Rollover Equity: Benefits for M&A Transactions

At Touchstone Advisors, we often see rollover equity as a common component of M&A transactions, especially when the buyer is a private equity (PE) firm. It involves the seller reinvesting a portion of their sale proceeds into the equity of the acquiring entity. The phrase “Second Bite of the Apple” refers to the possibility of a significant financial payout when the company is sold again in the future, potentially at a higher valuation.

By rolling over equity the seller has the opportunity to participate in future growth. The seller retains a stake in the business and has the potential to benefit from future appreciation in the company’s value. If the buyer successfully grows the company, the seller can achieve a substantial return on their reinvested equity. Normally we would only recommend investing in the NewCo if the seller is staying on in some capacity, but we have had situations where that is not the case.

Why Roll Over Equity?

Rollover equity aligns the financial interests of the seller with those of the buyer, as both parties are invested in the company’s future success. The alignment of shared incentives can create a stronger partnership and commitment to growing the business.

In some situations, rolling over equity can provide tax advantages by deferring the capital gains tax on the rolled-over amount. The tax is only paid when the equity is ultimately sold, which can result in a significant tax deferral benefit. You will need to consult with your accountant to see if this would apply to you. The potential to defer taxes may improve after-tax returns enhancing the overall financial return for the seller.

In some jurisdictions, rolling over equity can provide tax advantages by deferring the capital gains tax on the rolled-over amount. The tax is only paid when the equity is ultimately sold, which can result in a significant tax deferral benefit.

Lower Initial Exit Risk

In choosing this method, sellers receive a portion of the sale proceeds in cash while retaining equity in the company. This approach provides immediate liquidity while still participating in the future upside, thereby diversifying the seller’s financial outcome.

With rollover equity, the seller is not entirely dependent on the initial sale price, as they have the potential to realize more value in the future.

If the acquiring party is a private equity firm or an experienced strategic buyer, the business may benefit from new management practices, additional resources and strategic initiatives. The seller’s rollover equity can grow in value as the business flourishes under new ownership and professional management.

The acquiring firm may invest additional capital into the company, allowing for expansion and strategic initiatives that the seller could not have pursued independently.

Preservation of Legacy

Rollover equity can allow the seller to remain involved in the company, either as an advisor or in a reduced operational role and potentially have continued influence. This is especially appealing to sellers who want to see their legacy continue and be part of the company’s growth story.

Shared Risk

By rolling over equity, the seller shares the investment risk with the buyer. If the company performs poorly, the buyer also stands to lose, which adds an element of shared responsibility for the business’s success. Rollover equity signals the seller’s confidence in the future prospects of the company, which may mitigate buyer concerns and can make the deal more attractive to the buyer and facilitate better terms.

Rollover equity can be a win-win structure in M&A transactions, offering the seller an opportunity for future financial upside, tax advantages, and a continued role in the company’s success. It aligns the interests of both parties and provides a mechanism for the seller to share in the long-term growth of the business, while also offering immediate liquidity. This structure is particularly beneficial when the buyer has a strong growth plan and a proven track record of enhancing company value.

At Touchstone Advisors we can discuss Rollover Equity as an option when structuring the transaction. We work closely with our client’s deal team professionals including accountant, attorney and wealth advisor to achieve the best outcome for our client. Contact us to start the conversation.

Steven Pappas, M&A MI
Partner, Managing Director
Touchstone Advisors
860-669-2246
spappas@touchstoneadvisors.com

What is Rollover Equity and Why Should you Consider it When Selling Your Business?

Why Roll Over Equity?

Lower Initial Exit Risk

Preservation of Legacy

Shared Risk

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What is Rollover Equity and Why Should you Consider it When Selling Your Business?

Why Roll Over Equity?

Lower Initial Exit Risk

Preservation of Legacy

Shared Risk

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