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Understanding Rollover Equity in M&A

The world of Mergers and Acquisitions (M&A) is awash with jargon, and one term that sellers often come across is “rollover equity.” While the concept might seem intricate initially, understanding rollover equity is crucial for sellers as it can significantly influence their post-transaction financial position and future involvement with the company.

What is Rollover Equity?

Rollover equity arises when a seller, instead of cashing out completely, retains a portion of their ownership in the business being sold. Essentially, they are “rolling over” some of their equity into the new or continuing entity. This allows the seller to benefit from the future growth of the business, alongside the new owners.

Distinguishing Rollover Equity from Earnouts

It’s crucial to differentiate between “Earnouts” and “Rollover Equity,” as they serve distinct roles in M&A transactions:

  • Earnout: This involves deferred payment to the seller, based on the achievement of specified future performance metrics. In an earnout, there’s no retention of ownership; the focus is purely on future earnings. This mechanism helps bridge the gap when buyers and sellers cannot agree on valuation up front.
  • Rollover Equity: Unlike an earnout, rollover equity involves the seller retaining a stake in the business, which is often converted into shares in the acquiring entity. The objective is to participate in the company’s future growth and profits.

These two mechanisms can be standalone or combined in a hybrid structure for a more tailored approach to aligning interests and sharing risks.

Why Consider Rollover Equity?

  1. Alignment of Interests: Rollover equity ensures that the seller remains invested in the future success of the company, aligning their interests with the buyer’s. This alignment can give the buyer confidence in the deal, as it indicates the seller’s belief in the continued growth of the business.
  2. Tax Implications: Rolling over equity can offer potential tax deferrals on capital gains. However, specific tax implications vary based on jurisdictions, and sellers should consult with a tax advisor to understand the full benefits.
  3. Future Upside Potential: If the seller believes that the company will continue to grow under new ownership or with the infusion of additional capital, retaining a stake can allow them to benefit from future increases in company value.

Rollover Equity Structures

There are a variety of different ways to structure rollover equity in an M&A transaction. The specific structure that is used will depend on the needs and preferences of the seller and the buyer. Some common rollover equity structures include:

  • Simple rollover: In a simple rollover, the seller simply retains a percentage of their ownership in the company after the transaction.
  • Preferred stock rollover: In a preferred stock rollover, the seller receives preferred stock in the new or continuing company instead of common stock. Preferred stock typically has certain advantages over common stock, such as higher dividends and liquidation preferences.
  • Contingent Rollover: In this hybrid approach, the seller retains a percentage of ownership with future valuation adjustments tied to specific performance metrics. This is a mix of traditional rollover equity and an earnout mechanism.

Case Study: A Second Bite at the Apple for a Lower Middle Market CEO


Jim Smith was the owner-operator of a lower middle market software solutions firm, with an annual revenue of $25 million. After building the company over 20 years, he decided to explore an M&A transaction but wanted to remain deeply involved with the company’s future trajectory. A private equity firm, recognized the potential in Jim’s business and proposed an acquisition deal with a twist.

The Deal Structure

The private equity firm was keen on retaining Jim’s expertise and proposed an acquisition where Jim would roll over 30% of his equity, receiving cash for the rest. Furthermore, they offered him the continued role of CEO, allowing him to lead the company’s next growth phase backed by the private equity firm’s capital and strategic support.

Under the agreement, Jim’s software firm would benefit from the private equity firm’s resources, aiming to triple its revenue over the next five years. This growth strategy included potential acquisitions of smaller competitors and expanding into new market segments. Jim was excited not just about the immediate liquidity he would achieve but the prospect of the “second bite at the apple.”

The Outcome

Fast forward five years, the software firm successfully executed its growth strategy, growing its revenue to $75 million. With Jim still at the helm and backed by the private equity firm, they leveraged synergies, optimized operations, and made strategic acquisitions. It was time for the private equity firm to exit, and they decided to sell the company to a larger strategic buyer for $220 million.

Remember, Jim had retained 30% equity during the previous transaction. His “second bite at the apple” was even juicier than the first. His 30% stake was now worth $66 million, significantly higher than what he’d received in the initial deal. This successful outcome showcased the power of rollover equity, especially for owner-operators like Jim who are keen on driving their company’s future growth even after an M&A transaction.

Valuation of Rollover Equity

The value of rollover equity is typically based on the overall enterprise value of the transaction, but this can vary widely based on the circumstances. This enterprise value is calculated by taking into account the company’s assets, liabilities, and cash flow potential. A variety of valuation methodologies can be used to calculate enterprise value, such as discounted cash flow analysis (DCF) and comparable company analysis.

Once the enterprise value of the transaction has been determined, the value of rollover equity can be calculated by multiplying the enterprise value by the seller’s percentage ownership in the company. For example, if a seller owns 25% of a company that is being sold for an enterprise value of $100 million, the value of the seller’s rollover equity would be $25 million.

Key Considerations for Sellers

  1. Valuation: How is the value of the rollover equity determined? This typically is based on the overall enterprise value of the transaction.
  2. Minority Rights: Since sellers may now hold a minority position post-transaction, understanding their rights, such as voting powers, rights to financial statements, or say in future company decisions, becomes crucial.
  3. Liquidity Concerns: Rollover equity might not be as liquid as cash. Sellers should consider their financial needs post-transaction and the timeline for possibly monetizing this equity in the future.
  4. Exit Strategy: Sellers should clarify scenarios under which they can cash out their rollover equity. This could be upon hitting certain performance milestones, another M&A event, or after a specific period.

Minority Rights

Sellers who retain rollover equity in an M&A transaction typically have certain minority rights. These rights are designed to protect the interests of minority shareholders and ensure that they have a voice in the company’s operations. Some common minority rights include:

  • Voting rights: Minority shareholders have the right to vote on important corporate matters, such as the election of directors and the approval of mergers and acquisitions.
  • Right to financial information: Minority shareholders have the right to receive certain financial information about the company, such as its annual report and quarterly financial statements.
  • Right to inspect corporate records: Minority shareholders have the right to inspect the company’s corporate records, such as its bylaws and minutes of board meetings.

Role of Investment Bankers

Investment bankers can play a valuable role in helping sellers assess and execute rollover equity deals. Investment bankers can provide sellers with advice on the following:

  • Valuation: Investment bankers can help sellers to value their rollover equity and ensure that they are getting a fair price.
  • Negotiation: Investment bankers can help sellers to negotiate the terms of their rollover equity agreement, such as the purchase price, minority rights, and exit strategy.
  • Deal execution: Investment bankers can help sellers to manage the M&A process from start to finish, including due diligence, deal structuring, and closing.

Rollover Equity in Different Buyer Scenarios

Whether or not a buyer is open to rollover equity depends on a variety of factors, including their investment strategy, holding horizon, and exit plans. Sellers should carefully consider their own goals and objectives before deciding whether to pursue rollover equity in a particular transaction.

Private Equity

Private equity firms often favor rollover equity because it aligns their interests with those of the seller. PE firms also typically have clear exit strategies, which can provide sellers with liquidity in the future. For example, a PE firm may agree to purchase a business with a combination of cash and rollover equity, with the goal of selling the business within 5-7 years and returning a significant profit to their investors. By retaining a stake in the business, the seller is incentivized to work with the PE firm to achieve its growth and profitability goals

Strategic Buyers

Strategic buyers vary in their willingness to accept rollover equity. Those focused on “buy and build” strategies may be more receptive to rollover, as it can allow them to acquire smaller businesses and integrate them into their existing operations without having to pay a full premium. Publicly traded companies may also be open to rollover equity, as it can help them to reduce their upfront cash outlay and align their interests with those of the sellers. However, strategic buyers that are purely focused on integrating a business into their existing operations may prefer outright ownership, as this gives them more control over the business’s strategy and direction.

Family Offices

Family offices are a mixed bag when it comes to rollover equity. Some family offices avoid rollover equity altogether, preferring to hold their investments for the long term and negating the need for future liquidity. Others may find rollover equity to be a good way to align interests with sellers over a longer time horizon, particularly if the family office has a strong track record of investing in and growing businesses.

Successfully Navigate M&A Rollover Equity Decisions

Navigating the labyrinth of M&A is no casual stroll, and the choice of rollover equity is a game-changer that requires both analytical rigor and foresight. While it can offer sellers a second act in their business saga, replete with tax advantages and a share in future prosperity, it’s not without its pitfalls and complexities.

Sellers must weigh their risk appetite, financial needs, and long-term objectives before taking the plunge. But remember, the devil lies in the details—be it valuation methodologies, minority rights, or liquidity constraints.

Our advice? Don’t do it alone. The road is strewn with regulatory nuances and strategic imperatives that can make or break a deal. Consult seasoned M&A advisors who can offer a tailored strategy, thereby aligning your interests with that of potential buyers, and guide you through the maze of legal, financial, and operational intricacies.

Astria Group has navigated these treacherous waters and is keen to be your North Star. Interested in taking a deeper dive? Contact us. We’re here not just to guide you but to ensure you emerge from the transaction not just intact but thriving.

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