The private equity landscape has fundamentally changed how middle-market business owners approach selling their companies. Since 2020, rollover equity usage has steadily increased in middle-market private equity deals. According to a study by a private markets data provider, usage in North American buyouts rose from 56.4% in 2021 to 67.5% in 2023, making it a critical component that every seller must understand.
Rollover equity isn't just a financial arrangement—it's a strategic tool that can dramatically impact your wealth creation and post-transaction experience. Whether you're considering your exit options or structuring your next acquisition, understanding equity rollover in M&A could mean the difference between a good deal and a transformational one.
What Is Rollover Equity and How Does It Work in a Transaction?
The Foundation of Rollover Equity in Private Equity Deals
When a business owner sells their company to a private equity (PE) firm, they're often asked to "roll over" a portion of their sale proceeds into the new company. This reinvested portion is known as rollover equity—a key part of how private equity buyers structure deals to align incentives and manage risk.
The concept is elegantly simple: Instead of walking away with 100% cash, the seller reinvests part of their proceeds to maintain partial ownership. This creates a partnership between buyer and seller that extends far beyond the closing table.
In practice, rollover equity serves as both a financial instrument and a psychological commitment. When a business owner agrees to roll equity, they're essentially saying, "I believe this company will be worth more in the future under new ownership than the cash I could receive today."
The Typical Structure and Process
In a typical private equity acquisition, the buyer and seller agree on a purchase price. Instead of the seller walking away with 100% cash, the PE firm may ask the seller to reinvest 20-40% of their proceeds as new equity in the post-acquisition entity. Rollover equity typically ranges from 20% to 40% of the seller's proceeds, with percentages sometimes reaching higher in transactions where the seller's ongoing involvement is significant.
This equity rollover allows the seller to maintain a partial ownership stake and benefit from a future exit—often referred to as the "second bite of the apple." The mechanics typically unfold in several stages:
- Deal Structuring Phase: The private equity firm determines the optimal capital structure, including debt financing, their equity contribution, and the desired rollover amount.
- Tax Optimization: The structure is designed to potentially qualify for tax-deferred treatment, allowing sellers to defer capital gains taxes until the future liquidity event.
- Documentation: The rollover terms are embedded in the purchase agreement, including governance rights and exit provisions.
Strategic Value Beyond Financial Mechanics
From the buyer's perspective, rollover equity is more than just a financial tool—it's a way to ensure the seller and potentially the management team remain invested in the company's long-term success. For the seller, it can be a way to retain equity value upside, especially if they believe the PE buyer will increase the company's valuation through growth, leverage, or operational improvements.
The strategic value multiplies when you consider the operational continuity. A seller who maintains an equity stake is more likely to share critical institutional knowledge, maintain key relationships, and stay committed to driving performance improvements.
This alignment creates a powerful dynamic where both parties benefit from the company's success. The seller receives partial liquidity while maintaining upside potential, and the buyer secures experienced leadership with "skin in the game."
Why Buyers Use Rollover Equity to Structure Private Equity Transactions
The Strategic Imperative for PE Buyers
For a PE buyer, rollover equity isn't just a preference—it's often a critical component of the deal structure. It aligns the interests of the seller and the investor, reduces upfront cash outlay, and can help drive stronger post-acquisition performance.
While global private equity deal value continued to see a decline in 2024, the market remains competitive. As of June 30, 2024, private equity firms were managing around $9 trillion in assets, with over $4 trillion of that being dry powder ready for deployment. Rollover equity provides a competitive advantage by reducing the capital required per transaction.
Capital Efficiency and Deal Economics
In most private equity transactions, the PE firm provides some of the capital, layers on leverage (debt financing), and uses the remaining price to buy out the existing equity holders. By asking the business owner to roll over equity, the buyer decreases the amount of capital they need to contribute and ensures that the seller has a continued financial stake in the company's success.
As a form of deal consideration, rollover equity does not require a PE investor to call capital from its limited partners or draw on leveraged financing, particularly important in a period of elevated borrowing costs.
Consider the capital mathematics: If a PE firm is acquiring a $50 million company with 60% debt financing, they would typically need $20 million in equity capital. With a 20% equity rollover ($10 million), their actual cash requirement drops to $10 million—effectively doubling their capital efficiency.
Risk Mitigation and Performance Alignment
From the buyer's perspective, this shared risk is crucial. A seller who retains an equity stake is more likely to be cooperative during the transition, provide valuable insight into operations, and stay engaged as part of the management team post-transaction. The equity rollover signals to the buyer that the seller believes in the company's future growth and valuation potential—otherwise, they'd just cash out entirely.
Alignment Through Shared Equity Ownership
In addition, private equity firms use rollover equity as a form of alignment. When the seller becomes a fellow equity holder, both parties are incentivized to drive performance, increase total equity value, and plan for a future exit event that benefits everyone involved.
According to PitchBook, the median holding period for private equity-backed portfolio companies in the U.S. reached a record 6.5 years in 2023. During this extended period, having aligned management becomes even more critical for value creation.
Seller's Guide to Rollover Equity: Pros, Cons, and Real Tradeoffs
Pros of Rollover Equity for Sellers
Second Bite of the Apple: The Wealth Multiplication Effect
Retaining an ownership stake allows you to participate in a future sale, often at a much higher equity value if the company performs well post-transaction.
Real-world example: Consider a business owner who sells their $20 million company and rolls over $5 million (25%) into the new entity. If the PE firm doubles the company's value over five years, that $5 million rollover becomes $10 million—generating an additional $5 million that wouldn't have existed with a rollover equity vs cash deal comparison.
Strategic Alignment and Continued Influence
By rolling over equity, you're signaling to the PE firm and other investors that you believe in the business's future—this can lead to better negotiation terms or continued involvement in the management team.
Tax Advantages and Wealth Preservation
Depending on the deal structure and jurisdiction, rollover equity may be eligible for deferred tax treatment under Section 351 or Section 721 of the Internal Revenue Code. This means you might delay paying capital gains taxes until the next liquidity event.
Arguably the most powerful factor driving the use of equity rollover is that it can often be structured to take advantage of certain tax-deferral mechanisms in the tax code.
Cons of Rollover Equity for Sellers
Reduced Cash at Closing
The more equity you roll over, the less cash you receive upfront—impacting your immediate financial flexibility.
This liquidity constraint can create practical challenges including debt obligations, diversification needs, and lifestyle changes that may need to be deferred.
Lack of Control and Loss of Influence
After the transaction, your influence on the company may shrink significantly, especially if the private equity firm installs a new management structure. This shift from majority owner to minority equity holder represents a fundamental change in decision-making authority.
Illiquidity and Risk Exposure
Your new equity may be tied up for several years. If the PE buyer underperforms or market conditions change, your reinvested stake could diminish—or be lost entirely.
How to Weigh the Tradeoffs
Your decision to roll over equity should reflect your goals, risk tolerance, and confidence in the buyer's plan. If you're nearing retirement and value certainty, maximizing sale proceeds and minimizing post-deal involvement might be preferable.
But if you're excited about continued growth, believe in the PE firm's strategy, and want a second equity stake opportunity, a rollover could significantly boost your long-term return.
Deal Terms That Shape How Rollover Equity Works for Sellers
Sources and Uses: The Foundation of Deal Structure
- Understanding the Capital Architecture: One of the first things to examine in any private equity transaction is the sources and uses table. This outlines how the purchase price will be funded (sources) and how the money will be allocated (uses).
- Rollover Equity as Both Source and Use: In deals involving an equity rollover, a portion of the seller's equity is listed as a "source" of funding—reducing the private equity buyer's need for outside capital and increasing seller alignment.
What Type of Equity Are You Rolling Into?
The Critical Distinction: Preferred vs Common Equity
Not all equity stakes are the same. When sellers roll over equity, they may receive:
- Common equity: Often last in line in the capital stack, but with the most upside if the company succeeds.
- Preferred equity: May come with downside protection, such as liquidation preferences or fixed returns, but less upside potential.
The preferred vs common equity decision significantly impacts your risk-return profile and should align with your investment objectives.
Understanding Waterfall Provisions and Rights
Understanding whether your new equity is subject to any waterfall provisions, vesting schedules, or drag-along rights is critical. These terms dictate how much control you have, how value is distributed, and what happens if the company is sold again.
Rollover Equity Tax Treatment and Mechanics
The way rollover equity is structured can significantly affect your tax situation. Almost all rollover structures depend on the two standby nonrecognition rules for obtaining equity in an entity: sections 351 and 721.
Section 351 Requirements:
- Transfer to a corporation in exchange for stock
- Transferors must control 80% or more after the exchange
Section 721 Requirements:
- Transfer to a partnership (including LLCs taxed as partnerships)
- No control requirement
- Generally broader application than Section 351
Post-Transaction Governance and Investor Rights
Pay close attention to your role after the deal closes. Will you have a board seat? Observer rights? Veto power on key decisions? These details influence how much say you'll have in the post-acquisition company—and how well your interests stay protected.
Three Ways to Negotiate a Smarter Rollover Equity Position in Your Sale
1. Know What's Negotiable
Some parts of an equity rollover are standard in private equity deals—but many are not. The percentage of equity you're asked to roll over, the type of new equity you receive, your ownership stake, and your rights as an equity holder can all be points when you negotiate rollover equity. Sellers should ask:
- What kind of equity am I rolling into—common or preferred?
- Will I have board representation or governance rights?
- What happens if the PE firm sells the business earlier than expected?
Buyers typically push for rollover equity to align incentives and reduce their cash outlay, but that doesn't mean every term is fixed.
2. Align Interests for Post-Acquisition Success
Alignment between buyer and seller is the core reason rollover equity exists. To make that alignment real, sellers should ensure:
- There's a shared understanding of the exit strategy (e.g., timeline, valuation goals)
- Clear expectations for involvement in the management team, if any
- Fair participation in any dividends or distributions pre-exit
If the private equity firm is expecting you to stay on and help drive performance, you should be rewarded as a true equity partner—not treated as a passive investor.
3. Bring in Experienced Advisors Early
These are complex negotiations with major long-term consequences. A transaction attorney, investment banker, and tax advisor who specialize in private equity can help you:
- Structure your equity rollover to maximize future liquidity
- Avoid common pitfalls in control provisions or tax language
- Benchmark your offer against market standards
How Kubera Can Help With M&A Transactions
For business owners navigating an M&A transaction, rollover equity can be a powerful wealth-building tool—offering the chance to retain equity in the business and benefit from the future performance of a new, private equity group's holding company. While deal volume has seen fluctuations, with a notable slowdown in 2023 followed by a rebound in early 2024, the opportunities remain significant, but so does the complexity.
The challenge extends far beyond the initial transaction. Managing rollover equity involves ongoing complexities: tracking illiquid investment values, understanding evolving capital structures, monitoring performance against benchmarks, and preparing for eventual exit events. Traditional wealth management tools often fall short when dealing with these unique characteristics—illiquidity, complex valuation methodologies, governance rights, and intricate tax considerations.
That's where specialized tools like Kubera become invaluable. With Kubera, you can monitor your private equity deals, visualize changes in your equity capital, and maintain a real-time view of your equity ownership—even as your stake sits in a minority equity position within a private equity firm's portfolio company.
Kubera's platform addresses the unique challenges of rollover equity management through sophisticated tracking capabilities. You can enter capital calls and distributions with precise dates, track your committed capital against unfunded commitments, and stay updated about upcoming cash flow events. The platform integrates rollover equity investments alongside traditional assets, providing a comprehensive view of your portfolio while organizing critical information for tax planning and exit preparation.
For rollover equity investors, Kubera's capital call and distribution scheduling feature is particularly valuable. You can manage schedules for unfunded capital commitments, receive heads-up notifications about upcoming liquidity needs, and seamlessly integrate these projections into your overall cash forecasting through the platform's Fast Forward feature—ensuring you're always prepared for the complex cash flow dynamics of private equity investments.
Sign up for a trial and explore Kubera today.
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The private equity market continues to evolve rapidly, with new structures and opportunities emerging regularly. Staying informed about these developments—and working with experienced advisors who understand the nuances—remains critical for successful outcomes in today's complex M&A environment.
