A private equity firm is offering a strong valuation but requires our leadership team to roll over twenty percent of our equity into their new holding company. How do we evaluate this rollover structure to ensure it actually represents a valuable second-bite opportunity rather than a highly leveraged risk?

Question

Tyler Smith · Accepted Answer

Rollover equity can be highly lucrative, but it is also high-risk, especially when a financial sponsor loads the new company with significant debt. If the business struggles under the weight of that leverage, your rolled-over equity could easily be wiped out before the next exit.

To evaluate this structure, you must perform deep due diligence on the sponsor's capital structure and growth plan. Ask for the specific terms of the debt being placed on the operating company. High leverage reduces the equity cushion and increases the risk of default during economic downturns.

Next, negotiate for class-of-stock protections. Ensure your rollover equity is in the same class of stock as the sponsor's equity, rather than a subordinated class that gets diluted first. Demand tag-along and drag-along rights so you are not left behind when the sponsor decides to sell.

Finally, use your V/TO® to assess if your leadership team's long-term vision aligns with the sponsor's aggressive growth targets. If your team is expected to drive that growth, make sure they have a seat on the board or clear input on major capital decisions. Never treat rollover equity as guaranteed money; structure it with the legal protections necessary to ensure you actually participate in the upside of the second-bite exit.