) and enterprise value (EV).
Motivated by commercial pursuits, these firms prioritize lower-risk expansion, greater efficiency from scale, increased pricing power, stronger buyer power and valuation arbitrage. Some of these motivating factors can genuinely enhance product, service or supply chain quality.
However, powerful acquirers can easily find themselves in anticompetitive territory or demonstrating monopolistic behavior.
The Resurrection of Roll-Ups
There’s one thing that makes acquirers and investors salivate: cheap debt – something that was free-flowing until recently.
The 2008 financial crisis was a trigger point for institutional investors. As banks retreated, the expanded availability of private credit benefited both limited partners and general partners, further accelerating the asset class’s growth.
In the aftermath of the 2008 crash and Great Recession, traditional banks reduced leveraged loan involvement. Private equity happily filled that void, especially after the Obama administration’s zero-interest-rate policy (ZIRP) made borrowing dirt-cheap in an effort to stimulate the economy.
Then came COVID-19, and the ZIRP era got an unexpected extension.
As the world quarantined, central banks doubled down and flooded markets with liquidity, creating the 2020-2021 venture boom and a generation of “zero interest-rate babies.”
central banks doubled down, keeping interest rates low and flooding markets with liquidity.
Another huge driver of this roll-up fever pitch was (and is) the “silver tsunami.” Right now, baby boomers own 2.9 million – approximately half of all U.S. businesses – with 60% expected to sell within the next decade. In other words, it’s the ideal time to be in the business of buying businesses.
What You Get: The Good, Bad, and Ugly
Roll-up deals promise quick wins but hide complex trade-offs. Behind every success story lurks a cautionary tale.
The Good
There have been numerous success stories with this strategy, typically in industries with clear economies of scale. These two examples likely sound familiar:
The Anheuser-Busch-InBev merger eliminated American-owned beer operations while creating the world’s largest brewer and securing market dominance.
Waste Management Inc. pioneered this approach. From the 1970s through the 1990s, the company embarked on an aggressive acquisition spree, creating the planet’s largest waste disposal network in the process.
Though, it’s worth mentioning that top leadership was prosecuted and convicted in the 1990s for a “systematic scheme to falsify and misrepresent” financial records, overstating profits by $1.7 billion.
These mixed outcomes demonstrate the potential of roll-ups to create industry leaders – though the benefits to founders and consumers remains debatable.
The Bad
Serial acquisitions have expanded into newer sectors like e-commerce. Private equity has employed roll-up strategies in medical specialties including anesthesiology and emergency medicine. But once all of the transaction were complete, the failures of this M&A strategy began to show.
Envision
Envision, a healthcare company then-owned by private equity firm KKR, brought this method to the public’s attention. It first made headlines in 2019 for surprise medical billing – a practice that sticks patients with out-of-network bills despite visiting in-network providers. Experts have called this practice the “health equivalent of a carjacking.”
In one instance, a woman sick with COVID-19 was rendered unconscious. First responders airlifted her to a hospital 20 miles from home, resulting in a $52,000 bill. This quickly sparked backlash and demands for stronger regulation.
Thrasio
Known as “The Amazon Aggregator,” Thrasio was founded in 2018 and has dominated Amazon Marketplace. Their model involves buying any seller open to cashing out. In 2021 alone, Thrasio acquired an average of 1.5 independent e-commerce businesses weekly, amassing over 22,000 platform products.
The combined pressure from Amazon and Thrasio leaves many entrepreneurs struggling without equivalent alternatives. Making matters worse, Thrasio often lists products as independent sellers.
Ken Kubec, Thrasio’s VP of Acquisitions, revealingly stated: “Roll-ups underneath the covers is really where you add tremendous value.”
The Ugly
While small businesses are called the lifeblood of the U.S. economy, private equity firms increasingly target local businesses by flooding markets with scale and low prices to secure market control and squeeze out independents. Once competition is neutralized, most acquirers then raise rates – mirroring Walmart’s successful takeover model.
In another troubling trend, startups bought by PE firms are 10 times more likely to go bankrupt than their peers, as journalist Megan Greenwell reported in Bad Company.
And the bad news continues.
A 2022 report from the American Economic Liberties Project gave a grim outlook for the overall impact of the private equity. These models have shown to shake the resiliency of supply chains and the small business ecosystem, concluding that ultimately, “they have the potential to be a threat to competitive markets as a whole.”
The report also suggests that there is another layer of toxicity that fuels this sector, quoting Aswath Damodaran, a corporate finance and valuation professor at the Stern School of Business at New York University, as saying: “I firmly believe that acquisitions are an addiction, that once companies start to grow through acquisitions, they cannot stop. Everything about the M&A process has all the hallmarks of an addiction.”
Roll-Out?
While roll-ups offer quick exits, the original vision – and possibly the market itself – may not survive the acquisition. While firms like Khosla Ventures are committed to this path, everyone agrees: Serial acquisition expertise is urgently needed.
The VC world remains in the early stages of navigating the applications of roll-up strategy, leaving more questions than answers about the future of tech roll-ups and VCs.
In such turbulent times, for any founders considering exit options, it’s worth asking: What legacy will your startup leave?
About the Author: Tess Danielson is a journalist and writer focusing on the intersection of technology and society.
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