The popularity of equity rollovers in M&A transactions has increased in the past decade. Rolling equity is when certain equity holders in the target company are required or elect to roll a portion of their ownership stake into the post-closing business in lieu of receiving cash proceeds. This blog discusses the purpose of using this strategy in a business sale transaction.
Who Utilizes the Equity Rollover Strategy?
Financial buyers frequently use equity rollovers to incentivize and ensure seller participation in the post-closing company. By retaining an equity interest in the company, buyers believe that the seller will stay personally invested and work towards further growth of the company.
Why is this Strategy Popular?
The inclusion of an equity rollover reduces the buyer’s up-front capital investment, and it allows the seller to share in the future equity appreciation. Maintaining an equity stake in the post-closing company provides the seller with a potential “second bite at the apple.” Further growth of the business results in an increase in the value of the rollover equity and, thus, more money for the seller at a future sale or liquidity event of the post-closing company.
Equity rollover is also a popular vehicle for bridging a valuation gap. A valuation gap is when the seller values his business higher than what the buyer is willing to pay. The gap can be bridged by retaining some equity in the business and capture some of the future value.
Equity rollover also represents an attractive opportunity for owners that want to “take some chips off the table” while continuing to maintain an ownership position. Under this scenario, the owner is able to take some cash out of the business and retain a level of equity, as well as potential involvement in ongoing company operations. Key benefits for the seller could include the removal of personal guarantees, funding the expansion of the business, and less personal risk. In addition, the amount of the equity roll can usually be structured to be tax deferred (no taxes due until the ownership interest included in the equity roll is sold for cash).
Rollover interest varies from deal to deal but is frequently in the 10-40% range of total equity. It is important to note that the seller must wait until the buyer sells the business to realize the benefits of the rolled equity.
Dani Sherrets is an M&A Manager at Lutz. She began her career in 2014. Dani is responsible for supporting the execution of merger and acquisition transactions and business valuation services. She assists clients across various industries with valuation analyses, financial modeling, industry research, transaction materials, and due diligence related to M&A engagements.
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