The rollover equity method is commonly employed during mergers and acquisitions, where the seller holds a percentage of their 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 financial success.
The method is great for a business owner who wants to remove some chips from the table but still would like to be active and be a part of the future successes.
What is rollover equity? How Does It Function?
For illustration, take this example:
A business owner wants to sell their business in a deal with a private equity company for a sum of $10 million. Instead of taking the whole amount as cash payment, the owners choose to roll the $3 million in equity to the new company created with the purchaser. They now hold 30 percent of restructuring business. If the company expands and is then sold at a greater price, the seller will share in the profits.
This method creates a partnership with the buyer and seller. buyer, where both are motivated to increase the value of the business over time.
The Making of a Win-Win
Equity rollovers can benefit buyers and sellers since it helps them achieve their goals and assures that they are both successful.
- To Sellers This allows sellers to invest in the business they founded and could earn a better ROI if the business is sold in the near future. It also shows their trust in the buyers’ plans for the company.
- for Buyers It makes sure that the seller stays determined to grow the business and allows for a smoother transition of ownership by leveraging the experience and expertise of the seller as well as relationships. It also decreases the capital required to be committed at the beginning of the transaction.
Rewards and Risikens
Benefits
- Participation in the future Growth Sellers may get additional income in the event that the company expands and is transferred to a buyer with a higher price.
- An Alignment of Intentions: Buyers receive an investment partner who stays committed to the success of the company.
Risques
- Deferred Payment Sellers get less cash up front, and this could be a problem if immediate cash is required.
- Indeterminate Future Value The amount that you will earn 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, owners are able to defer certain capital gain tax. While they are not taxed for all the proceeds of the sale in the beginning, taxes on the rolled-over portion are generally delayed until the ownership stake of the new owner is sold later. However, the tax treatment for each jurisdiction is different and must be examined with tax professionals.
The most important considerations for sellers
In deciding whether to transfer equity, sellers must consider:
- Percentage of Equity How much of the sales proceeds should be invested? Fearful of retaining too much equity, it could expose sellers to risk, whereas the transfer of too little equity could limit the potential gains in the future.
- Valuation Sellers are required to ensure that the valuation of the rolled-over capital is reasonable and in line with market standards.
- Buyer’s track record Check the ability of the buyer to expand the company and make an exit that is profitable.
- Structure The devil always lies in the details. Financial buyers usually look to structure their arrangements to ensure that their equity receives an advantage in return prior to other equity holders taking part. Beware of this if feasible. I’ve seen it endin a bad way many times.
- Legal Security Minority ownership within restructuring a company can pose risks. Sellers should make sure that appropriate legally binding agreements exist in order to protect their interests.
Equity rollovers can be an effective strategy for those who are convinced of the growth potential of their company and wish to keep an interest in its growth. If you are aware of the advantages and potential risks, tax implications, and structuring issues to make educated choices and increase the value of your transactions.