Alternatives to Rollover Equity after recent SBA SOP

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by a searcher from Pomona College
in Asheville, NC, USA

1yr ago

Alternatives to Rollover Equity after recent SBA SOP

For those around LOI stage in SBA-funded deals who had initially offered 10-19% equity rollover to the seller, what are you thinking about replacing that with at this point in your offer structure, if anything? Top option appears to be a second seller note with EBITDA-based earnout hurdles. I've also considered a standby seller note, or adding performance-based equity grants (like public company PSUs) to the seller's consulting agreement. I'm not sure banks would allow the latter, however. I also don't think I would be allowed to, for instance, add the seller's child to the cap table as a minority equity investor, though I like the idea as a runaround. Curious what everybody here has come up with.

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reply by a searcher 1yr ago
from Georgia Institute of Technology in Charleston, SC, USA

Why was the rollover equity part of the deal? Does the seller want a second bite when you exit? Does business needs a license among the ownership? Is there a risk that the rollover equity is intended to mitigate? Answer these questions, and it should point you to the next best alternative.

reply by a searcher 1yr ago
from St. Joseph's College in Chicago, IL, USA

My logic could be flawed here... but in addition to the points you already mentioned, I think including rollover equity as part of your deal adds a layer of immediate risk mitigation. E.g., EV = $1,000,000; Seller note = 15% (or $150,000); Seller Equity = 15% (or $150,000); Buyer capital injection = 10% (or $100,000); SBA 7(a) = 60% (or $600,000). Assuming the seller note is on standby or interest only for first 2 years, and you decide not to take any distributions from the business during that time, the only debt service you have to worry about for the first 2 years is SBA debt (60%). Once the seller note kicks in by year 3, it only puts half as much pressure on the business as two 15% seller notes would. Assuming (again) that you're building cash or re-investing to increase cash flow, you could find yourself in a better position with multiple options for dealing with the seller note and seller equity in years 3-5 (pay off, refinance, etc.). Additionally, I believe any debt on the business would reduce the value of the seller's equity if they decided to cash out - particularly in the first half of SBA loan term... so they are inherently more invested in the long-term success of the business. As others have already said, once this goes away, I'd imagine the next best alternative is full standby seller notes...