Rollover equity is a method commonly employed during mergers and acquisitions. It is a method by which the seller holds a percentage of their ownership stake in the business following the sale. Instead of receiving the complete amount of the purchase in cash, the seller invests a portion of the profits into the new entity, which allows them to take part in the future growth of the company and profit.
This strategy is perfect for those who want to get some chips off the table but would like to be active and be a part of the future successes.
What is rollover equity? How Does It Do Its Work?
To illustrate, think about this example:
A business owner sells their business in a deal with a private equity company for a sum of $10 million. Instead of receiving the full amount with cash, they decide to roll the $3 million to equity in the new company created with the purchaser. They now hold 70% of restructuring business. If the business grows and is then sold at a greater price, the seller gets a share of the profits.
This method creates a partnership that is between both the vendor and buyer, where both are motivated to enhance the long-term value of the company.
Making A Win-Win
Equity rollovers can benefit buyers and sellers, as it is a way to align their goals and assure that they are both successful.
- for Sellers: It enables them to remain invested in the business they founded and could earn a better profit when the company is sold in the near future. It also indicates their confidence in the buyers’ plans for the company.
- To Buyers This ensures that the seller stays dedicated to the growth of the business and facilitates a smooth transition of ownership by leveraging the experience and expertise of the seller as well as relationships. It also lowers the capital needed to be committed at the beginning of the purchase.
Advantages as well as Risks
Benefits
- Participation in the future Growth Sellers could get additional income when the business grows and is transferred to a buyer with a higher price.
- Affiliation of Interests: Buyers receive an investor who is committed to the success of the company.
Dangers
- Deferred payment Sellers are paid less cash up front and this could be a problem if immediate cash is required.
- undetermined future value The final return on equity rollovers is contingent on the future performance of the business, which might not always be in line with expectations.
Tax Impacts
The rollover equity may also offer substantial tax advantages. In the event of rolling over a small portion of equity, investors can defer certain capital gains tax. While they are not taxed for the whole transaction, upfront tax on the rolled-over portion is generally delayed until the ownership stake that was acquired is sold in the near future. However, the precise tax treatment for each jurisdiction is different and must be discussed with tax experts.
The most important considerations for sellers
In deciding whether it is appropriate to carry over equity, sellers should consider:
- Percentage of Equity How much of the sales proceeds should be invested? Intentionally retaining too much equity could expose sellers to risk, and investing too little could decrease the amount of future gains.
- Valuation Sellers are required to ensure that the value of the rolled-over equity is fair and in line with market standards.
- Buyer’s track record Check the buyer’s capacity to grow the company and make the goal of a profit-making exit.
- Structure The devil always lies in the details. Financial buyers typically attempt to structure these agreements to ensure that their equity receives an advantage over other equity holders who take part. Beware of this if it is possible. I’ve seen it end in a bad way many times.
- Legal Security Minority ownership in an organization that has been restructured is risky. Sellers should make sure that appropriate contracts are in place that protect their interests.
Equity rollovers can be an effective option for sellers who are confident in the growth potential of their company and wish to keep an interest in its growth. If you are aware of the advantages and taxes, risks, structuring issues, and structuring considerations, you can make informed choices and increase the value of your transactions.