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As the SMB acquisition landscape evolves, one trend making a significant impact is seller rollover equity. Facilitated by recent SBA guidelines, this strategy is redefining acquisition structures and offering new pathways for collaboration between buyers and sellers. What does this mean for your acquisition journey? Let's delve into the nuances of this trend, drawing from Dean Street Law’s extensive experience in closing transactions and guiding clients through complex negotiations.
The Rise of Seller Rollover Equity
Rollover equity has become one of the biggest trends in SMB acquisitions, driven by SBA’s flexible lending guidelines. Under the SBA's recent guidelines, lenders that provide SBA loans are permitted to provide those loans to someone who is buying the company where the seller will retain a certain amount of equity. While not explicitly required under the guidelines, the majority of lenders interpret this to mean that the structure of the acquisition has to be a stock or equity purchase so that the retained equity is retained stock or limited liability company interests in the business. In letters of intent, we have seen considerably more buyers pursuing stock purchases instead of asset purchases, or at least providing in their LOI that either may be pursued with the rollover equity. Our battle-tested LOI templates in the Acquisition Insights Course & Templates bundle include this option and its implications, including video tutorials on how to customize it. For the seller to not be required to provide a personal guarantee on the SBA loan, the rollover equity should be below the 20% threshold to avoid the personal guarantee.
Weighing the Benefits and Challenges
Even though seller rollover equity is a great new opportunity for both parties, the challenge is to find when is the right time to engage it in an acquisition. You have to ask yourself, "Would you go into business with this person in the first place?". If the answer is no, don't offer seller rollover equity. There are plenty of other ways to address fundraising or equity gaps, but going into business with someone is just as serious as getting married. You need to make decisions that would be the most beneficial for yourself and your company. It's difficult to manage bad situations unless the documents are clear on the rights of each party to navigate exiting the business where nobody loses money, and it's a beneficial, positive experience for both parties.
The Importance of Rollover Equity
As mentioned above, the most important thing when considering the rollover equity is first whether you should pursue seller rollover equity, and then if you would like to pursue it, how you structure the terms of owning that business with the sellers. Even with all the protections in the world, if it's not a positive business relationship, it's not worth the advantages it provides.
Now, let's get to those protections. It's imperative that a lawyer draft the amended and restated operating agreement, or amended and restated bylaws of the company to have a well-thought-out, comprehensive understanding between the parties of their business relationship. This will act as a prenuptial agreement for business essentially and not only cover the expectations, but also how things will shake out if the relationship goes south. Be sure it covers buy/sell provisions, distribution rights, voting rights, and what happens in the event of death, disability, divorce or disagreement.
Legal Insights for Navigating Rollover Equity
Lawyers will work with their clients and assist them with the rollover equity process, but some buyers will try to do it on their own beforehand and then need support in resolving disagreements that follow. This may create stalemates that make it difficult for the parties to move forward amicably. Clients often bring lawyers in at this point, but unless the operating agreement provides a clear way for the parties to disentangle themselves, it can be something that goes on for months or years with little to no resolution, costing the parties thousands or hundreds of thousands of dollars. Therefore, it's much easier, faster, and less expensive to do it right from the beginning and have a lawyer draft those documents to properly reflect the rollover equity and the terms for both parties.
Strategic Advice for Today’s Buyers
When done right, rollover equity can be a fantastic opportunity. It might not be the best move for every situation, but when done well it is a great alternative. It will give buyers and sellers the opportunity to work together post-closing and grow the business together in a productive manner. Rollover equity can be a great tool that buyers can use in acquiring a business that they're interested in and boost their opportunity for growth in value.
Seller rollover equity represents both a challenge and an opportunity in the SMB acquisition market. Understanding the trends and the nuances that lie therein will assist buyers and sellers in pursuing new possibilities for growth and partnership. At Dean Street Law, we're here to make sure that your acquisition strategy is built on a foundation of legal excellence and strategic foresight.
Thinking of leveraging seller rollover equity in your next acquisition? Let Dean Street Law be your guide. With our comprehensive "Acquisition Insights" course, group consulting services, and customized legal services, we provide the tools and support you need to navigate the complexities of modern acquisitions successfully. Contact us today to start your journey.