Rollover Equity in a Sale to a Private Equity Firm: Seller’s Concerns | JD Supra (2022)

Rollover Equity in a Sale to a Private Equity Firm: Seller’s Concerns | JD Supra (1)

When a private equity (PE) firm acquires a closely held business, it is quite common for the seller to roll over some of its equity into equity in the entity (the “Company”) that is acquiring the business. If the seller has sufficient other assets, the rollover equity can be a very attractive high risk/high reward investment. Moreover, PE firms often want a seller to roll some equity. This can show that the seller believes in the business being sold. It also can help assure cooperation and commitment from the seller after the closing of the sale.

COVID-19 has led to a reduction of the amounts that lenders are willing to lend in M&A transactions. This may increase the amount of rollover equity that PE firms seek from sellers, to replace amounts that would have been borrowed in the pre-COVID market.

This article discusses a seller’s considerations and objectives when rolling over equity as part of the sale of their business to a PE firm. The focus is pro-seller provisions that should be pursued in the negotiations.

Pre-COVID-19, a seller who owned a well-performing business had a great deal of leverage in negotiations with PE firms. Commonly, multiple buyers were competing for the right to purchase the business, and thus sellers maintained substantial leverage to dictate the terms of the sale. However, while overall M&A activity has rebounded nicely in Q3 2020, M&A activity is still down compared to this time last year. As such, demand has decreased, so some leverage likely has shifted back to buyers. The shift in leverage may affect a seller’s ability to obtain all the desirable terms described below.

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Summary of Key Points:

  • If, after sale of the business, a high risk/high reward investment is appropriate for the seller, rolling over equity with a qualified PE firm in a business the seller knows typically is much more attractive than other investment choices.
  • The seller should receive the same class of equity that the PE Fund owns (normally not an issue).
  • The seller should have the right to hold the equity until an exit event occurs. For a successful Company this normally is when the best pricing is achieved.
  • There should be reasonable limitations on amounts that can be distributed to the PE firm from the Company.
  • Come along rights — which give the seller the right to participate on a pro rata basis in any sales for value by the PE firm — are always included, and will apply to an exit event. Sellers should push for these rights also to apply to other, smaller transactions where the PE firm is realizing value.
  • The seller should have strong protections against dilution.

Investment Considerations

When the deal goes well, a PE investment in a Company can have an excellent return, with a 20% or more rate of return often being achieved. However, PE owned Companies also sometimes fail, with little or no money being returned to investors. Even a PE Fund that is quite successful in terms of the overall return that its investors receive often will have several companies within the Fund fail.

This means that a seller rolling over into the acquiring Company should be able to afford to lose its entire investment. The seller should have sufficient secure assets to meet its needs, so that making a high risk/high reward investment is acceptable.

For a seller who has the financial strength and appetite for such an investment, rolling over equity as part of a sale of their business almost always is the best choice as compared to alternative investments. Unlike an investment from the open market, the seller knows the Company’s business very well and understands its prospects and risks. Moreover, the seller should believe in the PE firm who will be directing the Company, and be confident in its track record and abilities

We recently have represented sellers who went to market only to PE firms — no strategic acquirors — with an express requirement that the seller be able to rollover equity as part of the deal. This reflects the attractiveness that a rollover investment can have for the right seller.

Typical Structure

Normally the PE firm will set up a new entity (the Company, as defined above) to carry out the acquisition. (If the acquisition is an add-on by an existing platform company owned by the PE firm, the purchase will be made by an already existing entity. In such an add-on acquisition, an equity rollover may not be possible, or at a minimum will be more complex to work out.) Most commonly, the Company will be a limited liability company (LLC). The PE firm will invest in the Company from the fund (the “Fund”) then being operated by the PE firm. There may be other investors alongside the Fund, with likely candidates including companies providing funding to the transaction and principals at the PE firm.

Assuming the Company is an LLC, the document that will govern the seller’s rights and obligations with respect to its equity investment is the LLC Agreement or Operating Agreement (hereinafter referred to as the “LLC Agreement”). This usually is a complex document since it governs all the different investors in the Company. Besides the Fund and the Seller, these can include persons or entities who are investing alongside the Fund. There also are often provisions for equity incentives — such as profits interests — to be provided to management of the Company.

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As the majority owner, the PE firm will control the Company. The seller may have a seat or seats on the board or other governing body, but these will not convey control. The seller has to rely on provisions in the LLC Agreement to protect its interests.

The Rollover; Tax Treatment; Leverage and Percentages

In the classic rollover transaction the seller will sell most of its equity for cash, and exchange the rollover portion of its equity for equity in the Company. In many cases, it is possible for the seller to avoid paying current tax on the portion of the equity that is rolled over, especially where the Company is an LLC. Tax specialists should be involved in the transaction to determine if current tax can be avoided and to assist in structuring to achieve this result.

When the transaction is leveraged, so that the Company borrows some of the purchase price for the acquisition (which is nearly always the case with a PE-backed buyer), the effect of the borrowing is to reduce the percentage of the sale proceeds that the seller has to roll over to acquire any specified percentage in the Company. Consider a transaction where the business is sold for $100 million, $50 million of which is borrowed. This means that the seller will be paid $100 million, but the equity in the Company will have a total value of $50 million. If the seller wanted to obtain 20% of the Company, the seller would have to pay (in the form of rollover equity) $10 million, or only 10% of the proceeds received by the seller. So the seller would end up retaining 90% of the purchase price — $90 million — and still would own 20% of the Company.

Key Points for the Seller

Some of the most important points to negotiate on behalf of the rollover seller are:

Same Class of Equity. The seller should receive the same class of equity — e.g., A Units in an LLC — that the Fund acquires. This aligns the interest of the seller with the interest of the PE firm. While in years past this could be an issue, this now is pretty much the norm.

Right to Hold Equity Until There is an Exit Event. The PE firm’s first draft of the LLC agreement typically will include certain call options (a “Call”) to buy out the seller before an exit event. For example, if an individual seller was going to continue to be employed by the Company, there might be a Call to buy out the seller if employment is terminated. The Call normally will be at a value determined by appraisal or some other method intended to approximate fair market value. The Call might also include a provision requiring the seller to accept a note for a portion of the purchase price.

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These provisions should be strongly resisted. Where the Company is successful, the best value — in the sense of the highest multiple — will almost always be achieved when the Company exits by going to market through an effective sale process. Under a Call — where “fair market value” is determined by an appraisal — the multiple typically will be lower because the appraisal will be tied to normal pricing in the market. By contrast, where an effective sales process is conducted to sell the Company, the process should result in getting the buyer who is willing to pay the highest multiple. In addition, the PE firm will always try to take the Company to market when it can get the best return. A Call, on the other hand, could be triggered when the Company is not yet prime for sale, such as when the Company is still making investments which have not yet resulted in increased earnings. These factors mean that a seller who gets bought out before the exit event likely will get a lower rate of return than if it stayed in until the exit.

If part of the Call purchase price is paid by a note, the seller’s position is even worse. If the Company performs poorly and goes under, the note — which is at risk of being put behind secured creditors such as institutional lenders — likely will not be paid in whole or in part. On the other hand, if the Company performs well the seller will not participate in the increase in value, and will only receive the amount of the note. In other words, the seller continues to have much of the downside that it would have if it retained its equity, but none of the upside.

For all these reasons, we feel that the events which trigger a Call should be extremely limited. One acceptable event might be the seller breaching a noncompete agreement. Another might be the seller transferring or attempting to transfer the equity in a prohibited manner. The Company also will argue for a Call if a seller who has been employed by the Company is terminated for cause. This point can come out either way. Whatever the trigger events which are ultimately negotiated, protections for the seller such as materiality standards and notice and a right to cure should be included.

What About a Put? We have represented sellers who said that if they left the Company, and were no longer involved in its operations, they would want to have an option to require the Company to buy back their equity (a “Put”). We generally advise our client that it is better to forgo the Put and insist on the right to retain their equity until there is an exit event. The valuation for the Put will be at a lower rate of return, just like a Call. And, if the seller requires a Put, it will certainly have to give Calls to the Company. Moreover, the rights evidenced by a Put are somewhat illusory, because they will always be subject to the Company’s financial condition and to lender consent. Lender consent in particular can be subject to manipulation by the Company.

Come-Along Rights. Where the Fund is selling equity in the Company, come-along rights permit the seller to sell its equity, on a pro rata basis, at the same price, terms and conditions as of the Fund is selling. Some form of come-along right is standard in the LLC Agreement, and generally will always be triggered when there is a full exit. (Indeed, in a full exit the Fund will be requiring the seller to sell pursuant to bring-along rights.) A focus for rollover sellers should be extending the come-along rights to other situations where, before a full exit, the Fund, the PE firm or affiliates are transferring a portion of their equity for value. This can be highly negotiated, but the seller’s basic position should be that it gets to cash out, on a pro rata basis, whenever the Fund gets to cash out.

Limit on Payments from the Company to PE Firm. The LLC Agreement frequently will provide for some kind of payment to be made annually to the PE firm. Where the payments are not fair market value payments for products or services provided by the PE firm, they really are a type of preferred return, one in which the seller’s rollover equity does not share. Some form of these payments is very common. However, the seller should insist on limits to the amounts that can be paid, so the drag on return does not become excessive, and require that any other payments made by the Company to the PE firm or affiliates be on fair market price and terms.

Protection Against Dilution. The seller should focus on strong protection against its equity being diluted. Preemptive rights are the basic mechanism used for this purpose. Where applicable, preemptive rights give the seller the right to buy a proportionate amount of any new equity being issued at the same price and terms offered to others, thus preserving the seller’s percentage interest in the equity of the company. However, exceptions to the preemptive rights provisions are almost always proposed, and have to be carefully negotiated. Moreover, in some cases, even though preemptive rights are available, as a practical matter they might be difficult for the seller to exercise. For example, the seller might not be able or willing to expend the funds required to exercise the preemptive rights and buy additional equity. The seller should attempt to limit the rights to do these types of transactions without their consent. Also, any transactions proposed with entities affiliated with the PE firm should be a special focus for restriction.

Permitted Transfers for Estate Planning Purposes. The LLC Agreement will include broad restrictions on the transferability of the rollover units that are acquired by the seller. The seller should negotiate reasonable exceptions to these restrictions for legitimate purposes such as estate planning.

Protection Against Amendments. Having negotiated provisions such as those described above, the seller then must carefully review the provisions permitting amendment of the LLC Agreement to be certain the provisions are not subject to being amended without the seller’s consent.

General Deal Considerations

Where a seller is doing an equity rollover, the seller should carefully evaluate the quality and track record of the PE firm that it is dealing with, because the PE firm’s skill in managing the Company will contribute to a successful investment. Besides reviewing the PE firm’s success with previous investments and its expertise in the business of the Company, seller should also review the PE firm’s reputation for dealing with its minority investors. Where the PE firm has been successful, the seller should be sure that the individuals who were key to that success are still active in the firm.

The seller has the most leverage before it goes exclusive with the buyer, which typically happens when a letter of intent is agreed upon. Therefore, the seller also should consider addressing the points about the rollover, which are most critical to it (see above) at the time a letter of intent or term sheet is negotiated, rather than leaving the points to be addressed at a later time. Even though the terms negotiated in the letter of intent will not be legally binding, they will carry weight as the parties negotiate the definitive agreements.

The LLC Agreement usually is a long and complex document. There are legitimate reasons for this. However, the complexity, and in particular the definitions, sometimes can conceal provisions which do not benefit the seller. The seller’s counsel has to be prepared to review the draft very carefully to be sure it fairly reflects the seller’s interests.


An equity rollover provides a seller with a high-risk proposition, but where the seller possesses the resources, an equity rollover provides the seller with the opportunity for a high return. Where the seller possess the ability to rollover equity, the terms of the deal will determine the seller’s ability to maximize their return, and the seller should work with its legal counsel to ensure that rolling over equity is the best course of action, and that its rollover rights are adequately protected.

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What is rollover equity in private equity? ›

What is rollover equity? It is the amount of money that a business seller is expected to invest (e.g., rollover) into the future equity of the company. The class of buyers that are most active in today's market are private equity firms.

How does private equity rollover work? ›

Rollover equity arises when certain equity holders in the target company, including founders, and key members of the management team, roll a portion of their ownership stake over into the new equity capital structure put in place by the acquiring PE firm in lieu of receiving cash proceeds.

Are equity rollovers taxable? ›

A tax-free (deferred) rollover involves the deferral of taxes on the portion of the rollover participants' equity rolled over into the buyer's entity. The cash portion of the transaction consideration will be fully taxable.

Is rollover equity good? ›

PE Buyers Prefer Equity Rollover

Furthermore, using rollover equity for a portion of the transaction consideration will reduce the cash portion of the purchase price and allow for the use of greater leverage, which, in turn, will help the buyer increase its return profile.

What is a rollover and what are the rules? ›

A rollover occurs when you withdraw cash or other assets from one eligible retirement plan and contribute all or part of it, within 60 days, to another eligible retirement plan.

What does it mean to roll equity? ›

Rolling equity is when certain equity holders in the target company are required or elect to roll a portion of their ownership stake into the post-closing business in lieu of receiving cash proceeds.

What is the benefit of a rollover? ›

The benefit of a rollover is your ability to move money between invest- ment managers, institutions, or employers without paying income taxes or penalty taxes. Also, people will often consolidate their savings plans in order to more easily manage their accounts.

What is the difference between a rollover and a transfer? ›

The difference between an IRA transfer and a rollover is that a transfer occurs between retirement accounts of the same type, while a rollover occurs between two different types of retirement accounts. For example, a transfer is when you move funds from an IRA at one bank to an IRA at another.

What is the purpose of a rollover? ›

A Rollover IRA is an account that allows you to move funds from your prior employer-sponsored retirement plan into an IRA. With an IRA rollover, you can preserve the tax-deferred status of your retirement assets, without paying current taxes or early withdrawal penalties at the time of transfer.

What is a reportable rollover? ›

An eligible rollover of funds from one IRA to another is a non-taxable transaction. Rollover distributions are exempt from tax when you place the funds in another IRA account within 60 days from the date of distribution. Regarding rolling 401K into IRA, you should receive a Form 1099-R reporting your 401K distribution.

How is a rollover reported? ›

On your Form 1040 tax return, you'll need to report the amount distributed on Line 5a, “Pensions and Annuities.” On Line 5b, “Taxable Amount,” enter “0” and write “rollover” in the margin next to it.

Is a rollover a CGT event? ›

The capital gains tax (CGT) rules allow you to roll over capital gains in some situations. For example, a business that replaces an asset with a similar asset can roll over the capital gain on the original asset.

What is higher rollover risk? ›

Rollover risk is also associated with the refinancing of debt—specifically, that the interest charged for a new loan will be higher than that on the old. Generally, the shorter-term the maturing debt, the greater the borrower's rollover risk.

What does rollover mean in sales? ›

In trading, a rollover is the process of keeping a position open beyond its expiry. Many trades have an expiry date attached to them, at which point the position will automatically close and any profits or losses will be realised.

What is a rollover seller? ›

Rollover Seller means any holder of Company Units that enters into an agreement with Buyer or its Affiliates providing for the contribution by such holder of Company Units to Buyer on the Closing Date prior to the Closing.

What are two types of rollovers? ›

There are two main types of IRA rollovers—direct and indirect⁠—and it's crucial to follow Internal Revenue Service (IRS) rules to avoid paying taxes and penalties. A direct rollover is the safest way to move assets from one retirement account to another as the funds are transferred without you handling the funds.

What are the methods used most commonly during the rollover? ›

Rollover can be accomplished using text, buttons or images, which can be made to appear when the mouse is rolled over an image. The user needs two images/buttons to perform rollover action. An imagery rollover can be done with the help of a program with a scripting code or a tool that supports the rollover technique.

What two things are most important in preventing a rollover? ›

What two things are important to prevent rollover? Keep the cargo close to the ground, and drive slowly around turns.

What happens to equity when you sell a business? ›

In an equity sale, the buyer most typically acquires all of the equity in the company from the equity holders. In an equity sale, the company stays exactly the same—its assets and liabilities unchanged. The only thing that changes is the owners of the entity.

What does rolling over an investment mean? ›

A rollover involves the transfer of funds from one investment to another. These transactions usually involve the transfer of funds between similar investment vehicles, though a treasury department may shift funds into investments with different maturities, depending on when the cash is expected to be needed.

What does it mean to roll a transaction? ›

Rolling a contract is an investment concept meaning trading out of a standard contract and then buying the contract with next longest maturity, so as to maintain a position with constant maturity.

What is the most common cause of a rollover? ›

Common causes of tripped rollovers include potholes, guardrails, and curbs. Fall-Over: This rollover usually occurs when the vehicle falls over an embankment. Multi-Vehicle Collision: These rollovers often result from a high-speed collision between two or more vehicles.

Can you survive a rollover? ›

Rollover crashes generally result in catastrophic injuries. Being ejected from the vehicle often results in death. However, you could sustain life-threatening injuries, even if you remain secure in your seat.

What are the odds of surviving a rollover? ›

Can You Survive a Rollover Crash? About 35% of all rollover accidents result in a fatality. Statistics show that what the individual does as the accident is happening and after the crash increases their chances of survival and avoids horrific injuries.

Who initiates a rollover? ›

An employer-sponsored plan, such as a 401(k) or 403(b), you can initiate a rollover—typically, when you change jobs or retire. When you roll over retirement plan assets, you're moving them from a group plan into an IRA (which generally offers greater investment flexibility).

What are the different types of rollovers? ›

There are two types of rollovers: direct and indirect.

Is a transfer considered a rollover? ›

What is the difference between a transfer and a rollover? A transfer is used to move funds from a single type of account between two institutions. A rollover involves moving funds from one type of account to another type of account.

What is the difference between a direct rollover and a rollover? ›

If the rollover is direct, the money is moved directly between accounts without its owner ever touching it. Conversely, with an indirect rollover, the funds are given to the employee directly for deposit into a personal account.

What is an invalid rollover? ›

A rollover to an IRA could be a failed or invalid rollover under several circumstances, including if the rollover. Includes an RMD; Is made after the 60-day time limit without a valid waiver or extension; Violates the one-per-12-month IRA-to-IRA rollover rule (NA in this case since coming from a plan);

Is a direct rollover a reportable event? ›

A direct rollover is tax reportable, so you will receive tax documents related to this event. What should I know about withholdings? If any amount from the rollover was withheld for taxes or converted to a Roth IRA, this amount could be subject to taxes and possible early withdrawal penalties.

How do you avoid a rollover accident? ›

Preventing Rollover Accidents
  1. Make sure your vehicle is up-to-date on safety regulations. ...
  2. Check your tires often. ...
  3. Only replace your tires with types almost identical to the original equipment on the vehicle. ...
  4. Never overload your vehicle. ...
  5. Don't speed. ...
  6. Avoid distractions while you are driving. ...
  7. Take corners carefully.
21 Sept 2022

What is the 60 day rollover rule? ›

Keep in mind that the 60-day rule applies in the case of an indirect rollover. If you reinvest your funds in another IRA within 60 days, your distribution isn't taxed. If you miss the deadline, you will likely owe income taxes, and possibly penalties, on the distribution.

How are rollovers taxed? ›

The rollover transaction isn't taxable, unless the rollover is to a Roth IRA, but the IRS requires that account owners report this on their federal tax return. To engineer a direct rollover, an account holder needs to ask his plan administrator to draft a check and send it directly to the new 401(k) or IRA.

How does capital gains rollover relief work? ›

Rollover relief allows a trader to defer the payment of capital gains tax where the disposal proceeds of a business asset are reinvested in a new business asset. The deferral is achieved by deducting the chargeable gain from the cost of the new asset. It can be where proceeds are fully or partially reinvested.

How can I avoid getting hit with capital gains tax? ›

That said, there are many ways to minimize or avoid the capital gains taxes on stocks.
  1. Work your tax bracket. ...
  2. Use tax-loss harvesting. ...
  3. Donate stocks to charity. ...
  4. Buy and hold qualified small business stocks. ...
  5. Reinvest in an Opportunity Fund. ...
  6. Hold onto it until you die. ...
  7. Use tax-advantaged retirement accounts.
22 Sept 2022

Can I roll over my capital gains into another property? ›

In a 1031 Exchange, the seller is allowed to roll gains from a property transaction over to a new property, especially and most likely if the seller moves into an investment property and officially declares that it is his or her primary residence.

What are some rollover risk factors? ›

Some common factors contributing to rollovers include:
  • Improperly Loaded Cargo. Often, truck drivers rely on third party loading companies to load the cargo onto their vehicles. ...
  • High Rates of Speed. ...
  • Jackknife Accidents. ...
  • Driver Error. ...
  • Weather Conditions.
3 Feb 2020

Where does a rollover occur most often? ›

Location of the Vehicle: According to the National Highway Traffic Safety Administration (NHTSA) almost 75% of fatal rollovers occur in rural areas on roads where the speed limit is 55 mph or more.

What is roll over strategy? ›

It involves closing your long position in the near-month contract and simultaneously opening a long position in the next-month contract. It as if you are continuing with existing long position. Rollover strategy is important for derivatives traders.

What does it mean to rollover the amount? ›

In finance, the term rollover refers to the process of extending the due date of a loan, which usually incurs an additional fee. The extended due date on that loan will likely come with an increased borrowing cost, meaning that the loan would be more expensive to pay off when the new due date arrives.

What is rollover example? ›

As an example of a rollover, an investment in a U.S. Treasury instrument matures, releasing funds that can then be rolled over into a new Treasury instrument. As another example, a person rolls the contents of his 401(k) retirement account into the new 401(k) account that he has just opened with a new employer.

What is the difference between a distribution and a rollover? ›

A rollover includes both a distribution and a rollover contribution. The distribution is when the money is taken out of the first account, and the contribution is when it is rolled into the new account. As the receiving institution, Entrust reports the rollover on IRS Form 5498.

What happens in a rollover? ›

It occurs when a car's tire hits something — such as a curb or ditch — that shifts the vehicle's weight to one side, causing it to roll before it can regain its balance. Speeding: If you speed around a curve or take a turn too fast, the tires can lose their grip on the road, leading to a vehicle rollover.

What 2 things are important to prevent a rollover? ›

The following two things will help you prevent rollover-- keep the cargo as close to the ground as possible and drive slowly around turns. Keeping cargo low is even more important in combination vehicles than in straight trucks. Also, keep the load centered on your rig.

What is meant by rollover risk? ›

Rollover risk is a risk associated with the refinancing of debt. Rollover risk is commonly faced by countries and companies when a loan or other debt obligation (like a bond) is about to mature and needs to be converted, or rolled over, into new debt.

Is a rollover a taxable event? ›

The rollover transaction isn't taxable, unless the rollover is to a Roth IRA, but the IRS requires that account owners report this on their federal tax return. To engineer a direct rollover, an account holder needs to ask his plan administrator to draft a check and send it directly to the new 401(k) or IRA.

Is a rollover considered a distribution? ›

A rollover is a tax-free qualifying distribution to you of cash or other assets from one retirement plan that you contribute to another retirement plan. The contribution to the second retirement plan is called a “rollover.” This transaction is reported to the IRS.

What distributions are eligible for rollover? ›

An eligible rollover distribution (ERD) is a distribution from a qualified retirement plan (QRP), 403(a) or (b) plan, or certain governmental plans that may be directly or indirectly rolled over to an eligible retirement plan described in Internal Revenue Code Section (IRC Sec.)

How long does a rollover take to process? ›

Rollovers typically take 2-4 weeks to complete.

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