The private equity buyer expects us to roll over twenty percent of our equity into their new platform. How do we evaluate their governance terms and drag-along rights to make sure our minority equity does not get wiped out in a subsequent recapitalization?

Question

Tyler Smith · Accepted Answer

Rolling over equity can be highly lucrative, but as a minority shareholder in a private equity-backed company, you have very little control. If you do not negotiate strong governance protections up front, the majority owner can dilute your shares or restructure the debt to leave you with worthless paper at the second exit. First, scrutinize their drag-along and tag-along rights. While the buyer will insist on drag-along rights to force you to sell when they exit, you must negotiate tag-along rights. This guarantees that you have the right to sell your shares on the exact same terms, conditions, and price as the majority owner. Second, negotiate veto rights over key corporate decisions, such as taking on excessive debt, issuing new classes of preferred stock with liquidation preferences ahead of you, or entering into related-party transactions that drain cash from the company. Finally, insist that your rolled equity is pari passu, or on equal footing, with the sponsor's equity. If they have preferred shares with a guaranteed return, your rolled equity must have the same structure. Do not accept common stock if the buyer is holding preferred stock with a liquidation preference that wipes you out in a down-market scenario.