In this installment of the “What To Know” series, we’ll discuss some critical items to consider when evaluating and considering rollover equity, if any. Understanding the purpose of rollover equity helps sellers connect the risks and benefits. As a result, sellers should consider that buyers propose rollover equity largely to 1) share in the future risk of the business, 2) incentivize sellers to continue to contribute to the business, and 3) to bridge any funding gap in the buyer’s willingness to utilize cash or debt for the acquisition.
When we execute a full sell-side auction process, multiple offers are received and several will likely include some amount of rollover equity. After analyzing the level of rollover equity in relation to the enterprise values, we then consult our client on the strengths and weaknesses of each group proposing rollover equity. Selecting which buyer to choose is highly complex when considering the value of rollover equity with the new buyer. With more than 4,500 private equity funds, there are many flavors of i) management style, ii) value generation, and iii) timing of repayment.
Sellers operating with less than $3-5 million in annual adjusted EBITDA have historically not been a highly sought out investment type for minority investors. As a result, additional cautions should be taken. For companies larger than this size, there is a healthy amount of investors / private equity groups who would likely have interest. Some take a very active role in the operations and management of the company while others take a more hands-off approach. It’s worth mentioning that despite the minority ownership, these sophisticated investors often require many deal points that may not be obvious to those outside of the industry. By way of example, it’s not uncommon for certain minority investors to require a put right whereby the minority investor has the ability to sell the company back to the majority owner at an agreed price (which may or may not be viewed as “fair” depending on the majority owner’s expectations).
Irrespective of a minority or majority investment, every private equity group has its own set of value generation tools they intend to provide. Some of those value propositions may simply be window dressing to make them appear better than other buyers. We spend a considerable amount of time researching, reviewing, and interviewing our prospective buyers to flush out the true value we anticipate they would be able to provide to our selling clients. The difference between having rollover equity with one private equity group who brings real value vs. one that doesn’t is substantial. Depending on the situation of the seller, it can (and often does) drive the ultimate decision of selecting a particular buyer and, more often, one that may not have the highest total purchase price. We find this to be even more important and heavier weighted in local Midwest deals vs. others.
As mentioned above, there are many private equity groups, family offices, investors, etc. who have different mandates and investment theses. These may result in the seller not being able to receive their rollover investment back in more than 5 years. Just as business owners don’t receive their investment in the business until a sale, the same is true of their rollover equity. The largest difference when selling a majority is that the decision for the sale and terms of the eventual sale are dependent on the new majority owner. While we work closely with experienced M&A attorneys and wealth advisors, there are only a limited amount of protections minority owners are traditionally able to receive.
For more information, contact Ely Friedman, Director of M&A with VonLehman CPA & Advisory Firm at efriedman@vlcpa.com.
