Equity Rollover: Definition, Benefits, and Risks

What is an Equity Rollover?

• An equity rollover allows business owners to gain liquidity while remaining engaged with their business.
• Entrepreneurs can reinvest part of their business sale proceeds into a new venture under the same umbrella, retaining a stake in the business.

Equity Rollovers in Private Equity Transactions

• Common in founder-owned businesses valued under $100 million.
• Private equity firms often require a rollover, allowing original owners to retain a minority stake and continue managing the business.
• Example: A business worth $50 million is sold, the owner reinvests 20%, taking home $40 million and retaining a 20% stake.

Benefits of Equity Rollovers for Sellers

1. Taking Chips off the Table and Reducing Risk

• Sellers cash in a portion but remain involved, reducing downside risk and keeping a role in business management.

2. The Second Bite of the Apple

• Sellers benefit from future growth when the private equity firm increases the company value and exits.
• Example: If the company doubles in value, sellers can see significant returns on their retained stake.

3. Deferred Taxes

• Reinvested proceeds are tax-deferred, offering potential tax savings on the equity portion rolled over.

Potential Risks for Sellers

• Class of Shares: Ensure the highest class of shares to maintain priority in liquidation.
• Minority Rights: Ensure rights to hold investment until second exit to maximize the second bite.
• Dilution: Protect against dilution by ensuring rights to subscribe to new equity issues.
• Fit and Culture: A good fit between buyer and seller is crucial for productive collaboration.

Benefits for Buyers

• Retaining founders leverages their knowledge and maintains business continuity.
• Reduces initial cash outlay for buyers but requires sharing profits at exit.

Conclusion

• Equity rollovers are beneficial for both sellers and private equity firms, aligning interests and promoting growth.
• While offering significant benefits, sellers must address potential risks like dilution and fit.

Additional Resources

• Business Exit Strategy
• Portfolio Company
• Types of Due Diligence

CFI Resources

• CFI offers financial modeling courses and certifications to enhance financial skills.