A recent Seyfarth memo provides an overview of creative ways to bridge valuation gaps between buyers and sellers. The memo discusses earnouts, but it addresses a number of other alternatives as well. Here’s an excerpt on equity rollovers:
Equity rollovers are a tool used almost exclusively by private equity buyers in platform acquisitions, and sometimes for tuck-in acquisitions. Equity rollover transactions typically involve rollover participants taking between 10% and 40% of the purchase price in the form of equity in the buyer.
Equity rollovers are generally restricted to founders and other members of the seller’s management team who are joining the buyer post-closing. This provides founders and management with a meaningful equity stake in the buyer to align their respective interests to grow and sell the target company.
Generally, existing equity holders in the seller who are not founders or part of the management team (i.e., venture capital, private equity or angel investors) are excluded from the equity rollover since they have no ongoing role with the buyer postclosing and would rather exit the investment in the seller. Private equity buyers also like equity rollovers since they serve as a form of seller ﬁnancing which reduces the buyer’s up-front cash payments at closing.
While equity rollovers are already common, the memo says that, in the future, they will likely be used as a way of allocating more risk to the seller in order to address the unpredictability of post-pandemic ﬁnancial performance. The memo also suggests that the terms of and participation in equity rollovers may evolve to address post-pandemic considerations.
Other potential techniques for bridging valuation gaps discussed in the memo include the use of targeted management incentive bonuses by strategic buyers, and a “hybrid rollover” structure involving a purchase of less than 100% of the target’s equity with deferred purchase options for the remainder.
-John Jenkins, DealLawyers.com June 12, 2020