Rollover equity is priced by the buyer, not by a market

Rollover equity has no market price. The buyer sets the value, the class, and the exit terms, and the buyer controls the company that has to perform. Rolled dollars are purchase price you never receive in cash, exchanged for paper you cannot sell. Price it in the letter of intent, before leverage and preferred returns are fixed.

What is rollover equity, and what do you actually receive?

Rollover equity is the slice of purchase price you agree not to take in cash, taken instead as an interest in the buyer’s acquisition vehicle. You become a minority holder in a newly leveraged company, governed by documents the buyer drafts, with no market in which to sell the paper.

• You are not keeping your old equity. It is bought, and you subscribe for new paper in a holding company the buyer forms.
• That company carries acquisition debt it did not carry when you owned it. Your dollars sit behind the lender.
• You cannot sell the paper. Liquidity comes when the buyer sells, or when a negotiated put can be exercised and paid.

At what value do the rolled units go in?

Rolled units are typically priced at the same enterprise value the buyer is paying for the whole company. At that price you are repurchasing a piece of your own business at full retail, with no discount for lack of control or marketability, into a structure that now has debt in front of it.

Fix two things in writing before the letter of intent is signed. First, state the rollover as a dollar amount and as a percentage of post-closing equity, never as a percentage of enterprise value. On a twenty million dollar enterprise value funded half with debt, a three million dollar rollover is fifteen percent of enterprise value but thirty percent of the equity. Buyers quote the first and document the second.

Second, your units should carry the same price per unit the buyer’s own money pays. If the buyer’s dollars buy in cheaper, or buy a different unit, you are not rolling alongside the buyer. You are subsidizing them. No independent market tests that price, so your only leverage on it is the leverage you hold before exclusivity.

What class of security is the rollover — the same paper as the buyer, or common behind a preferred?

Class of security decides how much of the next sale you see. In one structure you take the identical units the buyer’s own capital takes, pro rata across every class. In the other you take common, behind a preferred that accrues a return and is paid in full first.

Which one you are offered depends on who is buying. An individual buyer, or a buyer using SBA financing, usually has one class of units and no preferred. The preferred appears when the buyer is a fund or an independent sponsor raising outside money, because that is what the money was promised.

A preferred has three moving parts: the rate, whether it compounds, and whether it participates, meaning it takes the accrued amount and then shares the common upside too. Participating plus compounding is a large head start.

I read the distribution waterfall and the accrual terms in the operating agreement before I read the price section of the purchase agreement.

How much of the second bite can a preferred return consume?

A preferred return can consume most of the second bite in a flat case and all of it in a down case. That is arithmetic, not bad faith: accrued preferred grows every year whether or not the business does, and it is paid before common. Modeling the exit under flat and down cases shows it.

The table illustrates, it does not forecast. Assume that structure, a five year hold, and debt paid to six million at exit. In the strip case you hold thirty percent of every class. In the common case the buyer’s seven million is a preferred accruing eight percent compounded, participating in seventy percent of the common.

Read the last column again. A forty percent rise in enterprise value returns about three and a half million on three million rolled, near three percent a year before tax. Flat returns a third of it. A twenty percent decline returns nothing. Rerun it on the buyer’s numbers, a turn lower.

A rollover priced at the buyer’s multiple and placed behind the buyer’s preferred is not a second bite. It is a second bet, at odds the buyer wrote.

What governance and liquidity terms should the rollover documents contain?

Governance and liquidity for a minority rollover holder come almost entirely from the operating agreement or stockholders agreement. Statutory defaults are thin and can be narrowed by contract. Information rights, tag-along, drag-along limits, transfer restrictions and any put must be written in, because courts read these documents as written.

• Information rights. Quarterly and annual statements, and K-1s by a date certain. Monthly reporting is realistic only where the company already produces it. No K-1 deadline means filing extensions every year.
• Tax distributions. In an LLC taxed as a partnership, income is allocated to you whether or not cash is. Require a mandatory tax distribution ahead of discretionary ones, and confirm the credit agreement allows it.
• Board or observer rights. A board seat for a minority holder is uncommon at this deal size. An observer right, a quarterly meeting, and consent rights over related-party transactions are realistic.
• Tag-along. Same proportion, same class, same price per unit, whenever the buyer sells. Ask for partial sales too; expect resistance.
• Drag-along. Define the trigger, the notice, and what you can be forced to sign. Cap indemnity exposure; refuse covenants added at exit.
• Put and call. A put is a negotiated term, not a feature. The formula matters more than the right: metric, multiple, net debt, who appraises, what discount applies on a call. And a put the senior lender’s credit agreement blocks is not liquidity. It is a letter.

The statutory floor sits low: Delaware’s default information right for an LLC member can be restricted by the agreement, fiduciary duties can be eliminated outright, and only the implied covenant of good faith and fair dealing survives to fill gaps. Drag-along language is read literally. Delaware has enforced an advance waiver of appraisal rights in a stockholders agreement signed by sophisticated, counseled holders, in a merger whose waterfall left the common almost nothing. It has also refused to give a drag effect where the party invoking it skipped the contract’s procedure. The words govern, and procedure is part of them. Both are corporate cases, and an LLC has no default appraisal right at all; appraisal there exists only where the agreement creates it.

Law: Manti Holdings, LLC v. Authentix Acquisition Co. (Del. 2021); Halpin v. Riverstone National, Inc. (Del. Ch. 2015); 8 Del. C. 262; 6 Del. C. 18-210, 18-305, 18-1101(c).

How is rollover equity taxed, and can the gain be deferred?

Rollover is commonly structured so the rolled portion is not taxed at closing, while the cash portion is taxed in the year received. Deferral is a structuring outcome, not a default. The route depends on whether the vehicle is a corporation or an LLC treated as a partnership. This states the federal position as of September 2026.

Law: 26 U.S.C. 351, 368(c), 721, 707(a)(2)(B), 368(a)(1)(F); Treas. Reg. 1.351-1, 1.707-3, 1.707-4; Rev. Rul. 2008-18.

Under either route, cash taken at closing is taxable in the year received. A disguised sale means the law treats a contribution plus a cash distribution as what it economically is: a sale. That presumption is rebuttable only on facts clearly establishing otherwise, and a rollover closing is the pattern, on the same day. If you own an S corporation, the entity step comes first: the usual path is an F reorganization before closing, with its own election deadlines, so you can roll without losing the S election.

If your shares may be qualified small business stock, raise it before you agree to roll. Replacement stock received in a Section 351 exchange or a Section 368 reorganization can keep the original acquisition date, but the exclusion is capped at the gain that would have been recognized at the exchange. Later appreciation does not ride along unless the new issuer independently qualifies, and a leveraged holding company frequently will not. The One Big Beautiful Bill Act, enacted July 4, 2025, also rewrote Section 1202: for stock acquired after that date the exclusion is tiered at fifty, seventy five and one hundred percent after three, four and five years, with a fifteen million dollar per issuer cap. Earlier stock stays under the prior rules. As of September 2026, confirm the figures and your state’s conformity.

Law: 26 U.S.C. 1202, 1202(h)(4); Pub. L. 119-21 (July 4, 2025).

Deferral is not the same thing as value.

Does SBA financing change what rolling equity costs you?

SBA financing changes the rollover analysis completely. Under SBA Standard Operating Procedure 50 10 8, effective June 1, 2025, a partial change of ownership must be a purchase of stock or membership interests, every buyer taking any interest becomes a co-borrower, and a seller who keeps any equity must guarantee the loan.

How long you carry it depends on how much you keep. Below twenty percent, the guaranty covers the full loan amount and runs for the later of two years after final disbursement or twelve consecutive months of the loan being current. At twenty percent or more you are an owner like any other: full unconditional guaranty under the ordinary rules, not capped at two years. Two years is the floor on the smallest stake, not the ceiling on your exposure.

Read that against what a sale is supposed to accomplish. You hand over control and stay liable for the buyer’s acquisition debt while someone else runs the business. Seller notes tightened too: to count toward the buyer’s equity injection, ten percent minimum on a change of ownership, the note must be on full standby for the loan’s entire term and cannot exceed half that injection.

As of September 2026, SOP 50 10 8 governs, with technical updates effective March 1, 2026. SBA published SOP 50 10 8.1 on August 14, 2026, effective for applications given an SBA loan number on or after October 1, 2026; it rewrites change of ownership into a new Appendix 15 that controls where the rest of the document conflicts. Ask the lender in writing which version applies and what it demands of a seller who rolls.

Authority: SBA SOP 50 10 8 (eff. June 1, 2025); SBA SOP 50 10 8.1 (published Aug. 14, 2026, eff. Oct. 1, 2026), Appendix 15; SBA Information Notice 5000-880695.

You cannot call it an exit while your signature is still on the buyer’s loan.

What do you negotiate in the letter of intent, and in what order?

Rollover terms are negotiated in the letter of intent or they are not negotiated at all. After exclusivity, the buyer holds the documents, the timeline and the financing, and rollover mechanics get papered as the buyer’s standard form. Three items belong in the letter of intent in writing: entry value, class of security, and exit mechanics.

• State the rollover as a dollar amount, as a percentage of post-closing equity, by named class.
• Require the same class at the same price per unit the buyer’s own capital pays. If the buyer refuses, make them describe the preferred: rate, compounding, participating or not.
• Name the governance terms now: information rights, K-1 delivery date, tax distributions, tag-along, drag-along limits, and any put formula.
• Ask in writing whether the credit agreement permits payment of a put and, on an SBA deal, what the lender requires of you personally.
• Model the after-tax cash you take home at closing and confirm it covers your obligations without the second bite.

I ask for the buyer’s sources and uses and their own model of the second bite, with the preferred accruing, before I ask what multiple they are paying.

Then size the roll to what you can afford to lose entirely. A rollover you could zero out without changing your retirement is an investment. A rollover you are counting on is an unsecured, unmarketable, subordinated bet on a company you no longer run. Price it while the buyer still needs your signature.