A private equity buyer is offering a high valuation but requires me to roll over twenty-five percent of my equity into their new holding company. How do I assess the actual risk and value of this rollover equity so I do not get burned on the second bite of the apple?

Question

Tyler Smith · Accepted Answer

Rollover equity is a common mechanism used by private equity buyers to align your interests with theirs post-sale, but you must treat that twenty-five percent rollover as a completely new, highly speculative investment. You are trading cold cash today for a promise of future appreciation, which may or may not materialize.

To assess this risk, you must look past the headline valuation and perform due diligence on the buyer:

First, analyze their historical track record with previous acquisitions. Ask for references from other founders who rolled equity with them. Did those founders actually receive a second bite of the apple, or was their equity diluted to zero by subsequent debt rounds and preferred share classes?

Second, understand the capital structure of the new holding company. Ensure your rolled equity is pari passu, meaning it has the same rights, liquidation preferences, and classes of shares as the private equity sponsor. If they hold preferred shares with high compounding dividends while you hold common stock, your equity value can easily be wiped out before you see a dime of profit.

Third, evaluate the operational plan. If they plan to leverage the business with high levels of debt, your company cash flow will go toward paying down debt rather than growing the business, which increases your operational risk.

Never accept rollover equity simply to achieve a higher cosmetic sale price. If the business fails under their management, that twenty-five percent is gone. Make sure you are comfortable with the cash-at-close amount as your walk-away number.