Business owners
Rollover Equity in a Private Equity Sale: How It Works and How It Is Taxed
Private equity buyers often want sellers to reinvest part of the price. We explain how rollover works, the tax deferral it can bring and the traps to watch for.
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Key takeaways
- 1Instead of taking all the price in cash, you accept part of it as shares, and sometimes loan notes, in the buyer's holding company.
- 2When you exchange shares in your company for shares in the buyer's group, the gain on that portion is usually deferred.
- 3If you will work for the group after the sale, the shares you receive can count as employment-related securities.
If a private equity house makes an offer for your company, expect a request that you reinvest some of the price. This is called rollover, and it is one of the most important parts of the deal for both your tax and your long-term return.
What rollover means
Instead of taking all the price in cash, you accept part of it as shares, and sometimes loan notes, in the buyer's holding company. Those shares move up and down with the value of the whole group until the fund sells, usually some years later.
On a buy-and-build platform, the group grows by buying other businesses, so your stake is in the entire platform and not just the company you used to own.
Tax on the rolled-over part
Deferral
When you exchange shares in your company for shares in the buyer's group, the gain on that portion is usually deferred. It is not taxed until you dispose of the new shares, which are treated as if you had owned them since you first acquired your original ones.
The exchange must have genuine commercial reasons and not be mainly about avoiding tax. Many sellers obtain HMRC clearance beforehand to be sure.
Business Asset Disposal Relief
Deferral is normally welcome, but it has a hidden cost. When you finally sell the new shares, you may be unable to claim Business Asset Disposal Relief, because you are very unlikely to hold 5% of a private equity group.
You can choose to elect so that the gain on the rolled-over portion is crystallised at the time of the sale, and tax is paid then at the relief rate instead of being deferred. Whether this is worthwhile depends on the size of the gain, how much of your lifetime limit remains and what you expect of the future.
Loan notes and preference shares
Rollover packages often include loan notes or preference shares as well as ordinary shares. The instrument you receive affects whether the gain is deferred and when tax falls due.
When you exchange shares in your company for shares in the buyer's group, the gain on that portion is usually deferred.
The employment-related securities trap
If you will work for the group after the sale, the shares you receive can count as employment-related securities. That can lead to income tax charges where you acquire the shares for less than market value, or where their value is depressed by restrictions such as leaver terms.
Elections to manage this can often be made, but only within a short window after the shares are acquired. Missing the deadline can be expensive.
What to negotiate
- The type of shares. Do you receive the same instruments as the private equity house, known as an institutional strip, or only ordinary shares that sit behind its preference shares and loan notes?
- Leaver terms. What happens to your shares if you leave, and at what price?
- Dilution. On a buy-and-build platform each acquisition dilutes earlier shareholders. Joining sooner can mean a bigger slice of the group.
- Exit rights. Tag-along and drag-along rights, and when you can realise your investment.
What happens if you leave the business
Your rolled-over shares usually come with leaver terms in the shareholder documents. These set out what happens to your holding if you depart, and the price at which it is valued. A good leaver and a bad leaver can be treated very differently, so the definitions deserve close reading. Leaver terms can also change the employment-related securities position, which is another reason to negotiate them carefully and early.
A practical order of work
- Decide how much to roll over, and in what form, before heads of terms.
- Model your tax both with and without the election to crystallise the gain at completion.
- Obtain HMRC clearance where needed.
- Deal with employment-related securities points, including any elections, on time.
Why this matters now
Rollover terms are agreed early and are hard to change once the legal documents are underway. A small difference in the instrument or the leaver clause can move your outcome far more than a small difference in the headline price. Our team works with sellers on these negotiations, and all advice is prepared by our specialist team and reviewed by a Chartered Tax Adviser. If a fund has approached you, book a call with our team before you agree heads of terms.
This article is general information, not advice. Tax rules change and their effect depends on your circumstances. Please speak to us before acting.
For a closer look at selling or buying a business, see our specialist practice, Transaction Tax Partners.
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