Don’t Gloss Over the Rollover

Rollover equity is a purchase price component that often appears in financial advisory/wealth management services transactions. In short, rollover equity is an equity interest (i.e., shares of stock, limited liability company units, etc.) in the purchaser entity or a related entity that is issued to the seller. Oftentimes, rollover equity is generally mentioned in an indication of interest or letter of intent as it relates to purchase price, but granular details are rarely provided early on in a transaction. This can be problematic, which is why we encourage sellers to conduct diligence early on in the sale process. The results of such diligence can prove pivotal in choosing a transaction suitor or determining whether your purchaser remains a good fit. Below are some items to consider when conducting diligence on rollover equity.

Exchange vs. Re-Investment

The manner in which rollover equity is issued can have material tax consequences. For example, in an asset transaction, it is ideal for sellers to contribute a portion of the assets in exchange for the issuance of the rollover equity. If structured properly, this will be a tax-free transaction. In some instances, however, purchasers will structure a transaction such that a seller will receive cash, then be required to re-invest a portion of such cash in exchange for an issuance of equity. This can have negative tax implications as sellers will be taxed on the cash consideration prior to the re-investment.

Restrictive Covenants

Restrictive covenants, such as non-competes and non-solicits, can appear in multiple places in a transaction. For example, almost all purchase agreements will contain restrictive covenants. In addition, if a seller is entering into post-transaction employment, then his or her employment agreement may contain restrictive covenants as well.

It’s also possible that rollover equity can be tied to restrictive covenants. Governing documents (i.e., operating agreements) of purchaser entities may contain additional restrictive covenants that can be more onerous than those in a purchase agreement or employment agreement.

Involuntary v. Voluntary Exit Strategies

Post-transaction exits, whether involuntary or voluntary, come into play as well. First, you should identify what constitutes an involuntary exit (e.g., death) versus a voluntary one (e.g., retirement). Then, you can determine what “exit” triggers an optional versus an automatic redemption of the equity. Finally, you should obtain a clear understanding of calculating the redemption price of your equity, including any discounts, and the payment terms with respect to the purchase price.

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These considerations, along with a few others, should be vetted during the initial phase of evaluating transaction suitors. While due diligence is heavily emphasized by purchasers, sellers shouldn’t lose sight of their ability to conduct reverse diligence throughout the transaction process.