What does it mean?

Owners who sell to professional buyers ( often Private Equity firms) are often offered different deal structures than other sellers. The terms “rolling equity” and “second bite of the apple” may come up. Here’s what they mean.

PE firms buy companies typically with the intent to resell them in 3-5 years. These buyers have capital to invest but not always the expertise to run the company they’re acquiring. For this reason, they’d prefer to keep the owner involved in the business while they work to grow it.

The best way to do that is to ask the seller to roll some of their equity – profits from the sale – back into the business. The seller takes their share of the profits in cash, often rolling around 25% of the equity into the new company. They are retained as a minority owner and as a general manager to keep the company running smoothly and profitably for the next few years. 

Three to five years later, when the PE firm is ready to sell, the owner gets to take “the second bite of the apple,” getting 25% of the sale of a larger company. When it works, it works well for the seller and the investors.

Here are some issues an owner should think through carefully before agreeing to this kind of deal.

Make sure you understand who you’ll be going into business with. PE firms, by definition, have the cash to grow a business. The private equity firm can take on the back-office operations, so the owner can get back to the work he loves – selling, repairing, or spending his time on building and maintaining customer relationships. You may be able to draw a salary comparable to your owner benefit over the past few years, so you get the best of both worlds – being well compensated without the headaches of running the company.

You’ll also receive an infusion of capital to hire new employees, invest in equipment, and upgrade systems. If you’re a younger owner who would like to stay and see the business grow, this might be a good deal for you.

But it’s important to understand the people and the firm that will take over the business. You’ll be an employee of your former company, which isn’t a good fit for some owners. If the new management team is making decisions you don’t agree with, you won’t have much say in the matter.

You’ll be risking a significant portion of your retirement. If you’ve put your company up for sale, you probably were ready to leave the business. That won’t happen with a rolling equity deal; you’ll be tied in financially and be employed in the company for the next few years. It’s important to think through whether that’s what you want.

If you’re close to retirement age, you could be putting 25% or more of your nest egg at risk, and there is no guarantee that the PE firm’s growth projections will come through. The company could remain flat, or even contract, and your expected windfall of cash could disappear or be decreased.  You and your family should have a serious discussion about your tolerance for risk before you agree to this kind of deal.

On the other hand, your tax liability from the sale will also be reduced by 25%, which may be a consideration as you plan for the future. Your accountant and financial planner can help you think through whether this is an option that might benefit you in the short and long term.

I’ve written before that rolling equity deals are one way to extend your time in the company without the full burden of ownership. An experienced broker can help you understand all the implications of this kind of deal and avoid costly pitfalls and consequences you might not have thought through. 


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