A private equity buyer requires us to roll twenty-five percent of our equity into their holding company, but they plan to issue an eight percent management equity pool that could dilute our minority stake. How do we negotiate dilution protections and governance rights on rollover equity?

Question

Tyler Smith · Accepted Answer

Rollover equity is often marketed by financial sponsors as a second bite at the apple, but without protective covenants, your minority interest will be methodically diluted by subsequent financing rounds, management option pools, and parent-level debt issuances. If an eight percent profits interest pool is created exclusively at the subsidiary level or carved entirely out of common units post-close, you bear an outsized share of that equity dilution.

Protect your rollover valuation by negotiating strict minority governance terms in the operating agreement:

- Require anti-dilution provisions specifying that any management incentive pool or unallocated profits interest must be issued pro-rata across all equity classes, or diluted solely out of the sponsor's retained equity.
- Match your equity class to the sponsor's position. Insist on pari passu treatment with the private equity firm. If the sponsor holds preferred units with a compounding cumulative hurdle, your rollover must be issued in the exact same preferred unit class rather than subordinate common units.
- Secure tag-along rights and pre-emptive subscription rights. Tag-along rights guarantee that if the sponsor sells a controlling interest in the platform, you have the contractual right to sell your shares on identical terms and valuations. Pre-emptive rights ensure you can participate in future capital calls to maintain your ownership percentage.
- Establish information rights, including quarterly financial packages and an observer seat on the board of directors. Your leadership team needs insight into enterprise valuation adjustments, debt recapitalizations, and corporate overhead allocations.

Rollover equity is real capital. Treat it with the same governance rigor you applied when building your standalone company.