Equity Rollover vs Earnout-Is one better than the other?
July 13, 2024
by a searcher from Keller Graduate School of Management of DeVry University in Centennial, CO, USA
I am in the process of submitting an LOI for a company that has experienced tremendous growth in the current year and has contracts for future growth, far exceeding previous years revenues and earnings. The seller is willing to do a substantial equity rollover but I am wondering if an earnout might make more sense. Would love to get feedback from those that have used earnouts and equity rollovers in deals or any other creative strategy to handle this situation. Thanks so much in advance!
from University of Notre Dame in New York, NY, USA
1. Rollover Equity/ Partial Buyout – Will reduce the amount payable at closing and also will incentivizes the Seller to help retain the largest customer contracts because they'll still have "skin in the game" and will want to hold on to the business upside. Also allows you to have unlimited duration consulting agreements under the new SBA rules (see below for further explanation there).
2. Seller Note -In lieu of an earn-out, the seller can finance a portion of the purchase price in the form of a seller note. You can also structure this seller note in an “earn-out-esque” fashion whereby tranches of the note are forgivable if certain revenue thresholds aren’t hit post-closing.
3. Post-Close Consulting Agreement - Occasionally the Seller would be willing to take a reduced purchase price (or "move around the economics") if you offer a post-closing consulting agreement whereby the Seller would get paid out a commission for certain revenue milestones being hit. This isn't an earn-out since it's not part of the purchase price but can still be tied to performance under important customer contracts. It keeps the Seller engaged with economics tied to the retention of customer revenue. Note that if the Seller isn’t retaining equity in the deal the max length here can be 1 year; if you do a partial buyout (even if you only leave the Seller with 5% of equity) you have an unlimited duration. So in theory could structure the consulting agreement like a 5 year earnout and get better terms on your SBA loan since it technically wouldn’t be part of the purchase price. Hope this helps. Happy to chat through more (and take a look at the LOI if it would be helpful). Shoot me an email redacted or DM me.
from University of Michigan in Bay City, MI, USA
Accepting an equity roll means that you're getting a business partner in the deal, both the good aspects and the bad aspects. He or she will bring all of the experience and expertise accumulated, but that can also lead to friction if you want to make a change and he or she doesn't.
If you go that route, you need to focus a LOT of time on the operating agreement, making sure you've got clauses addressing operations, governance, triggering forced sales, valuation, etc.