You are elated because you have begun the process of selling your business. You have received some great initial offers from private equity groups and you are already thinking about buying the vacation home. Hopefully, as you and your investment banker review those initial offers, you are paying attention to the request to roll equity back into the transaction.
Rolled equity is when a buyer requests that a seller take some of the proceeds from the transaction and re-invest it back into the company. Buyers request this for a couple of reasons. The first, and most important reason, is that the buyer wants the management team to have an interest in the continued success of the company. When private equity buys a business, they often require that the key managers stay on to run the company. This can be a tricky situation if the managers have received a large amount of money. At some point, the money in your bank account can encourage managers to leave, or lose interest in their job running the company. This can be exacerbated by the fact that a manager that was once an owner, can have a difficult time adjusting to working for someone else.To combat this issue, many financial buyers request that key managers who are staying with the company roll equity back into the business. This amount varies (and can be negotiated as part of the overall transaction Letter of Intent) but can range anywhere from 5% to 49% of the company's equity.
For smaller transactions, rolled equity can help bridge a gap in valuations between buyer and seller.
Rolled equity might feel a bit strange to a seller, but it isn't necessarily a bad thing. Think about a couple of reasons why you (or other members of your management team) may want to roll equity.
You will be investing in a business that you know and understand
As an employee of the business, you will have a hand in its growth. This gives many sellers comfort. Instead of investing all your money in the stock market, some people like the opportunity to invest back into their former company because they know all the dynamics related to its success and challenges.
You are participating along with the buyer in generating PE-level returns
PE investments generally carry some higher risk but also generate higher returns for investors. Assuming you understand the risks associated with your former business and are OK with them, you can generally receive better returns on the rolled equity than you can in the stock market.
PE groups will invest in the business to drive growth
PE groups generally look for ways to stimulate growth of the businesses they buy. As an equity-holder in the company, this can be exciting. Acquisitions, a new CRM system, or installing a new machine can mean dramatic results for the business and it's not necessarily your personal balance sheet that needs to support it.
Of course, rolling equity also means that you have to think like a seller and a buyer at the same time and that can present some challenges.
For instance, an aggressive debt structure can lead to a very high offering price (good for the seller) but might make the company unstable in uncertain market conditions (bad for a buyer).
Your investment banker can walk through the offers you have received as a seller, highlight the rolled equity opportunities or requirements and analyze the different risks that are apparent as a seller and a buyer.