The math behind rollover equity
Many business owners looking to sell their business will sell to private equity groups. Most equity groups will require the seller to invest “rollover equity” into the transaction. For a business owner just starting this process, it can be helpful to understand the math for how rollover equity is calculated.
Consider a hypothetical business sale for $100 million. When a private equity group buys the company, the transaction is usually financed with a combination of debt and equity. In our hypothetical case, it is funded with $50 million each. If a seller were to rollover a 20% stake, that seller would need to retain $10 million equity. See column (1) in Table 1. If the seller increases the rollover stake to 30% or 40%, the retained equity rises to $15 million and $20 million. See columns (2) and (3).
Table 1 (1) (2) (3)
Deal terms 20% rollover 30% rollover 40% rollover
Enterprise value $100M $100M $100M
Debt $50M $50M $50M
Equity $50M $50M $50M
Rollover % 20% 30% 40%
Rollover $ $10M $15M $20M
Net proceeds $90M $85M $80M
as % of base case 100% 94% 89%
Another scenario to consider is the impact of the rollover stake on the ultimate price of the business. It is possible that buyers might be willing to pay more when the seller retains a high rollover stake – because they see a seller committed to the future. If price rises 10% as a result, the implications are laid out in Table 2.
Table 2 (1) (2) (3)
Deal terms 20% rollover 30% rollover + price 40% rollover + price
Enterprise value $100M $110M $110M
Debt $50M $50M $50M
Equity $50M $60M $60M
Rollover % 20% 30% 40%
Rollover $ $10M $18M $24M
Net proceeds $90M $92M $86M
as % of base case 100% 102% 96%
The calculations assume the debt level is unchanged and the increased price is fully funded by equity. The interesting result is that net proceeds to the seller are essentially the same but the seller gets to keep 30% or 40% of the rollover equity.
The challenge for a seller is that one cannot know whether a higher rollover stake will yield a higher price. If one can live with the results from Table 1 as a worst case, then Table 2 shows the upside if price improves as well.
It pays to do the math before you make your decision.
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