Rollover Equity

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Rollover Equity

In this post, we'll be looking at rollover equity: what it is, and why it’s (as) exciting (as the law gets).

What is rollover equity?

In a traditional rollover, the buyer forms a new company to purchase all or substantially all of the assets of a target company. The seller then rolls a percentage of the target company’s equity into the new company via a tax deferred contribution, and receives equity in the new company in return.

At the closing, the seller owns a stake in the new company with tax deferred upside.

Why is this (as) exciting (as the law gets)?

Do you recall?

In The Purchase Price (Part 2), I wrote “[r]ollovers are more and more common in the SMB M&A space.”

This is true. But not 100% accurate.

Until very recently, a traditional rollover, like that described above, wasn’t permitted under SBA rules (SBA loans being the debt most searchers rely on).

Instead, the SBA allowed for partial changes of ownership. The buyer could purchase less than 100% of the equity in a target company, with the seller keeping a minority position post-close.

Everyone referred to this as a rollover. But in truth, it wasn’t. Not in the traditional sense of the word. It was retained equity.

And to be fair, even this was brand new.

Until 2023, an SBA loan could only be used for a complete change of ownership. No partial changes of ownership were allowed.

Well, the SBA has changed its rules again. As of December 2024:

Traditional rollover equity is now permitted.

Buyers are no longer restricted to retained equity offers.

This change is big!

As I’ve stated time and time again, buyers should aim to purchase assets over equity. From the buyer’s perspective, an asset deal is preferable from a liability and tax perspective.

Yet under the prior SBA rules, a partial change of ownership had to be structured as an equity sale. If the buyer (or the buyer’s lender) wanted the seller to retain equity post close, the buyer had no choice—she had to buy stock.

Now, the buyer can structure a deal as an asset deal and offer the seller rollover equity.

The buyer gets the benefits of an asset deal AND can have the seller remain involved in the business post-close.

At the time of writing, this is a very recent change. We’ll have to wait and see how quickly lenders incorporate this change into their practices. But in theory, the traditional rollover is a go.

What language should I include in my LOI?

If you want to include rollover equity in your purchase price offer, you could use the following language:

The purchase price for the Assets, which assumes a cash-free-debt-fee balance sheet at the Closing, will be $[______] (the “Purchase Price”), subject to adjustment, and payable as follows . . .

$[______], in the form of Seller’s equity contributed towards the equity ownership of Buyer[, on an equal footing (pari passu) with Buyer’s preferred equity investors]. Following the Closing, Seller’s ownership position in Buyer will be approximately [__]%.

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In my next post, we’ll address how to treat a stock sale like an asset sale for tax purposes.