FAQ
What does it mean to roll equity?
Rolling equity means the seller, in a business sale transaction, agrees to reinvest a part of the sale proceeds back in exchange for an ownership stake in the newly formed entity (Newco).
What are the benefits of rollover equity?
The benefits of rollover equity are allowing sellers to maintain a stake in the potential future success of Newco, align with a new, value-added partner, capture value by securing a portion of the sale proceeds, and manage personal risk. Buyers also benefit from reduced upfront capital requirements, alignment of interests, improved risk management, and the continued utilization of the seller’s knowledge and experience.
What percentage of equity is typically rolled over?
The percentage of equity that is typically rolled over in a business sale varies widely depending on the seller’s preferences and the buyer’s requirements. However, the percentage of rollover equity typically falls between 10% to 40%.
Rolling equity means the seller, in a business sale transaction, agrees to reinvest a part of the sale proceeds back in exchange for an ownership stake in the newly formed entity (Newco).
The benefits of rollover equity are allowing sellers to maintain a stake in the potential future success of Newco, align with a new, value-added partner, capture value by securing a portion of the sale proceeds, and manage personal risk. Buyers also benefit from reduced upfront capital requirements, alignment of interests, improved risk management, and the continued utilization of the seller’s knowledge and experience.
The percentage of equity that is typically rolled over in a business sale varies widely depending on the seller’s preferences and the buyer’s requirements. However, the percentage of rollover equity typically falls between 10% to 40%.
Rollover equity is an arrangement in which the seller effectively retains an ownership stake in the company after selling it to another party. This is done by the seller taking a mutually agreeable portion of their proceeds from the sale in the form of equity in Newco. Newco is a company that is formed by the buyer to buy out all of the company’s assets that are being sold.
Business owners put decades of effort into building a business. When it comes to selling it, many may feel there is significant upside potential in the business and they want to be a beneficiary of its future success. Therefore, they may not want to divest themselves from the business completely.
This is commonly done when a business is owned by several business owners and one or more of them want to continue to stay in the business and have an equity stake post-close.
While selling a business, taking a portion of the proceeds as rollover can help business owners take some chips off the table while staying invested in its growth potential. This also means that if the business gets sold again in the future, they can profit once more from the minority stake.
Moreover, equity rollover might be an important precondition of a business sale, particularly in deals involving private equity (PE) firms as it lowers their cash outlay and aligns economic interests. By requiring the seller to have “skin in the game”, PE firms ensure that the seller continues working towards the company’s growth and profitability.
Rollover equity has steadily become a great enabler of M&A deals, particularly in deal values upwards of 30m. According to estimates, in 2023, 20% of these transactions involved rollover equity.
Let’s now look at how equity rollover works and incentivizes both buyers and sellers.
Understanding How Rollover Equity Works
Rollover equity is when the seller of a business accepts a portion of the payment for it in the form of equity in the go-forward company. This go-forward company can be referred to as Newco. If however, it is being acquired by a larger holding company, the seller may have the opportunity to rollover equity into that holding company. This is referred to in the industry as “rolling up into Holdco.”
This means the seller can both benefit from the immediate value of the sale and stay invested in the future success of the company under new ownership. Let’s look at how a simple rollover equity arrangement works.
Suppose you are planning to sell your business valued at $100 million to a PE firm. The PE firm wants you to roll 25% of the sale proceeds – which equals $25 million. So, you get to pocket $75 million and a 25% stake in the new PE-owned entity.
Now suppose five years later, after making substantial business improvements, the PE firm sells the acquired company for $200 million. Your 25% stake is now valued at $50 million, allowing you to pocket an additional $25 million over the rolled equity of $25 million. This chance of having a ‘second bite of the apple’ makes equity rollover quite lucrative for sellers.
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If you are a business owner and looking for ways to take some chips off the table by divesting a part of your business, you might find our “How to Sell a Portion of a Business” guide helpful.
The Benefits of Rollover Equity for Sellers
Rollover equity offers these 3 major benefits to sellers:
Capturing value and managing risk: Rollover equity allows you to partially cash out, pocket a large part of the value that you have created over the years, and limit your personal exposure. Plus, by staying attached to the business as a manager or consultant, you can still influence its future direction while drawing a sizable paycheck.
Having a stake in potential future success: The reason a PE firm wants to buy your business is to create larger value by making operations improvements and facilitating business expansion. Rollover equity allows you to retain a stake in the future growth and success of the business you built i.e. have a second bite of the apple.
Aligning with a new, value-added partner: Rollover equity helps sellers get associated with seasoned partners, such as PE firms, who have specialized expertise and access to additional resources and capital that can be used for expansion, acquisitions, or other growth initiatives.
While rollover equity offers substantial benefits to business owners, there are some potential downsides too – let’s have a look.
Potential Risks of Rollover Equity to the Seller
Here are some of the drawbacks of rollover equity for a seller:
Loss of control and influence: Even though rollover equity allows you to maintain a share in the company, the minority stake doesn’t allow you to exert as much control and influence over the business as before. Plus, there can be potential conflicts if your goals and vision for the company don’t align with those of the new owners or PE firm.
Potential for decreased value: Future return is never guaranteed. So, if the company underperforms or faces challenges, the value of the seller’s retained equity may decrease.
Continued financial exposure: By maintaining an equity stake, you are going to continue a financial exposure to the company’s performance.
How Buyers Benefit from Equity Rollovers
Rollover equity benefits buyers too in several ways:
Alignment of interest and risk management: Equity rollover helps buyers ensure that both the buyer and seller have aligned interests in the company. When a seller is ready to stay put with some stakes, this means they have solid confidence in the business’s future potential. This also helps PE firms lower their risk exposure by sharing risks with sellers.
Lower upfront capital requirements: By having the seller roll over a portion of their equity into the new ownership structure, the PE firm can reduce the amount of cash needed for the acquisition. This helps PE firms acquire more companies with their total available capital.
Utilize the seller’s knowledge and experience: Rollover equity allows PE firms to continue utilizing the seller’s expertise, deep knowledge about the business, and rapport with the employees.
What is the Difference Between Rollover Equity and Earnout?
Rollover equity is different from earnout in that the former involves the seller maintaining a stake in the acquiring company to benefit from its future success, while the latter makes cash payments to the seller as various performance thresholds are met post-close.
What is Earnout?
An earnout is a payment structure where part of the purchase price is contingent on the company achieving specific performance targets after the sale. This arrangement helps bridge the valuation gap between the buyer and seller by introducing additional payments to future results, such as revenue or profit goals.
Rollover Equity vs. Earnout
Both rollover equity and earnouts are designed to align interests and manage valuation risks – however, they operate differently. Sellers must weigh these options carefully, considering their willingness to continue having a stake in the company versus the potential for contingent payments based on future performance.
Raincatcher, an Inc. 5000 M&A advisor and business broker, specializes in assisting business owners with annual revenues exceeding $2M to achieve optimal exit prices and terms. Reach out today for a consultation to discover how we can help you maximize the value of your business.
