A private equity buyer requires us to roll twenty percent of our equity into their new platform company. How do we evaluate whether this rollover equity is real upside or just subordinated risk capital for the sponsor?

Question

Tyler Smith · Accepted Answer

Private equity firms frequently require founders to roll over ten to thirty percent of their enterprise value into the acquiring entity. They sell this as your chance to get a second bite of the apple when the platform sells again in four to six years. While rollover equity can generate substantial wealth, it often serves as subordinated risk capital that shields the sponsor from losses while diluting you into irrelevance.

To determine whether the rollover is genuine alignment or a trap, evaluate three structural components of their operating agreement. First, examine the equity class. If the sponsor issues themselves preferred equity with an eight percent accruing dividend and gives you common units, their capital must be fully repaid with cumulative returns before your equity receives a single dollar. You take primary downside loss while they guarantee their return. Insist on rolling into the exact same class of units as the sponsor, pari passu with their institutional capital.

Second, analyze the governance and drag-along provisions. Will you have information rights, board observer seats, or minority veto protections over major recapitalizations and debt issuances? Without these, the sponsor can issue debt to pay themselves management dividends while diluting your ownership percentage to zero. Third, look at management incentive pools. Ensure your equity is not diluted alongside employees when new options are granted. If the sponsor refuses parity in the equity structure, reduce your headline enterprise valuation slightly in exchange for taking one hundred percent cash at close.