If you sell your family-owned business to a private equity buyer, the buyer will most likely pay a portion of the purchase price with equity in the buyer’s new company, rather than with cash. The equity that you receive in the buyer’s new company in exchange for a portion of the equity in your existing business is commonly referred to as “rollover equity.”
Rollover equity stakes typically range from 10 to 20 percent of the buyer’s new company. Rollover equity is beneficial to the buyer because it reduces the cash portion of the purchase price and aligns the seller’s interest with the success of the new company.
While the rollover equity component reduces the amount of cash that the seller receives at closing, rollover equity can also benefit the seller. If the equity rollover is structured properly, the seller will not pay tax on the value of the rollover equity until there is a future sale or liquidity event with the buyer’s new company. Rollover equity also gives the seller a potential “second bite at the apple.” If the buyer grows the acquired business (either organically or through additional acquisitions), the seller will participate in the future growth of the business and will profit from a future sale or IPO of the new company.
In our experience, private equity buyers may also allow family-business owners to hold their rollover equity in a trust or a family limited liability company or partnership, which creates opportunities for future gifts and estate planning.
It is important to carefully consider the rights and restrictions that will be attached to your minority equity position in the new company. For example, your rollover equity may be in the form of common equity in the new company, while the private equity buyer owns preferred equity with financial and governance rights superior to yours. There also will be restrictions on your ability to transfer your equity in the new company. In addition, the buyer will likely have “drag-along” rights that will enable the buyer to require a sale of your rollover equity in a future sale or liquidity event approved by the buyer (even if you don’t like the deal).
While there are a number of tax, corporate and estate planning issues to consider and negotiate, including a rollover equity component in the sale of your family-owned business can be mutually beneficial to the buyer and the seller.