Seller Equity Rollover: Enterprise Value or Equity Value %?
March 25, 2025
by a searcher in Montreal, QC, Canada
Assuming you buy a company for $10M with the following structure:
- 70% debt ($7M)
- 20% seller rollover ($2M)
- 10% sponsor equity ($1M)
In this example, what would be the equity ownership of the seller in the company post-close?
Option 1
- The seller will own 67% of the equity post-close ($2M / ($1M + $2m))
- The 20% rollover is only applied to the Equity Value and not the full Enterprise Value
Option 2
- The seller rolled over 20% of the enterprise value and will also own 20% of the equity value while you own 80% post-close
- You will finance only 80% of the enterprise value - making it a lot easier to take on debt (i.e., buying 80% of the business, but using 100% of the EBITDA to repay your debt)
- The seller's 20% equity ownership will be set at a minimum value of $2M in the negotiations, and will likely need a structure where you buy him out in 3-7 years at a fixed price (i.e., he'll have a put option, or you'll have a call)
What's the correct way to model the seller's rollover in a transaction?
Do sellers that rollover a % of the purchase price (EV) end up owning that same % of the equity? Or does that % need to be adjusted to reflect the pro-rate equity ownership once we lever up the company?
Been getting different opinions on this.
from Harvard University in Calgary, AB, Canada
Another way to see this is to consider the case where the seller simply takes on the debt themselves. Then they could pay themselves the $7M and be left with a levered company. If they are then willing to sell you 80% of the levered equity for $1M, again that implies an equity value of $1.25M and an EV of $8.25M.
Watch out with language too- in option 2 "the Seller rolled over 20% of the enterprise value" is not a true statement. They actually rolled 3% of the EV ($250k/$8.25M).
This all changes if they're getting some sort of instrument with a face value of $2M. "The seller's 20% equity ownership will be set at a minimum value of $2M in the negotiations" In that case, option 2 would be consistent with an EV of $10M. If seller and sponsor both get preferred equity, then you can set up the common equity split however you want so common could be 80/20 even though the preferred equity split is 33/67.
Taxes, fees, and guarantees all alter the math, but not in significant ways if the values are small.
from The University of Chicago in Chicago, IL, USA
You cannot "OWN" a % of EV. One may have the economic rights to a % of EV, but the concept of "owning" a % of EV does not exist. Equity is a tangible asset, % of EV is not.
There might be a way to structure option #2, such that the seller contributes $x and owns Y% of common (X can be $1 and the sponsor contributes $100 million. Y can be any number, say###-###-#### %), and seller has liquidation preference for $2 M. However, make sure this is clear. I have received many calls over the years, where the buyer and/or broker crying b/c seller's advisors (mostly attorneys) found out, or finally understood, about the capital stack at closing table and the deals fell apart. So, if Searcher wants to pursue this route, make sure seller and his/her advisors fully understand this.
A cleaner way to achieve above is as follows. P= $10 M, Cash at closing =$8 M (= $7 M debt + Sponsor $1 M), Seller Note = $1,75 M w/ very low interest, Seller rolls over $250 k for 20% of common (= 250/(1000+250)).
We just did a deal recently. P = $11 M, Seller rolled over $1 M for ~16% equity on a pari-passu basis (Option #1)