Portfolio add-ons and roll-ups are a great way for venture capital funds focused on tech companies in Africa to qualify an existing portfolio for an IPO, grow revenues, lower costs and improve an underperforming portfolio. This legal update highlights some of the key strategic and legal considerations for venture capital funds looking to execute a roll-up strategy in Africa.
1. What is a Roll-Up Strategy?
A roll-up strategy involves the acquisition of two or more target companies with a view to rolling the companies up into one main company. This is similar to an add-on because, with an add-on, a private equity fund essentially acquires the assets or business of another, usually smaller, company in the same or a related industry. A roll-up has largely proven to be a great tool for enhancing valuation multiples as well as for financing and operational efficiency.
In the following paragraphs, we discuss some key assumptions and considerations for executing a roll-up strategy.
(a) An Existing Venture Capital Platform Company
A portfolio add-on assumes the existence of a platform company within the portfolio of a venture capital fund. Typically, such platform company would be in the same industry where a potential add-on company operates. The platform company would also have attained some level of management and operational expertise. The reason is because an add-on company is generally intended to be run by the management of a platform company. In some situations, an add-on is a product line or a division of a larger company. It is useful to note that a venture capital/private equity fund need not have an existing platform company and may instead execute an Africa strategy by first acquiring a platform company as a strategy for entering a market and subsequently, adding-on a number of other smaller companies, as part of a buy and build strategy.
(b) The Earnings History of the Add-on
With an add-on company acquisition, the predictability or consistency of earnings is probably not going to be as important compared to situations where the target is a platform company. The reason is because, as opposed to achieving stand-alone growth, the strategic purpose of an add-on strategy is generally to enhance the value of a platform company post acquisition/integration. Such considerations can be independent of the earnings history of an add-on. Such value can also be in the form of a strategic asset, technology, synergies, the prospect of expanding into a new market or economies of scale. Some of the most ideal candidates for an add-on include, a financially troubled company with an asset which a venture capital firm considers to be valuable and also, generally, smaller businesses in a fragmented industry.
(c) Competition Review & Regulatory Approvals for an Add-on Acquisition
Private and public mergers and acquisitions that meet certain turnover thresholds in Nigeria have to be submitted for competition review. Given that add-ons or roll-ups often involve a large-cap company acquiring a smaller one, it is not unlikely that add-ons increase competition risk and that such transactions will require a competition review. Add-on acquisitions that involve targets in other jurisdictions will also require competition review by foreign counsel. As with other jurisdictions, competition authorities in Nigerian can delay or block a deal. For this reason, it is important for parties plan a competition review and compliance at the outset. Also, parties need to take into consideration the amount to be paid as transaction fees to competition authorities. This is typically a percentage of the consideration for the transaction or the last combined annual turnover of the parties.
Sectoral approvals across the relevant sectors will be important and will also differ depending on the sector of operation. As with all mergers and acquisitions transactions, it is often prudent to assess the risk of government action at the outset. For additional insights on the competition regime in Nigeria, see:
Turnover and Control Considerations for Merger Clearance in Nigeria
(d) Optimal Legal Structures For an Add-on Acquisition
It is often prudent for parties to decide with the aid of legal counsel the optimal legal structure for consummating an add-on acquisition. Generally, this may involve a stock or asset acquisition or a combination of both. A merger may also be an optimal structure depending on the strategic consideration of an acquirer. It is often useful for parties to retain a degree of flexibility in transaction term sheets as the results of a legal due diligence, may inform a different legal strategy. This is a common outcome with roll-up acquisitions. It would also be prudent for parties to consider the need for both horizontal and vertical tax efficiency, as well as the impact which a type of acquisition financing can have on the proposed acquisition structure.
Conclusion
A roll-up strategy remains one of the most predictive ways to build strong IPO candidates in Nigeria. Given that markets in Africa are highly fragmented, the case for a roll-up or add-on strategy is compelling and deserves some consideration.
The foregoing insight is not intended to constitute legal advice and is not prepared with a specific context in mind. Kindly seek professional advice specific to your situation. You may also reach out to your usual Balogun Harold contact or via support@balogunharold.com for support.
