The rollover: what is it and how does it work?

When a company is acquired, the selling shareholder’s involvement usually ends on the closing date. In principle, the shares are transferred and the purchase price is paid, after which the parties go their separate ways. However, it also happens that selling shareholders and/or management choose not to cash in part of their stake, but to reinvest it in the new structure. This mechanism is called a rollover (also known as a share swap); instead of receiving (exclusively) cash, they receive shares in the buyer or the new holding company. In other words: you sell your company, but become a partial co-owner of the buyer or the new company.

The rollover occurs in a variety of contexts: scale-up exits, management buy-outs and buy-ins, private equity takeovers, strategic acquisitions of start-ups and growth companies raising fresh capital. It may sound like a simple administrative step. Legally, it is not. In this article, I will explore the rollover in more detail: why you might consider it, what forms it takes, and key considerations.

Why a rollover?

A rollover is chosen for a variety of reasons. The buyer wants the seller or management to retain a ‘skin in the game’. This ensures that the seller retains a financial interest after the sale. That continued involvement reduces integration risk, particularly in management buy-outs and management buy-ins where continuity of the existing management is essential. The seller wishes to share in future value creation, even after the formal sale. In the event of a successful subsequent exit, that second payment may exceed the first in size.

In some cases, the rollover makes the transaction possible in the first place: the buyer lacks sufficient liquid funds to acquire the entire stake. The rollover also regularly serves as a negotiating tool in the event of valuation differences: if the parties cannot agree on the price, a higher rollover percentage bridges the gap by allowing the seller to share in the upside they themselves foresee.

Whatever the motivation: as soon as a shareholder exchanges his shares for shares in another company, he enters legal territory that raises different and more complex questions than a standard sale.

Structure of the rollover

There are several ways to effect a rollover. The most obvious way is for the seller to receive a shareholding in the acquiring company. In this way, the shareholders of the buyer and the seller become co-shareholders of the acquiring company.

The buyer may issue new shares, or the existing shareholders may transfer a portion of the existing share capital to the seller.

Another common method is for the buyer to acquire the target company through a newly established company (a special purpose vehicle).

In that case, the seller may also acquire a (minority) interest in this new company (often referred to as NewCo).

Points to consider

There are a number of important matters that must be carefully considered in a rollover. These include the points listed below.

Valuation

Valuation is central to every rollover: at what value are the shares to be exchanged valued, and at what value are the new shares issued? In this regard, the due diligence review (on both sides) is of particular importance. This allows an assessment to be made of the value of both companies and, consequently, how the share swap should be structured financially.

Governance

It is customary for a shareholders’ agreement to be entered into between the shareholders. This shareholders’ agreement includes, amongst other things, the arrangements between the shareholders and the board. A list of approval resolutions is also often included to ensure that the new shareholder has sufficient control. However, common omissions include: it is not clearly specified whether follow-on financing, material investments or a change to the share structure require the consent of the rollover shareholder. The consequence is that the majority shareholder can take decisions that structurally dilute or affect the value of the rollover interest, without the new shareholder being able to formally object.

Practical experience

We regularly assist clients in scenarios of this kind. Most recently, we assisted a client who sold 100% of the shares in the company but acquired a stake in the acquiring entity. Furthermore, the acquiring entity was not a company established in the Netherlands. In this case, we negotiated extensively on governance to safeguard our client’s control as a new shareholder as effectively as possible.

Conclusion

A rollover is not a minor matter in a takeover. It is a legal arrangement that requires precise structuring, involves specific company law formalities and entails significant contractual risks that only become apparent upon departure, a subsequent transaction or a dispute over value.

When executed properly, the rollover is a powerful tool for aligning the interests of buyer and seller: the seller is given the opportunity for a second, often larger payment, whilst the buyer achieves continuity, commitment and a lower investment. If poorly executed, disputes only arise years later, at a point when rectification is practically impossible. The difference often lies in the details of the purchase agreement and the shareholders’ agreement.

Questions?

Do you have any questions regarding this article? Please contact one of our solicitors via email, by telephone or fill in the contact form for a no-obligation initial consultation. We’d be happy to help!