What is “Management Rollover”?
A management rollover, or a “management roll” as it is sometimes referred to, is the amount of equity the managers of a target acquisition invest from the buyout into the new company which is now controlled by the financial sponsor. While this is negotiable, it is almost always required that the new managers staying on with the new company invest some of their buyout funds alongside the equity capital of sponsor in order to keep the interests of both parties aligned.
Key Learning Points
- In many cases, financial sponsors will require the managers of the target company to invest capital earned in the buyout into the new company as a way of aligning interests
- Managers can receive favorable tax treatment by postponing the capital gains on the buyout
- The amount of the investment is negotiable, but sponsors and managers will often use this as a way to bridge a valuation gap between the two parties on the buyout
- Typically rollover equity is pari passu with the ordinary equity owned by the sponsor; however, it is very common for this equity to be subordinated to a class of preferred stock owned by the sponsor
- Management’s equity stake in the deal can increase over time due to incentive compensation plans (previous stock options can also be rolled forward into the new company)
Determining the Stake
The typical rollover transaction involves participants receiving between 8% and 40% of their deal consideration in equity rather than cash. Much of this will depend on the size of the company being acquired. The average historically has ranged around 20%. The amount of resulting ownership in the new company will depend greatly on the size of the deal. A large majority of equity rollover transactions are structured to allow for participants to roll over their equity on a tax-deferred basis.
In the negotiations to purchase the target equity, management has an incentive to seek the highest possible price while sponsors want the lowest. Occasionally, this gap can be bridged by offering a slightly higher price but requiring a larger percentage of management roll.
The equity acquired by management can come in several different forms. Managers can continue to own shares of the target (now ‘newco’) or it can own shares in the holding company that holds the shares of the target and/or shares of other portfolio companies. These arrangements which only have value on sale are considered much more favorably by sponsors than earnouts, which will incentivize management over time for hitting performance targets over time.
At the next liquidity event (sale to another company or sponsor), management will often be asked again to continue to “have skin in the game” by rolling forward equity. Sponsors view this continued re-investment as critical to closing deals where management continuity is important.
Sponsors and buyout targets will spend a good deal of time with each other prior to consummating a deal. This due diligence is critical to work out the potential conflict between management and the majority owner sponsors. Management will often receive additional incentive compensation in the form of stock options, profits interest, or sweat equity arrangements, which depend on longer timeframes for management to hit pre-defined earnings and valuation targets. Sponsors are driven by achieving the highest price for an asset regardless of when that sale might happen and whether management has maximized its value.
Senior management is not often included in the planning and decision-making of the sponsors regarding the company. This can create conflict between the two groups. Generally, none of the equity owners have a put right or other voluntary exit opportunity until the resale of the portfolio company occurs several years later.
With management rollover, the management of a target company trades part of their controlling stake in a business for a non-controlling stake in a sponsor’s business. With like-minded groups, the potential for upside is increased as management and sponsors are both now clearly motivated to drive value for a future sale. Management will also receive tax-deferred status for not cashing out its shares in the target and can be expected to roll forward again if the previous deal was a success.