We have a cash offer from a strategic buyer and a higher-valuation offer from a private equity firm that requires us to roll over thirty percent of our equity into their new platform. How do we evaluate the true risk-adjusted value of this rollover equity so we do not accept paper value that gets diluted to zero?

Question

Tyler Smith · Accepted Answer

Comparing a clean, cash-at-close strategic offer to a leveraged private equity structure is not an apples-to-apples comparison. Private equity sponsors offer higher headline valuations because they use your rollover equity as cheap, subordinated capital to fund their acquisition.

To assess the true value of that second bite of the apple, you must look past the multiple and audit their capital structure.

First, analyze the liquidation preferences. If the sponsor structures their investment with preferred equity that carries a cumulative compounding dividend, they will get paid back their entire capital plus interest before your common rollover equity receives a single dollar. You must negotiate for pari passu treatment, meaning your rollover equity has the exact same terms and rights as the sponsor's equity.

Second, inspect the debt leverage. High leverage increases the risk of equity dilution if the market turns. Ask the sponsor for their projected debt-to-EBITDA ratios and debt service coverage.

Third, evaluate their operational track record. Do they have a proven playbook for scaling businesses, or are they just relying on financial engineering?

Bring these questions to your leadership team during your weekly Level 10 Meeting™. Use your IDS® process to identify the real operational risks of staying aligned with a financial sponsor. If your team does not GWC™ their roles under a high-growth, highly leveraged private equity environment, the strategic cash offer, even at a lower multiple, may yield a much higher risk-adjusted return for your personal balance sheet.