That Apple Might Be Rotten

In Deal Note^® 190, we discussed how buyers value companies. A related question comes up often: are you willing to roll a portion of your proceeds into the new company?

Rollover equity means the seller reinvests part of the sale proceeds — typically 10% to 30% of total consideration — into the buyer’s post-closing capital structure, rather than taking the full purchase price in cash at closing. Buyers typically ask for rollovers for three reasons: i) to confirm the seller’sconfidence in the business, ii) to keep the seller financially motivated to see the venture succeed in the future, and iii) to reduce the cash needed to fund the acquisition. If the buyer is successful and their business is sold for a higher price in the future, the seller shares in that upside. Buyers often refer to this as “a second bite of the apple”.

The issue for the seller is a risk that the apple may be rotten when they bite into it in the future.

Before agreeing to any rollover, sellers should understand what they are actually accepting. Rollover equity is not cash. It is an illiquid, minority stake in a private company. Its eventual value depends on the buyer’s ability to sell their company in the future for a higher value than it is worth today, because rollover equity is usually at the value (per share) of the buyer at the time of your transaction (this is a complex topic in itself, which we will cover in another Deal Note).

Rollover equity can meaningfully increase total proceeds if the second sale goes well. It can also result in you selling your business for less than you wanted, because the rollover equity ultimately has less value than you had hoped.

When it comes to rollover equity, the expression is accurate: it is “a second bite of the apple”. Just remember, some apples are rotten.

Have a great day everyone.