What is Rollover Equity?
Rollover equity is when a business owner or founder reinvests a portion of their proceeds from a sale into the acquiring company, rather than cashing out entirely. It is common in mergers and acquisitions (M&A), especially in private equity (PE) transactions.
Instead of receiving 100% cash at closing, the seller retains an equity stake in the new or surviving entity. This aligns their interests with the new owners and allows them to participate in future upside.
How Does Rollover Equity Work?
Negotiation: The buyer and seller agree on what percentage of the purchase price will be in cash versus equity. A good banker can help assist in this negotiation to maximize or minimize the rollover amount.
Transaction Closing: The seller receives a combination of cash and shares in the acquiring or newly formed entity.
Ownership Stake: The seller maintains partial ownership, typically in a minority position.
Exit Strategy: The seller’s equity position remains until a future liquidity event (e.g., the company is sold again, goes public, or reaches another planned exit).
Advantages and Disadvantages for a FOUNDER
Advantages:
Potential for Future Gains (“Second Bite of the Apple”) – The founder retains a stake in the business and benefits from future growth or a second exit at a higher valuation. PEAK has had numerous clients receive a larger payout upon the second liquidity event, despite having significantly less ownership.
Alignment with Buyer – Shows confidence in the new owners and may result in better deal terms or a higher valuation.
Tax Deferral – Typically, the equity portion is not taxed immediately—allowing for tax-efficient wealth accumulation.
Disadvantages:
Reduced Liquidity – Instead of taking full cash up front, some value remains tied up in the business.
Loss of Control – The founder transitions from an owner-operator to a minority shareholder with limited say in decision-making.
Risk of Underperformance – If the new management underperforms, the rolled-over equity could lose value.
Advantages and Disadvantages for an ACQUIRER
Advantages
Founder Retention & Incentive – Keeps the founder engaged in growing the business post-sale—reducing operational risks.
Lower Upfront Cash Requirement – The acquirer doesn’t have to pay 100% in cash—reducing the need for external financing.
Better Valuation Alignment – The founder has skin in the game—ensuring they help drive performance.
Disadvantages:
Complicated Deal Structure – More negotiation is needed—especially on valuation, governance, and exit provisions.
Minority Shareholder Challenges – The founder’s expectations may conflict with the new owners—creating friction.
Future Buyout Obligations – The acquirer may need to buy out the founder’s equity at a later date, which could be costly.
Tax Treatment of Rollover Equity
Tax Deferral (1031-like Treatment): In most cases, the portion of equity that is rolled over is not taxed immediately. Instead, capital gains tax is deferred until the founder sells the equity in a future exit.
Step-Up in Basis: If structured properly, the seller’s new equity retains the original cost basis—reducing immediate tax liabilities.
Taxable Portion: Any cash received at closing is taxable as capital gains.
The specific tax treatment depends on deal structure, jurisdiction, and entity type (C-corp, S-corp, LLC). Consulting a tax advisor is recommended for optimizing tax efficiency. PEAK is not a tax specialist, but we always receive professional tax guidance when structuring deals.
Final Thoughts
Rollover equity is a strategic tool in M&A that balances risk and reward for both sellers and buyers. Founders should assess whether they believe in the company’s future growth and are comfortable with illiquidity, while acquirers should ensure alignment and smooth integration. The tax benefits make it attractive, but proper structuring is key. PEAK can assist in the negotiation to optimize the transition for a selling founder.