Best Way to Explain how Searcher Carry Impacts Seller Equity Roll?

October 03, 2024

by a searcher from Northwestern University - Kellogg School of Management in Chicago, IL, USA

Anyone have ideas on how to explain to an owner the impact of carry of the seller's equity roll?

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Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

It depends on the waterfall and what class of equity the seller has. If the company post-close has a preferred class of equity (investor equity), you will need to determine whether the seller's rolled equity will be of the same class, of a more junior class (but still above the carry), or of the same class as the carried interest. If it's more senior, you attribute a value to it (likely a % of the deal value) and the seller will presumably receive that value in distributions before you get your carry (and then the seller will share in subsequent distributions pro rata based on the % you agree on). If it's of the same class as the carry, the easiest way to explain it is just as a % interest after your investors receive their capital back. You don't need to describe it in terms of carry, it's really just your ownership interest that you have earned and will earn after the preferred get paid.

Reply by a searcher
from Indiana University, Bloomington/Indianapolis in Chicago, IL, USA

I don't think it's a winning proposition to try to convince a seller that his [10%] rollover into newco is actually going to be diluted by your [70%] carry right off the bat. In my experience, if you're going to give a seller rollover, you should assume that ownership is coming entirely out of your pocket. So [10%] rollover, means they own 10%, you own 60% (instead of 70%), and your LP's still own 30%. I think that's the only practical way to go about it. Otherwise you're left trying to convince a seller that his equity is actually worth less than he thinks because you (a first time owner, never owned a business before, etc), are taking up the majority of the stack. That's a tough sell....

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