The sponsor requires us to roll twenty percent of our equity into their holding company, but they issue common units while institutional investors hold preferred units with a compounding return. How should we negotiate rollover terms to avoid being wiped out?

Question

Tyler Smith · Accepted Answer

Rolling equity as common units underneath preferred equity is a structural trap. If the sponsor issues themselves preferred units with an eight percent compounding return, their hurdle grows every year. If the company is sold in five years for a modest gain, the preferred return is paid first, potentially reducing the value of your common equity to zero.

First, demand pari passu treatment with the sponsor. If the private equity fund invests through preferred equity, your rollover equity should be issued in the exact same class of preferred stock on the exact same terms. You should ride in the same economic vehicle as the sponsor, dollar for dollar.

Second, if the buyer insists on common rollover equity to maintain their fund structure, negotiate for structural downside protection. Require anti-dilution provisions so your percentage ownership cannot be arbitrarily diluted through future intra-fund equity issuances or affiliate management transactions.

Third, secure clear governance and exit protections. Include tag-along rights ensuring you can participate in any future sale on the same pricing terms, and demand a drag-along threshold that prevents the sponsor from forcing a sale that fails to return at least your initial rollover basis. Additionally, prohibit the sponsor from charging excessive monitoring or transaction fees that drain cash before equity distributions occur.

Rollover equity is real consideration you earned at closing. If a buyer treats your rollover as subordinated sweat equity while giving their cash preferred status, adjust their headline valuation downward and re-open negotiations on cash proceeds.