Seller Equity Rollover: Enterprise Value or Equity Value %? - Searchfunder

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by a searcher
in Montreal, QC, Canada

1yr ago

Seller Equity Rollover: Enterprise Value or Equity Value %?

Assuming you buy a company for $10M with the following structure:

- 70% debt ($7M)
- 20% seller rollover ($2M)
- 10% sponsor equity ($1M)

In this example, what would be the equity ownership of the seller in the company post-close?

Option 1
- The seller will own 67% of the equity post-close ($2M / ($1M + $2m))

- The 20% rollover is only applied to the Equity Value and not the full Enterprise Value

Option 2
- The seller rolled over 20% of the enterprise value and will also own 20% of the equity value while you own 80% post-close

- You will finance only 80% of the enterprise value - making it a lot easier to take on debt (i.e., buying 80% of the business, but using 100% of the EBITDA to repay your debt)

- The seller's 20% equity ownership will be set at a minimum value of $2M in the negotiations, and will likely need a structure where you buy him out in 3-7 years at a fixed price (i.e., he'll have a put option, or you'll have a call)

What's the correct way to model the seller's rollover in a transaction?

Do sellers that rollover a % of the purchase price (EV) end up owning that same % of the equity? Or does that % need to be adjusted to reflect the pro-rate equity ownership once we lever up the company?

Been getting different opinions on this.

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reply by a professional 1yr ago
from University of Michigan in Detroit, MI, USA

^redacted‌, your question re. the PG ties into Mike's point. If cash is the only consideration offered in exchange for the equity, the searcher can't walk away with 80% of the company having only put in $1MM to the seller's $2MM (in Mike's example, the gotcha is a busted S election due to an impermissible different class of stock). But cash isn't the only consideration that can be offered in exchange for equity. You can purchase equity with anything of value. And the searcher usually receives additional sweat equity. So it's not simply about whether the seller takes on a PG or not. Like all things, it's a negotiation about the relative value that the parties are bringing to the table. Similarly, the terms of the seller's rollover investment is also a negotiation. Often, the seller participates pari-passu with the searchers other investors (if the searcher has other investors).

reply by a searcher 1yr ago
from Northwestern University in Hamburg, Germany

I am not an expert on rollovers and have nerver done one, but a way I always think about it is a two-stept approach.(1) the seller is selling the business to you and himself and (2) the seller buys the business together with you at the same time. In my view the equity ownership in this process is determined by whatever each party puts in (so for it to be 50/50 they shoudl put in the same amount of money) or whatever is negotiated. In your example it would most likely be option one or fpr the 20% stake the seller would need to put less money in the deal.

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