Caps and Baskets: How Buyers and Sellers Negotiate Risk in a Business Sale
A beautifully drafted set of seller promises is worth very little if the cap is too low to recover under or the basket is structured so you can never reach it. This…
Rollover equity is the part of the purchase price a seller takes as ownership in the buyer, or in the buyer's holding company, instead of cash. It is common when a private equity firm or other investor group buys a company and wants the owner to keep a stake.
The seller is selling a business and making an investment at once. The purchase agreement decides what the seller is paid at closing, and the buyer's company agreement decides what the rolled stake is worth later, so we review both together.
Key Terms of a Rollover
Class of Equity
Whether the seller gets the same preferred or common units as the buyer's investors, or a junior class.
Valuation and Dilution
The price per unit, and how fees, incentive equity and later investments dilute the stake.
Governance and Transfers
Board or observer seats, information rights and limits on selling the stake.
Exit Rights
Put, call and redemption rights, and the price when the stake is bought back.
What the Seller Receives
The central question is whether the seller's stake has the same rights as the investors' cash. Investors often hold preferred units that are repaid first, sometimes with a return, before common units receive anything. A seller rolling into common units behind that preference carries more risk than the headline percentage suggests.
The buyer's company agreement also sets:
Drag-along and Tag-along
Whether investors can require the seller to join a later sale, and whether the seller can join theirs.
Transfer Limits
Consent requirements, rights of first refusal and estate-planning transfers.
Redemption, Put and Call Rights
When the stake can be bought back or sold to the company, and at what price.
Our shareholder and buy-sell agreements page explains these terms in closely held companies.
Tax Deferral and the Purchase Agreement
The usual paths to deferral are a contribution to an entity taxed as a partnership, or a contribution to a corporation, which requires the contributors to control the corporation immediately afterward. When the company being sold is an S corporation, the seller may be asked to complete an F reorganization before closing, which our article on asset and stock purchases describes. These are tax decisions we make with the seller's CPA.
The rollover documents and the purchase agreement must use the same valuation, closing date and price adjustments, and say whether the buyer can recover indemnification claims by canceling rolled units. See also selling to private equity and SBA-financed acquisitions.
How a Rollover Is Documented
Letter of Intent Terms
The rollover amount, class of equity and valuation are agreed along with the price.
Tax Structure
The seller's CPA and the buyer's tax advisers settle how the rollover is structured.
Contribution Agreement
The seller contributes part of its equity or assets to the buyer's company for units or shares.
Company Agreement Review
We negotiate the operating or company agreement that will govern the seller's stake.
Frequently Asked Questions
Have a question that isn't answered here? Call us at (817) 631-8842 or send a message.
Ask a QuestionWhy do buyers ask sellers to roll over equity?
A rollover reduces the cash the buyer needs and keeps the seller invested in the business's next stage. For the seller, it is a second chance at value if the buyer grows the business and sells it later.
Is the rolled portion taxed at closing?
It often doesn't have to be. Rollovers are commonly structured as tax-deferred contributions, while cash the seller receives is generally taxable. Whether deferral is available depends on the entities and the steps, so we work through it early with the seller's CPA or tax adviser.
What happens to my rolled equity if I leave the company?
The company agreement decides. Many let the company buy back an owner-employee's stake on departure, some at a lower price after a for-cause termination. Because rolled equity was paid for with part of the price, sellers usually push for fair value in every case.
Can a seller keep a stake when the buyer uses an SBA loan?
Only in limited structures. Under current SBA rules, a seller generally can't keep a stake after selling the whole company. A partial sale can allow it if the seller guarantees the loan, but structures that put the existing and new owners in a new holding company aren't eligible. The rules change from time to time, so we confirm them with the lender on each deal.
More in Business Acquisitions
- Mergers and AcquisitionsBuyer and seller representation in Main Street and lower middle market deals.Learn More
- Buying a BusinessStructure, diligence, negotiation and closing for buyers.Learn More
- Selling a BusinessPreparation, negotiation and closing for owners selling their companies.Learn More
- Asset PurchasesBuying or selling a company's assets while the seller keeps the entity.Learn More
- Stock PurchasesBuying a corporation's shares, with its contracts and its history intact.Learn More
- Membership Interest PurchasesBuying an LLC's ownership under a membership interest purchase agreement.Learn More
- Partner BuyoutsBuying out a co-owner, or selling your stake, on clear terms.Learn More
- SBA-Financed AcquisitionsPurchase agreements and closings built around SBA 7(a) lender requirements.Learn More
- Seller FinancingSeller notes with clear payment terms, security and remedies for both sides.Learn More
- Earn-OutsContingent price terms defined clearly enough to measure, report and pay.Learn More
- Selling to Private EquityRepresenting owners who sell to private equity firms and PE-backed platforms.Learn More
- Search Funds and SponsorsVehicles, investor terms and acquisitions for searchers and independent sponsors.Learn More
- Franchise ResalesBuying or selling an existing franchise location, with the franchisor's approval.Learn More
- Letters of IntentSetting the price, structure and key protections before the deal is drafted.Learn More
- Due DiligenceFinding the legal issues in a business before the buyer owns them.Learn More
- Purchase AgreementsThe negotiated terms that decide who carries the risk in a business sale.Learn More
- Closing an AcquisitionChecklists, payoffs, funds flow and the follow-up that finishes a deal.Learn More
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