Consider a family-owned distributor whose founder receives a $20 million offer from a private equity firm. The buyer plans to borrow $8 million to complete the acquisition. The distributor also owes $2 million on its existing bank loan. Which debt comes out of the founder’s sale proceeds? Under the proposed terms, the distributor’s $2 million loan will be repaid at closing. The buyer’s $8 million loan supplies part of the money needed to close. If the founder takes the full equity value in cash, the two loans appear on opposite sides of the closing statement, and the founder receives $18 million before fees and taxes.
That distinction matters in a leveraged buyout, or LBO, in which a buyer uses debt and equity to acquire a business and expects the business’s future cash flow to service the debt. The seller can receive cash for the entire ownership interest even when the buyer borrows a substantial part of the purchase price. The more consequential question arises if the lender approves less than the buyer expects. At that point, the owner may learn how much of the offer the buyer is prepared to fund with its own money.
Assume the $20 million offer values the distributor on a cash-free, debt-free basis. The company has no excess cash, owes $2 million to its bank, and will deliver the agreed level of working capital. That leaves $18 million of equity value for the founder. To isolate the effect of the payment terms, the illustration below excludes fees, taxes, escrows, and other closing adjustments.
Two buyers offer the same enterprise value. Under Offer A, the founder sells the entire interest for cash. Under Offer B, the founder reinvests $4 million of the proceeds in the business under its new ownership. This retained investment is commonly called rollover equity.
| Illustrative transaction terms | Offer A | Offer B |
|---|---|---|
| Enterprise value | $20 million | $20 million |
| Existing bank debt repaid at closing | ($2 million) | ($2 million) |
| Equity value attributable to the founder | $18 million | $18 million |
| Portion reinvested as rollover equity | $0 | $4 million |
| Cash paid to the founder at closing | $18 million | $14 million |
Both buyers plan to borrow $8 million. Under Offer A, the private equity firm contributes the other $12 million, providing enough to pay the founder $18 million and retire the $2 million bank loan. Under Offer B, the firm contributes $8 million of its own equity. Together with the acquisition loan, that provides $16 million in cash: $14 million for the founder and $2 million for the bank. The founder receives the remaining $4 million of consideration as equity, credited at that amount for purposes of the transaction.
When comparing actual bids, an owner can ask each buyer for an estimate of seller proceeds and a summary of how it expects to fund the purchase. The first shows how the stated price translates into cash, retained equity, and any deferred payments. The second shows how much of the cash depends on a lender or another investor. At this stage, the estimates should also identify assumptions that could change the calculation, including transaction expenses and working-capital adjustments.
The distributor’s annual earnings appear sufficient to support the proposed $8 million acquisition loan. Its monthly accounts tell a more complicated story. The company pays suppliers in February to build spring inventory, but many customers pay in May. During the intervening months, the distributor needs cash to meet payroll and place its next round of orders. After reviewing the size and timing of that seasonal requirement, the lender is willing to provide $6 million for the acquisition.
The private equity firm now has a $2 million gap to fill. Under Offer B, it could increase its own equity contribution from $8 million to $10 million and deliver the original terms. If the firm expects its investment to earn more than the debt costs, using more of its own capital would lower its projected percentage return. It may therefore ask for a price reduction, propose a seller note payable over time, or invite the founder to make a larger equity investment.
Suppose the founder agrees to cover the shortfall through additional rollover. The buyer can still describe the transaction as a $20 million deal, even though the founder’s cash at closing has fallen from $14 million to $12 million. The founder now has $6 million invested in the business after the sale. A seller note would produce a different result again: the founder would become a creditor for the deferred amount, with repayment depending on the note’s terms and the borrower’s ability to pay.
For a business with seasonal cash needs, monthly inventory balances, receivables collections, and borrowing history can help resolve this issue early. Those records give lenders a basis for sizing both the acquisition loan and the financing the company will need to operate. They also give the owner a chance to compare bids while several buyers are still at the table.
The best time to ask how a buyer would cover a financing shortfall is before granting exclusivity under a letter of intent. Once the owner pauses discussions with other bidders, a request for more rollover or a seller note carries a different weight. Rejecting it may mean reopening the sale process. An owner weighing two similarly priced bids can learn a great deal from three questions.
For the distributor’s founder, the question can be put plainly: If your lender approves $6 million, will your firm contribute the additional $2 million and close on the terms you offered? A buyer that has considered the question can explain who will make that decision and what approvals it already has.
Under Offer B, the founder is also making an investment decision. Before accepting $4 million in rollover equity, the founder should know which entity will issue the shares. An interest in the distributor gives the founder exposure to a familiar business. An interest in a parent company that owns several distributors introduces the earnings, debt, and capital needs of the other operations as well. A founder who understands the business being sold may still have diligence to do on the business being acquired through the rollover.
The next question is how a future sale would divide the proceeds. Debt repayment may increase the value available to shareholders, but different equity classes can have different claims on that value. If the sponsor is entitled to recover its investment or receive a preferred return first, the founder’s ownership percentage tells only part of the story. Ask the buyer to illustrate what the founder would receive at several exit values after repayment of debt and application of those preferences. A modest exit can reveal a difference between the two investors’ rights that an optimistic forecast obscures.
If the founder will remain an executive, the buyer should distinguish the equity received for reinvesting sale proceeds from any incentive equity earned through continued employment. The two may carry different vesting or repurchase terms. An owner considering retirement in three years, for example, has reason to ask what happens to each interest on that date, who can require a repurchase, and how the price would be determined.
The founder may welcome the opportunity to invest $6 million alongside the buyer. But a willingness to invest $4 million at the outset says little about whether the additional $2 million is attractive on the same terms. Before agreeing to the change, the founder can ask a question that stands apart from the sale: Knowing what I now know about the lender’s decision and my rights as a shareholder, would I choose to invest another $2 million in this business? The answer is more informative than a second look at the $20 million headline.
The buyer’s new loan helps fund the purchase. Existing company debt can reduce the equity value payable to you if the offer is stated on a cash-free, debt-free basis. Ask for a proceeds estimate that identifies which obligations will be settled at closing and how much cash you will receive.
A buyer may request a price reduction or revised payment terms. Whether it can decline to close depends on the stage of the transaction and the agreements in place. Before exclusivity, ask whether the buyer would fund a shortfall with additional equity. When negotiating the definitive agreement, review the financing provisions and closing conditions with transaction counsel.
Yes. A buyer can combine borrowed funds with its own equity and pay the seller entirely in cash. In Offer A above, the founder receives the full $18 million of equity value in cash even though the buyer borrows $8 million. A rollover or seller note is a separate term for the parties to negotiate.
Versailles Group advises private company owners on sell-side M&A transactions, including the evaluation of buyer financing and the comparison of cash proceeds, deferred payments, and rollover equity.