At Persient, we’re often asked by our clients what “seller rollover equity” means as part of an M&A deal. Many may informally know seller rollover equity as keeping “skin in the game” or “getting a second bite of the apple.” Seller rollover equity is particularly common as part of an offer from private equity (and though less frequent, may also be a component of an offer from a strategic buyer), as it shows commitment by the seller to continue growing the company and creating value, which benefits both the new owner and the seller, when a future exit occurs.
For sellers, understanding the nuances of seller rollover equity is crucial to evaluating an overall deal.
What is Seller Rollover Equity?
Seller rollover equity occurs when the seller retains a portion of their equity stake in the business as part of the transaction structure. Instead of cashing out entirely, the seller reinvests a portion of their sale proceeds into the acquiring entity, which as mentioned, is most common as part of an offer from private equity but may also be part of an offer from a strategic buyer.
The retained equity typically represents a minority stake in the newly capitalized company. The exact percentage varies based on the negotiated terms but often ranges between 5% and 25% of the transaction value. The retained stake enables the seller to participate in the potential upside of the future growth under new ownership (i.e., “keeping skin in the game” or “getting a second bite of the apple”).
While cash may be king, there are several benefits to seller rollover equity worth considering as a business owner:
- Alignment of Interests: By retaining an equity stake, sellers demonstrate confidence in the future of the business and its new management. This alignment reassures buyers, particularly private equity, who value the seller’s expertise and continued involvement.
- Opportunity for Additional Returns: Sellers could benefit from the “second bite of the apple” when the buyer exits the investment at a future date. If the business achieves its growth targets, the value of the retained equity can appreciate significantly.
- Tax Efficiency: Depending on the structure, rollover equity can defer taxes on the reinvested portion of the proceeds. Sellers should consult their tax advisors to understand the specific implications for their situation.
- Continued Involvement: For sellers who are not ready to step away completely, rollover equity often coincides with an operational role in the business post-transaction. Based on one’s preference, this arrangement can be personally and professionally fulfilling.
While seller rollover equity does offer several benefits, it is important for sellers to carefully evaluate several factors alongside their M&A advisors and legal counsel:
- Valuation and Terms: The terms of the rollover – including the valuation of the business and the equity’s terms in the new entity – are critical. Sellers should feel the valuation is fair and that their retained stake is structured favorably.
- Governance Rights: Sellers should understand their role and influence in the new ownership structure. Key questions include whether they will have board representation, voting rights, or input in strategic decisions.
- Exit Timeline: The investment horizon of the buyer significantly impacts the timeline for realizing returns on the seller rollover equity. Sellers should align their expectations with the buyer’s plans for a future liquidity event.
- Risks: Seller rollover equity is inherently tied to the future performance of the business. If the business underperforms or market conditions deteriorate, the retained equity could lose value. Sellers should weigh this risk against the potential upside.
The structuring of rollover equity involves legal and financial intricacies, which again need to be evaluated alongside the M&A advisor and legal counsel. Often, the seller’s retained equity is held in a new entity formed by the buyer for the acquisition. The specifics can vary based on whether the buyer is a private equity firm, strategic acquirer, or other investor.
Some of the most common considerations for a seller include:
- Preferred vs. Common Equity: Seller rollover equity may take the form of common equity, preferred equity, or a combination. Preferred equity often provides additional protections, such as liquidation preferences.
- Tag-Along and Drag-Along Rights: These provisions ensure sellers can participate in future sales or be required to sell their stake under certain conditions.
- Tax Implications: Proper structuring can help sellers defer or minimize capital gains taxes. Sellers should consult with their tax advisors.
As a seller, it’s important to enter negotiations from a position of power. And, as we all know, knowledge is power. Seller rollover equity can become complicated (though hopefully the above explanation helps), and having experienced M&A, legal, and tax advisors at your side is essential to ensuring the best possible deal structure for a seller.