Selling a Business: What is “Roll Over” Equity?
17 March 2025: Selling a Business: What is “Roll-Over” Equity?
Do you know what area of the buying market is most active right now?
We receive multiple inquiries every week from well-capitalized buyers; so many, in fact, that there’s no way we can satisfy all their needs. But as we’ve discussed previously, identifying your buyer will help the seller understand what an offer is likely to look like and be able to prepare for such offers.
“Knowing your buyer” means, among other things, developing an avatar of the type of buyer the business you’re selling is likely to attract. For example, smaller businesses – ones with revenue of less than $2M or $3M, for instance – are likely to attract individual, financial buyers. Some “search firms” – one or two people backed by committed capital who intend to buy and operate a business – may also be interested.
Larger businesses, on the other hand, are more likely to attract strategic buyers – larger companies in the same or related industry segment – and private equity (PE) firms.
These different buyers have different goals driving their acquisition activity and, thus, the deals they make – and the offers sellers receive – vary accordingly. As such, when selling a business, having some idea who the buyer is likely to be, helps focus the marketing and usually saves time.
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These larger deals usually involve different financing structures but most generally have one thing in common: deferred compensation.
Most of the inquiries we’ve been getting for the past two years or so have been coming from private equity. We’ve previously discussed how PE firms have been expanding their search criteria and have been investing in everything from landscaping contractors and HVAC service businesses to laundromats and car washes. The largest roofing company on the U.S. is constantly sending us emails reminding us they want to buy.
PE firms and many strategic buyers often structure the offers they make – and the deals they subsequently do – so that some of the sellers proceeds are deferred beyond the closing. The most common type of deferred payment is escrow, which is usually between 5–20% of the deal, with a term of six months to two years and bears interest to the seller.
Another type of deferred payment is an earn out, which offers the seller some upside if the business does well after closing.
A third deferred payment is a seller note, where a portion of the deal is in the form of a note, generally with a term of between two and 10 years. This note is almost always in a second position and the term often is as long as the senior debt. Interest/principal payments may depend on the terms of the senior lender. A seller note may be less risky than an earn out or rollover equity, but there is usually little or no upside. Most offers include one or more types of deferred payments. Before getting into M&A discussions, owners should be familiar with the different options.
It’s notable that the fourth deferred payment option – roll-over equity – is becoming more common. The amount of roll-over equity any offer contains varies but generally falls somewhere between 10% and 40% of the deal’s proceeds. We need to advise our sellers that the amount needs to be reasonable and at a level that motivates the seller to continue to grow the business. As such, less than 10% is somewhat rare because it is not enough to provide that motivation.
If a seller is looking to retire, they typically prefer a lower amount of rollover equity and shorter period of continued employment to extend the company’s growth. Conversely, if the seller is younger, plans to stay in the business, and is looking for the proverbial “second bite at the apple,” they may wish to roll over a higher percentage of equity in the hope that their remaining equity will appreciate smartly over the term they’ll stay with the company.
Rolling over more than 40% is rare because the seller would then retain majority ownership, a situation unsuited to the objectives of most PE firms.
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How It Works
Here’s a simple example of how roll-over equity works:
If the offer is for $5 million, the rollover equity is $1 million (20%), and escrow is 10% ($500,000), the seller would receive $3.5 million at closing (before closing costs, fees and taxes). The seller will own $1 million worth of stock (equity) in the buying entity, which may represent MORE than 20% of the acquiring company.
The hope is that the buyer will grow the company and obtain a higher multiple when they eventually sell, giving the seller a higher return on the rollover equity investment. Since many PE firms have a positive track record of providing returns to their investors, rolling over equity can be a solid bet.
Although rollover equity has the growth potential, it carries a level of risk. A seller considering rolling over a portion of their proceeds into equity in the acquiring entity should understand the buyer’s plans for structuring and growing the company. Of particular importance if the seller’s future proceeds are dependent upon the company’s future performance is the amount of management control the seller will after after the closing. Without a reasonable amount of control, it may be impossible for the seller to generate the results hoped for and that equity he or she rolled over does not increase in value. undertake due diligence on the buyer, their growth strategy, and what the company will look like post-transaction.
The Bottom Line
There are several potential benefits to rolling over equity when selling a business. For example, rolling over equity could defer taxes on that portion of the deal, meaning you may not owe taxes until you sell that portion, possibly years later.
PE firms like the concept because they want the seller’s goals to be aligned with the buyer’s. While most sellers say they want the company to succeed, from the buyer’s standpoint, knowing the seller’s money is on the table gives the buyer a reasonable sense of certainty that the seller and buyer want the same result.
A seller willing (or even eager) to roll over some proceeds of the deal can be a strong negotiating tactic insofar as it can motivate the buyer to make some of the other terms – i.e., escrow amount and term, representations and warranties, etc. – more attractive because it shows confidence in the company on the seller’s part.
First and foremost, if, after developing the buyer avatar, you can determine that buyer is likely to be strategic or private equity, a seller must be prepared for the possibility that one aspect of an offer may be that the seller roll over a portion of his or her proceeds into equity in the acquiring entity. When selling a business, roll-over equity can provide an extra return on the proceeds of the deal, but it can be risky and consume more of the seller’s time post-closing. Though the seller might understand the concept, they should be advised to consult with their legal and financial advisors.
“You have to perform at a consistently higher level than others. That’s the mark of a true professional.
– Joe Paterno
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at
jo*@Wo*******************.com