Rollover Equity: Key Concepts and Calculations

Table of Contents

1. What is Rollover Equity?
2. How Does Rollover Equity Work?
3. Modeling Rollover Equity in LBO Analysis
4. Importance of Management Rollover Equity
5. Risks of Equity Rollover in M&A
6. Tax Treatment of Rollover Equity in M&A
7. Calculating Rollover Equity
8. LBO Rollover Equity Calculation Example

What is Rollover Equity?

• Rollover Equity: Exit proceeds reinvested by a seller into the equity of a newly formed entity post-acquisition.
• Aligns economic incentives among participants in the post-transaction entity.

How Does Rollover Equity Work?

• Reinvestment of sale proceeds into equity of post-acquisition company under new ownership.
• Sellers retain an interest, indicating belief in future upside.
• Opportunity for sellers to mitigate risks while retaining potential for profits.
• Aligns seller’s and buyer’s interests and mitigates risks of losing key personnel.

Modeling Rollover Equity in LBO Analysis

• Rollover equity included in LBO structures to align interests.
• Sellers roll over part of proceeds into the new entity, reducing upfront investment for financial sponsors.
• Involves a balance between debt and equity.
• Rollover equity contributes to the sources side of the LBO sources and uses schedule.
• Typically ranges between 5% to 25% of total deal consideration.

Importance of Management Rollover Equity

• Ensures existing management continues running the company post-buyout, aligning incentives.
• Reduces capital contribution by financial sponsors, improving return profile.
• Provides assurance that management is incentivized for a successful exit.

Risks of Equity Rollover in M&A

• Potential dilution if new assets are added post-acquisition.
• Importance of diligence on post-acquisition plans to protect seller's interests.
• Key considerations include classes of shares, voting rights, and order of distribution.

Tax Treatment of Rollover Equity in M&A

• Can be tax-deferred; taxes paid only on the percentage sold.
• Encourages partial cash-out while retaining ownership.
• Aligns seller’s and sponsor’s economic interests, reducing reliance on leverage.

Calculating Rollover Equity

• Requires seller exit proceeds and seller rollover percentage.
• Rollover Equity = Seller Exit Proceeds × Seller Rollover (%)
• Involves estimation until detailed data is available.

LBO Rollover Equity Calculation Example

• Example with $50 million LTM EBITDA at a 10.0x purchase multiple.
• Calculation of purchase enterprise value, net debt, and equity value.
• Example management team rolls over 12.5% of exit proceeds, resulting in specific equity values.
• Total uses and sources of funds calculated for complete financial picture.

This guide provides an overview of rollover equity and its implications in M&A, particularly in the context of leveraged buyouts. Rollover equity serves as a critical tool for aligning incentives and structuring transactions to balance risks and rewards for all parties involved.