Seller Equity Roll Considerations

February 25, 2023

by a searcher from Harvard University - Harvard Business School in Westchester County, NY, USA

Seller wants to slow down and cash out, mostly, but is willing to roll some equity. Does anybody have any experience for such a scenario? Can you write in an option to purchase the remaining equity or a ROFR on the sale of the minority stake? Any other land mines to avoid or things I should be thinking about?

0 Likes

8 Replies

200 Views

Replies

Reply by a professional
from Boston College in Baltimore, MD, USA

Rollover equity is a common component of many deals. Lot's of considerations including: (i) tax treatment of the rollover equity (most sellers assume that they will retain or receive rollover equity on a tax deferred basis -- that's often achievable, but not always); (ii) impact on tax attributes of the deal (e.g. will the buyer be able to obtain a step-up in basis and depreciate goodwill -- usually solvable but structure could change); (iii) minority owner protections (savvy sellers will expect certain rights that will vary with the size of the rollover); (iv) impact on individual tax status (e.g. impact of moving from a corporation to a partnership on rollover owner - employee); (v) indemnification (i.e. how do you measure a loss in certain circumstances where the rollover owner holds a material portion of the equity in the company); (vi) structural subordination created by put-call rights (i.e. buyer and other LPs may not like ability of rollover equityholder to exit first and get priority); (vii) impact on financing (both underwriting and technical/process issues); and (vii) list goes on....

Put-call rights are common where there is an agreed-upon time horizon where the rollover equityholder anticipates full retirement/exit. Call rights are common (but negotiated) in the event that the rollover equityholder leaves the employ of the company. ROFR is going to encumber rollover equity almost all the time.

Reply by an investor
from Harvard University in Denver, CO, USA

As ^redacted‌ mentioned, the biggest drawback of offering rollover equity is that it (generally) doesn't work with the SBA loan structure. However, it's often a great way of aligning incentives toward a smooth transition and the future growth of the business, maintaining key customer and employee relationships, etc.

To answer your other question, yes, it's quite common for minority equity positions to have "put/call" agreements that specify a time window and a valuation at which the minority holder can sell, and/or the majority holder can buy, the minority position. A ROFR is also not uncommon but there's not generally a liquid market for minority stakes in small businesses, so really the two ways to get liquidity for the minority holder are 1) sell to the majority holder, and 2) "tag along" in a sale of the whole business

+6 more replies.

Join the discussion