A strategic buyer is offering us a premium valuation but wants us to roll fifty percent of our equity into their private stock. How do we evaluate their valuation methodology to make sure we aren't accepting inflated paper?

Question

Tyler Smith · Accepted Answer

Accepting a large portion of your purchase price in a buyer's private stock is highly risky, especially when there is no public market for those shares. To ensure you are not accepting inflated paper, you must conduct the same level of rigorous due diligence on the buyer's business and valuation methodology that they are conducting on yours.

Demand complete transparency regarding how they calculated their own enterprise value. A strategic buyer may be using an aggressive, subjective multiple to value their own shares, while applying a conservative multiple to yours. Insist on reviewing their historical financial statements, audits, and any recent third-party valuations.

Examine the share classes and preferences. Private equity firms and large strategic buyers often issue preferred stock to themselves while offering common stock to rolling founders. This means they have liquidation preferences, dividend rights, and anti-dilution protections that you do not. If the company is sold for less than expected in the future, their preferred shares are paid out first, which can completely wipe out the value of your common stock.

Finally, secure protective governance rights. In the shareholder agreement, negotiate tag-along rights, drag-along rights, and information rights. You must also establish a clear, formulaic redemption mechanism that allows you to sell your shares back to the company under specific conditions if the ultimate exit timeline is delayed. This protects your equity rollover from being locked up indefinitely.