When evaluating offers, business owners exploring exit strategies are increasingly encountering the concept of rollover equity, as buyers and sellers look for innovative ways to bridge valuation gaps and structure mutually beneficial deals. Rollover equity has emerged as a compelling option, but it’s important to fully understand the concept before proceeding.
Definition and Advantages
Rollover equity is a component in a transaction structure where the seller of a business retains a stake in the newly combined entity by selling less than 100% of their company. Essentially, the seller “rolls-over” a percentage of the transaction purchase price in the form of equity into the acquirer’s business on a tax-deferred basis, becoming a minority shareholder in the combined enterprise. This approach allows sellers to participate in future upside potential, while providing tax advantages through deferred capital gains on the reinvested portion.
Rollover equity has several advantages. By maintaining a stake in the combined entity, sellers can benefit from synergies and economies of scale that the acquisition may bring. If the combined entity increases in value, sellers may realize a higher return on their retained equity in a future liquidity event. There are also the aforementioned potential tax benefits, as deferring capital gains taxes on the rolled-over portion can result in significant savings.
For owners passionate about their business, rollover equity can provide a path to continued involvement and investment, often in leadership or advisory roles. Rollover equity can be particularly attractive when you believe in the acquirer’s vision and growth potential, you’re not ready to fully exit and want to stay involved in the business, or you’re looking to optimize your tax situation through deferred capital gains.
Key Considerations
However, it’s not always the best choice for everyone. If you’re seeking a clean break from the business due to personal or professional reasons, or if your business represents a significant portion of your net worth and you need to diversify your portfolio, rollover equity may not be right for you.
If you’re contemplating a rollover equity transaction, there are several key factors to keep in mind. The rollover percentage typically ranges from 5% to 25% but can vary. Choose a percentage that aligns with your risk tolerance and financial goals. It’s important to negotiate clear terms for earning your equity stake over time and liquidity options. Your due diligence is even more important when you have a continued interest in the ongoing operations; thoroughly investigate the acquirer’s financial and operational performance, as well as the prospects of the combined entity. Given the complexities of these transactions, engaging experienced advisors and counsel is essential to protect your interests in these deals.
To maximize the potential benefits of rollover equity, focus on key areas during negotiations. Ensure a fair valuation that accurately reflects your business’s value and growth prospects. Negotiate for board representation, voting rights, or veto power over certain decisions to protect your minority stake. Seek provisions that safeguard against future dilution of your ownership percentage. While non-compete and non-solicitation clauses are common, ensure these have reasonable time and geographic limitations to protect your future interests.
Rollover equity presents opportunities, but increased complexity, for business owners contemplating a sale. While it offers the potential for continued growth and wealth creation, it also requires careful consideration of your individual circumstances to negotiate the right package. The decision to accept rollover equity should be based on a thorough evaluation of the acquirer’s capabilities, your personal goals and risk tolerance, tax implications, and diversification needs. By seeking professional advice and conducting rigorous due diligence, you can make an informed decision that aligns with your long-term objectives.
Where Align Comes In
When you’re selling your business, rollover equity can be a powerful tool for aligning buyer and seller interests and bridging valuation gaps. By carefully weighing your options and negotiating favorable terms, you can potentially secure a deal that provides both immediate liquidity and long-term upside potential. As with any significant business decision, thorough research, professional guidance, and careful consideration of your unique circumstances are key to successful negotiation of a deal that involves rollover equity. At Align, we’ve closed over $2.5 billion worth of transactions for business owners just like you and can help you structure the best deal that maximizes the value of your business. Contact us to learn more about your options.