You won’t find any security labeled “rollover equity” on a cap table, yet rollover equity is quite common. Typically, rollover equity is the product of the following three things:
- a business is sold to an investment firm (e.g. private equity fund),
- senior management owns a significant amount of the equity, and
- senior management will be staying with the company post transaction.
Rollover equity is a portion of the transaction proceeds which is then required or elected to “rollover” into the business post transaction.
So, let’s say a CEO is entitled to $10 million of the sale proceeds and will be staying on with the business post transaction.
An investment firm may require the CEO to rollover (or reinvest) a portion of those proceeds in the business. Requiring this CEO to rollover 10% of his/her proceeds, means they receive $9 million from the sale of the business and would invest $1 million in the new company.
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So, why would an investment firm require a CEO to rollover their hard earned money?
The purpose of rollover equity is to ensure that management’s interests are aligned with the investment firm.
This is particularly important in privately held businesses when key management personnel receive their first major liquidity event.
After all, you don’t want your CEO to check out after receiving $10 million dollars. Your business, and thus your investment, will suffer.
In the end, rollover equity is exceptionally common and can benefit both management and the investment firm.
While you may not see the term “rollover equity” on a cap table, every business owner should be aware of the concept, especially those that might sell their business one day.