Most people sell their business once to a buyer. But only the cool business owners sell a business twice to the same buyer.😎
Commonly referred to as ‘rolling-over equity’ in a transaction, selling a business twice to the same buyer allows a business owner to retain ownership of their business after the sale. Meaning, that they sell some percentage of their business today at an agreed valuation and the remaining percentage later at a higher valuation.
You may be wondering - why would I do that? The reason I want to sell my business is because I’m [stressed/tired/burn-out] from my business. Well, if any of those adjectives describes you, then you’re probably not a good fit for this strategy.
So who is this strategy for? We find it works best with business owners who:
- Are not burnt-out from daily operations
- See a path to growing their business, but have limited resources
- Want to exit their business in the next 3-5 years
- Would like some liquidity (cash) to meet short-term cash needs
If this is such a great strategy, why doesn’t every business owner do it 3-5 years before they want to retire? Well, not every owner is qualified for this type of transaction, plus there are a few cons worth understanding.
In this article, we’ll cover what you need to do to position your business to become eligible for this strategy and whether it’s the right path for you.
Understanding Equity Rollover
At its core, an equity rollover occurs when a business owner sells their company but reinvests a portion of the proceeds back into the business, alongside the new owner. This transition creates a scenario where the seller retains a stake in the company, aligning their interests with the new owner's success. This strategy is practically mandated in deals with private equity firms (think $5M+ transactions), as the continuity of the seller's involvement can add significant value to the business post-acquisition. While almost a requirement for big deals - it’s not common. But what's in it for the seller?
Pros of Rolling Over Equity
- Aligned Interests: One of the most compelling advantages of an equity rollover is the alignment of interests it creates between the seller and the buyer. By retaining a stake in the business, the seller remains invested in its success, often facilitating a smoother transition and ongoing growth.
- Reduced Capital Gains Taxes: Sellers can potentially* benefit from deferred capital gains taxes on the portion of equity rolled over. This deferral can result in significant tax savings, especially for large transactions, providing a more tax-efficient outcome for the seller.
- Opportunity for a Second Bite of the Apple: Sellers who believe in the future growth of their business often view equity rollovers as an opportunity for a "second bite of the apple." If the business grows under the new ownership, the value of the retained equity could increase, offering the seller a chance to reap additional financial rewards in the future.
- Risk Mitigation: For buyers, having the seller retain a stake can mitigate risk. The seller's continued involvement can ensure the retention of critical knowledge, relationships, and operational expertise, contributing to the business's ongoing stability and growth.
*Before implementing any tax strategy, please confirm your eligibility with a qualified tax professional. We’re just people writing articles on the internet (i.e. we are not qualified tax advice-givers).
Cons of Rolling Over Equity
- Reduced Immediate Liquidity: Sellers opting for an equity rollover forego a portion of immediate liquidity they would have received from a full sale. This can be a significant drawback for those relying on the sale proceeds for retirement or other investments.
- Potential for Conflict: While aligned interests are a benefit, they can also lead to potential conflicts, especially if the new owners and the rollover equity holders have differing visions for the company's future direction.
- Market Risks: The retained equity is subject to market and business performance risks. Should the business falter under new ownership, the value of the rolled-over equity could diminish, impacting the seller's financial return when they sell their remaining ownership stake.
- Complexity in Agreements: Equity rollover transactions often involve complex legal and financial arrangements, requiring meticulous negotiation and documentation. This complexity can lead to increased transaction costs and prolonged deal timelines.
Making Your Business Roll-Over Eligible
From a broker’s perspective, a rollover equity deal makes a lot of sense because we have a lot of conversations with buyers.
The following are recurring issues whenever we try and sell a small businesses without a strong management team:
- Transition + Training: Buyers always want the owner involved in transition post-sale anyways - usually in the form of full-time training for up to 3 months after closing the deal. Sellers hate this because they don’t get paid for this training.
- Owner Dependency: The biggest issue with selling small businesses is the dependency on the owner’s involvement - it makes a lot of businesses unsaleable (too hard to find a replacement). In a roll-over equity transaction, the buyer doesn’t need to worry about this because the owner is staying involved. Together, the buyer and seller can build out a multi-year recruitment strategy to hire a new General Manager or CEO.
While these seem like 2 small things, they’re often enough to kill a deal. The beauty of roll-over equity is that these issues are addressed - making it easier for transactions to close. The only problem? A lot of owners write this strategy off before even getting started.
Self-Sabotage: How Sellers Make Their Business Ineligible
While the benefits to brokers are obvious, we find many owners make themselves ineligible for this strategy because:
- They feel they don’t have the gas to operate the business for 3+ years ⛽
- They have never had a business partner and are scared about partnering now 😨
- They are too focused on today's valuation, not the future valuation 🔮
Self-Help: How Sellers Implement This Strategy To Their Advantage
To address the above and make your business eligible you need to:
- Start the process ASAP. It is important to start the sale process up to 2-5 years before you actually want to retire (or move on to new projects). It is also important to remember that by finding a new business partner - you may be able to delegate the parts of your business you hate. For example, hate managing your bookkeeping and accounting? Well, many strategic buyers already have centralized accounting systems and could take this off your plate. This is a great segue to point #2!
- Remember you pick your partner for this strategy. By working with a business broker, they can help you run a sale process, interview possible buyers, and help determine who is the best fit for your business. This also makes it important to not pick a partner with the wrong vision for the future. For example, partnering with a private equity firm that wants to fire 20% of your staff, increase profit margins as much as possible, and then sell the business in 2 years (flipping your business like a house). Instead, select a partner that shares your vision for the future - as it will ultimately maximize your future pay-day. This is another great segue to point #3 (man, we’re on a roll).
- You don’t want to sell for less than what your business is worth, however, this strategy works best when you sell at a good price today for a great price in the future. Going back to #2 - you need to believe that the resources your new partner will provide (client referrals, more money for investment, etc.) will help you reach a business size that would not have been possible on your own. This also means you will be able to sell your remaining stake for more than what you could have achieved on your own.
Wrapping Up
We’ll be honest - this strategy isn’t for everyone. But for those of you who are interested - it can lead to great outcomes for both buyers and sellers. That said, you should approach this strategy by completing your own research:
- Talk to your accountant + lawyer to ensure you are corporately eligible for this strategy (from a tax and legal perspective).
- Interview business brokers (ask us for a recommendation to a qualified broker in your area) to see if they have completed a transaction with roll-over equity in the past + their relationship with buyers who may be interested in your business.
- Answer the following questions:
- How much money (after tax) do I need to retire or start my next project?
- How much longer do I see myself operating this business?
- What roles & responsibilities that I currently have do I want to eliminate and take off my desk?
Completing the above will give you a lot more confidence and clarity on whether a roll-over equity strategy is the right path for you.
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