Key insights
- What's rollover equity? It's when sellers reinvest part of their ownership into the new entity, so they keep some equity instead of taking all cash. This is common when founders or management stay involved after the acquisition.
- Why it's good for everyone: Buyers get aligned incentives and capital efficiency, while sellers get a chance for future gains and possible tax benefits.
- Valuation challenges: Valuing rollover equity isn't straightforward. You need to consider equity class structures, distribution waterfalls, company performance, and expected liquidity timing.
Learn the benefits of rollover equity in your next deal.
Rollover equity is a beneficial way to align incentives between buyers and sellers while preserving capital and enabling long-term value creation.
As a cornerstone of private equity (PE) deal structuring, particularly in middle-market and founder-led transactions, rollover equity is common when purchasing a platform acquisition or completing add-on acquisitions.
What is rollover equity?
Rollover equity refers to the portion of a seller’s ownership interest that is reinvested into the acquiring or newly formed entity during a transaction. Instead of receiving full cash proceeds, the seller retains equity — either by contributing existing shares or receiving new equity units in the buyer’s structure.
This mechanism is especially common when founders or management teams remain involved post-acquisition.
What are the benefits of using rollover equity in private equity deals?
For buyers
- Incentive alignment — Keeps key management or founders motivated to drive performance post-close
- Capital efficiency — Reduces the buyer’s upfront cash requirement, allowing for more flexible capital deployment
For sellers
- Future upside — Offers the opportunity to participate in the future growth and potential exit of the business; allows the seller to get equity before a beneficial exit event is consummated by the private equity firm that purchased the seller’s business
- Tax deferral — Depending on the structure, may allow for deferral of capital gains taxes until a future liquidity event
How timing impacts equity value
Valuing rollover equity is complex and often misunderstood. A common — but flawed — approach is to base the value of rollover equity on the initial cash contributions made by the private equity sponsor.
This method assumes all equity units are economically identical, which is rarely the case — especially as time lapses between cash contribution, acquisitions, and if the company is materially over or underperforming since the initial cash contributions made by the private equity sponsor.
Key valuation considerations when using rollover equity
Equity class structure
Rollover participants may receive different classes of equity (e.g., Class B units) with distinct rights, preferences, and participation thresholds compared to the sponsor’s Class A units.
Waterfall and participation rights
The distribution waterfall, including preferred returns and catch-up provisions, can significantly affect the value of rollover equity.
Performance-based adjustments
The value of rollover equity should reflect the performance of the specific portfolio company, not just the aggregate enterprise value or sponsor’s capital structure. Subsequent cash contributions into the company by the private equity sponsor may help determine how rollover units should be valued.
Lack of ASC 805 valuation
In smaller acquisitions where an ASC 805 valuation is not performed — often due to the absence of intangible asset valuation (e.g., customer lists, non-competes) — the stated value in the purchase agreement may not reflect fair market value.
Time to liquidity
The expected holding period and exit strategy can influence the discount rate and valuation assumptions applied to the rollover equity.
The pitfall of using initial cash contributions
Using the sponsor’s initial or subsequent cash contribution as a proxy for rollover equity valuation can lead to significant mispricing. This approach ignores the specific risk profile, rights, and performance of the specific portfolio company. It also fails to account for changes in value between signing and closing, or between different tranches of equity.
Inaccurate valuation can result in disputes, tax complications, and misaligned expectations — particularly when the rollover equity is a substantial portion of the seller’s consideration.
How CLA can help with rollover equity deal structuring
CLA’s valuation professionals and transaction advisory teams bring deep experience in structuring and valuing equity instruments across a wide range of industries and deal sizes.
We help you by:
- Performing independent, third-party valuations of rollover equity to reflect the specific rights, preferences, and performance of the underlying business
- Reviewing operating agreements and capitalization tables to identify potential valuation pitfalls
- Structuring rollover equity to align with buyer and seller objectives
- Mitigating risk by confirming rollover equity is properly valued and documented before acquisition agreements are signed — reducing the likelihood of post-close disputes or regulatory scrutiny