The private equity firm is offering a high valuation but is forcing us to roll over thirty percent of our equity into their NewCo. How do we ensure that our rolled-over equity is valued on the exact same terms as their cash investment, and not diluted by preferred share classes?

Question

Tyler Smith · Accepted Answer

A high headline valuation is meaningless if your rolled-over equity is structured to be wiped out. Private equity buyers often invest using preferred equity that carries a liquidation preference and a high accruing dividend, while forcing sellers to roll over into common equity.

In this scenario, the buyer gets paid back their entire investment plus their accrued dividend before your common equity receives a single dollar. If the business is sold down the road for a moderate price, your thirty percent rollover could easily be worth zero.

To protect yourself, you must negotiate for pari passu treatment. This means your rolled-over equity must be in the exact same class of security as the buyer's new cash investment. If they are buying preferred units, your rollover must convert into those same preferred units, carrying the same liquidation preferences and dividend rights.

Use your dedicated Thinking Time to evaluate the true risk-adjusted return of their offer. If they refuse to grant you pari passu status, you must treat their offer as a discount on your cash at close. It is often better to accept a lower overall valuation with one hundred percent cash at close than a high valuation with a toxic rollover structure.