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How is rollover equity calculated when selling to private equity?

The percentage of proceeds a seller rolls is not the percentage of the new company it owns, and the difference is the leverage.

Julian R. Sterling · from Closing the Deal

Rollover equity is the part of the sale proceeds the seller reinvests in the buyer's new holding company, and the stake it buys is the amount rolled divided by the holding company's total equity, not the percentage of proceeds rolled. On an illustrative 100.0 million equity value, a founder who rolls 20 per cent, or 20.0 million, into a holdco funded with 60.0 million of new debt owns 31.25 per cent of the new company, not 20 per cent, and banks 80.0 million in cash at completion.

Worked in full in Closing the Deal by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

The headline in a sale to a private equity sponsor is the price for 100 per cent of the shares. What the seller actually receives is two things: cash on the day, and shares in a new, more leveraged company. The second part is where the arithmetic is usually skipped, because the percentage rolled sounds like the percentage owned. It is not, and the gap decides how much of the second bite the seller gets.

The assumptions

An illustrative sale to a sponsor, EUR million.

Input	Value
EBITDA	12.0
Purchase multiple	10.0x
Enterprise value	120.0
Existing net debt, repaid at completion	20.0
Equity value, the price for the shares	100.0
New acquisition debt raised by the sponsor	60.0
Transaction fees paid by the buyer	4.0
Share of proceeds the seller rolls	20%

Step 1: size the holding company's equity

The sponsor buys through a new holding company. Its uses are the enterprise value plus the fees; its sources are the new debt and the equity, which is the sponsor's cash plus the seller's rollover.

Sources and uses at completion, EUR million.

Uses	Amount	Sources	Amount
Purchase of shares	100.0	New debt	60.0
Repay existing net debt	20.0	Seller rollover	20.0
Fees	4.0	Sponsor cash equity	44.0
Total	124.0	Total	124.0

Total holdco equity is 124.0 less 60.0 of debt, or 64.0 million. The building of that table is worked in full in the sources and uses table for an LBO; here it only matters for its bottom line.

Step 2: the seller's stake

The seller rolls 100.0 × 20% = 20.0 million and takes 80.0 million in cash. The stake is 20.0 ÷ 64.0 = 31.25 per cent; the sponsor holds the other 68.75 per cent for its 44.0 million. The seller's percentage rises because the debt has replaced part of the equity: the same 20.0 million now buys a slice of a smaller equity cheque. Without the fees the holdco equity would be 60.0 and the stake 33.33 per cent, so the fees, which the equity funds pro rata, cost the seller about two points of ownership.

Step 3: what the rollover is worth at exit

Assume EBITDA grows to 18.0 million over five years, the exit is at the same 10.0x, and the debt is paid down to 35.0 million.

Exit in year 5, EUR million.

Line	Amount
Exit enterprise value, 18.0 × 10.0x	180.0
Less net debt at exit	−35.0
Exit equity	145.0
Seller, 31.25%	45.31
Sponsor, 68.75%	99.69

The 20.0 million rolled returns 45.31 million, 2.27x and an IRR of 17.8 per cent, the same multiple as the sponsor because both hold the same instrument. Cash at completion plus the second bite gives the seller 125.31 million in nominal terms, against 100.0 for selling everything on the day. Reading the stake as 20 per cent would value the rollover at 29.00 million and understate it by 16.31 million.

The leverage cuts both ways. If EBITDA ends at 11.0 million and net debt at 50.0 million, exit equity is 60.0 million and the seller's 31.25 per cent is worth 18.75 million: 0.94x on the 20.0 rolled. The rollover is a levered position in the business the seller has just sold.

What if: more rolled, or more debt

Rollover percentage, 60.0 of new debt, same exit.

Rolled	Amount	Cash at completion	Stake	Value at exit	Total to seller
10%	10.0	90.0	15.62%	22.66	112.66
20%	20.0	80.0	31.25%	45.31	125.31
30%	30.0	70.0	46.88%	67.97	137.97

At this leverage, a rollover above 32.0 million, 32 per cent of proceeds, would hand the seller a majority, which a sponsor buying control will not accept. That ceiling, not the seller's appetite, often sets the rollover range.

20.0 rolled, new debt varied; the extra debt is still outstanding at exit.

New debt	Holdco equity	Stake	Exit equity	Seller at exit	Multiple
40.0	84.0	23.81%	165.0	39.29	1.96x
50.0	74.0	27.03%	155.0	41.89	2.09x
60.0	64.0	31.25%	145.0	45.31	2.27x
70.0	54.0	37.04%	135.0	50.00	2.50x

The common mistakes

• Equating the percentage rolled with the percentage owned. They are equal only if the buyer uses no debt and pays no fees. In a leveraged deal the stake is always higher, and the exit value has to be calculated on it.
• Rolling into a different instrument. Sponsors often fund most of their cheque as preference shares or shareholder loans carrying a fixed return, with a thin layer of ordinary shares. If the seller rolls only into ordinaries, the 31.25 per cent sits behind the sponsor's compounding instrument and the simple pro rata split above no longer holds. The rollover must take the same strip as the sponsor, or the price of not doing so must be calculated.
• Forgetting the rollover in the price bridge. The rolled amount is consideration, paid in shares rather than cash. It comes off the cash at completion, alongside the escrows and deferred payments worked in how much cash a seller actually receives at completion.

Takeaway

Calculate the rollover stake as the amount rolled over the holding company's total equity, after the new debt and the fees. Here 20 per cent of proceeds buys 31.25 per cent of the company and is worth 45.31 million in the base case, 18.75 million in the downside. The price on the signature page is the starting point; the free workbooks for Closing the Deal take that price through every line to what is actually paid for the shares.

Questions readers ask

What percentage of proceeds do sellers usually roll over?

There is no fixed rate; it is negotiated and illustrative ranges vary by deal. The ceiling is set by control: with 64.0 million of holdco equity, any rollover above 32.0 million, or 32 per cent of a 100.0 million equity value, would give the seller more than half the company, which a sponsor buying control will not accept.

Why does the rollover stake exceed the percentage rolled?

Because the new holding company is funded partly with debt, so its equity is smaller than the equity value paid. Rolling 20.0 million into a holdco with 64.0 million of equity buys 31.25 per cent. With 70.0 million of new debt instead of 60.0, the same 20.0 million buys 37.04 per cent, and the position is more levered.

Is rollover equity riskier than the cash taken at completion?

Yes. It is a levered stake in the business just sold. In the base case 20.0 million rolled returns 45.31 million, 2.27x. If EBITDA falls to 11.0 million and net debt is still 50.0 million, the same stake is worth 18.75 million, 0.94x, while the 80.0 million cash taken at completion is unaffected.

Also on this site

• How do you build a sources and uses table for an LBO?List every use, then let equity balance it: 450.0 of EV plus 25.0 of fees and cash is 475.0; 275.0 of debt leaves an equity cheque of 200.0, not 175.0.
• How much cash does a seller actually receive at completion?Headline less earn-out, net debt, debt-like items, working capital, escrows, deferral and costs: a 110.0m deal pays 61.1m on the day, 55.5%.
• How much does a management incentive plan dilute a co-investor?A 10 per cent option pool at entry value takes 45.0 of a 750.0 exit, cutting 2.50x to 2.35x. As full-value shares it takes 75.0 and leaves 2.25x.
• How is a completion accounts price adjustment calculated?Price = EV + cash - debt - debt-like items + (NWC - peg), estimated at closing then trued up. 82.7 paid becomes 80.3, and the seller repays 2.4.
• Earn-out cliff vs straight line: what is each worth to the seller?On a €12.00m earn-out projected at target with €1.5m of volatility, a cliff is worth €6.00m, a straight line €8.79m and a line from zero €11.60m.
• Escrow vs W&I insurance: which costs the seller less?Price both in present value. A 15.0m escrow held 18 months costs the seller 1.43m in carry and claims; a W&I policy with the same limit costs 0.30m.

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