The Corporate and Mergers & Acquisitions and Veterinary practice groups at Forchelli Deegan Terrana LLP would like to share this short overview regarding “rollover equity,” including when such equity is offered, what it is, and why it should be considered in connection with the sale of a business.

    Often times, when a business is purchased, not all of the consideration is cash.  In these types of transactions, the buyer will often pay a certain percentage of the purchase price in the form of “rollover equity”.

    Rollover equity is a form of consideration in which the seller reinvests a portion of its proceeds into equity ownership of a buyer.  Though, the rollover equity does not need to be equity in the buyer entity itself.  For example, the buyer may organize a separate company to issue rollover equity.

    The short answer is that a rollover helps to align the interests of sellers and buyers by incentivizing and motivating sellers to remain interested in the business’s continued growth.  It is important to note that most buyers want the “rollover holders” to continue their involvement in the business post-sale, and often also require the seller to sign an employment or consulting agreement for the post-closing period.

    The seller (and/or its principals) is effectively given “a second bite at the apple” because the value of the rollover equity can appreciate and, on a future re-sale of the business, may result in a significant return on investment.  However, it is important to understand that returns are not guaranteed – there is always a risk that the rollover equity loses value as economic factors change (i.e., change in market, success of the business, etc.).  Buyers are eager to allow sellers the opportunity to reinvest in the business so the buyer can pay less cash at the time of closing.

    Rollover equity is also attractive to sellers because rollover equity receives tax-deferred treatment. Of course, all cash received by the seller must be reported and taxed.  However, if there is a rollover, then the cash price is lowered and the rollover equity amount is only taxed upon a future exchange or transfer event (such as a future sale of the business or a buy-back of the equity), so there is no tax on the rollover equity at closing.  Generally, the tax gain on rollover equity is considered a capital gain and is taxed at lower tax rates.

    While this article does not address other considerations concerning rollover equity, including management, voting, preemptive rights, and buy-back rights, the attorneys at Forchelli Deegan Terrana LLP are well-versed in such matters and are happy to assist you in structuring your deal and explaining the terms of such deal.

    This article was co-authored by David J. Borkon and Jeremy M. Musella. If you have any questions about structuring your deal, please call 516.248.1700 or email David or Jeremy for more information.