We are reviewing an offer structured as 65 percent cash, 15 percent rollover equity, and 20 percent seller note. In the event the buyer's post-acquisition growth plan fails, what is the legal and economic priority between our seller note and rollover equity, and how should we balance this split?

Question

Tyler Smith · Accepted Answer

Rollover equity and seller notes occupy fundamentally different positions in the post-close capital stack. Confusing the two or treating them both as generic deferred compensation exposes you to massive downside risk.

A seller note is debt. Even when it is contractually subordinated to the buyer's senior commercial lender, it remains senior to all classes of equity, including preferred units and common stock. If the business encounters turbulence or liquidates, debt holders must be satisfied before any equity receives a single dollar. Furthermore, a properly drafted seller note accrues interest, carries a defined maturity date, and can be structured with personal guarantees or second-lien security interests on enterprise assets.

Rollover equity, by contrast, sits at the absolute bottom of the waterfall. If the private equity sponsor overleverages the company, trips senior debt covenants, or dilutes the cap table through emergency capital calls, your rolled equity can be wiped out completely.

When balancing this split:

- If your primary goal is capital preservation and certainty of exit proceeds, push to minimize rollover equity and maximize the seller note.
- Demand that any seller note carries a cash-pay interest rate at or above market, a maximum five-year maturity, and strict negative covenants that prevent the buyer from paying distributions or management fees to their sponsor if your note is in default.
- For the rollover equity component, insist on pari passu treatment with the sponsor's institutional equity class. Never accept common units if the buyer is holding preferred units with compounding liquidation preferences.

If the sponsor is not confident enough in their growth thesis to service your subordinated note, do not trust their promises about rollover equity returns.