We are choosing between a full cash exit and rolling over twenty percent of our equity into the buyer's newly formed holding company. How do we evaluate the structural risks of this rollover equity to ensure we are not getting diluted or stuck with illiquid, subordinate stock?

Question

Tyler Smith · Accepted Answer

Rolling over equity can lead to a second, larger payout, but it also carries significant risk of dilution, illiquidity, and subordination. To evaluate a rollover offer, you must look closely at the class of stock and the governance rights attached to it. First, verify whether your rollover equity will be the exact same class of stock as the financial sponsor's equity. You want pari passu treatment, meaning your shares have the same rights, preferences, and liquidation priorities as theirs. Avoid accepting common stock if the sponsor is taking preferred stock with a liquidation preference, as they will get paid first in a subsequent sale, potentially leaving you with nothing. Second, negotiate strong anti-dilution protections. Ensure your equity cannot be diluted by future capital calls or sponsor management fees unless the sponsor is also diluted proportionally. Third, secure drag-along and tag-along rights. Tag-along rights ensure that if the sponsor sells their majority stake, you have the right to join the transaction and sell your twenty percent on the same terms. Drag-along rights protect you from being left behind in a partial exit. Finally, request a seat on the holding company board or at least information rights so you can monitor the performance of the combined entity. Evaluating these structural terms ensures your rolled-over equity remains a valuable asset rather than a paper promise.