Posts made in June 2019

When I sell my company, should I consider “rolling over equity” into the buyer’s company?

The Denver Post | BUSINESS

By GARY MILLER | | GEM Strategy Management

PUBLISHED:  June 23, 2019 at 6:00 am

It depends. It is no secret that this year and next may be the best time to sell your company. A lot of money is on the sidelines looking for investment opportunities and buyers are paying premiums for well run, privately held companies. Often, buyers offer business owners an opportunity to roll over a part of the purchase price proceeds into the buyer’s company.

Gary Miller

This is particularly true with many private equity (PE) firms who are searching for companies in the lower end of the middle market space. We see many private equity acquisitions and some add-on deals offering business owners what is referred to as rollover equity. Rollover equity arises when certain equity holders in the target company, including founders and key members of the management team roll a portion of their ownership stake over into the new equity capital structure put in place by the acquiring PE firm. In other words, they sell less than 100% of their interest with the balance becoming equity in the new capital structure.

Equity rollovers generally result in post-transaction ownership by the seller from 10% to 40%. In a 30% rollover, for example, the private equity firm would own 70% of the newly capitalized equity in the business with the seller “rolling” a proportionate amount of value to equate to 30% of the new equity. Most PE firms strongly prefer equity rollovers for seven reasons:

1. Asymmetric information benefits the Seller. The seller has more knowledge than the buyer since the owner has operated in his/her industry over many years. Buyers believe that the acquisition will be more successful with the sellers at the helm.
2. Confidence is built with the buyer. When the seller accepts an equity rollover, it signals confidence to private equity buyers that continuity will be assured, and the interests of the seller and buyer will be aligned.
3. Rollover equity incentivizes sellers to continue to grow the business. With “skin in the game” sellers provide buyers with some comfort that those who built the business are incentivized to continue to grow it since they retain an economic interest in the business.
4. Less capital is needed in the acquisition from the buyers. Since the sellers are investing some of their profits from the sale into the buyer’s business, less capital is needed from the buyers to buy the seller’s business.
5. Alignment between the parties provides the buyer to grow the business in a shorter period of time. This arrangement helps align the seller’s management team to align with the buyer’s management team’s growth objectives since the seller will continue to have “skin in the game” post-acquisition.
6. Seller receives major liquidity from the initial sale of their company. At the same time rolling over a portion of their equity allows them to participate in further upside — a “second bite at the apple” in a second sale by the PE firm.
7. Sellers rolling over equity can defer taxes. From a tax perspective, taxes can be deferred by sellers on the portion of the purchase price that is rolled over into the new capital structure from the seller.

How does an equity rollover work?

Owners contemplating an equity rollover often find themselves facing a new world in terms of capital sources and leverage. Most of our clients have a modest amount of bank debt and a single class of stock (perhaps split among several shareholders/members). Private equity capital structures typically consist of multiple tranches of debt (mezzanine, junior, and senior debt), or one large piece of “unitranche” debt. Also, the structure can include differing levels of liquidation preferences in the equity structure of the capital stack. The increased complexity of the capital stack and the different debt structures are not business characteristics many owners are experienced or comfortable with.


Equity rollovers offer substantial upside, and downside. For example, consider the hypothetical transaction involving an equity rollover with a PE firm. Two brothers jointly own a distribution business. They are considering a transaction with a private equity firm. The enterprise value of their company is $12 million; the outstanding debt is $1 million, and a $2 million equity rollover has been requested from the PE firm. After paying off the debt and reinvesting the $2 million, the brothers pocket $9 million. The new capital structure, post transaction, is 50% equity and 50% debt (a mixture of senior and mezzanine debt), with the PE firm owning 80% and the brothers owning 20% of the recapitalized company. Leverage is implicitly touted as a benefit to sellers considering an equity rollover. The argument is that when the business grows, debt is paid down, and the business is eventually sold to a strategic buyer for a higher price. In this example, the second transaction will yield $50 million for the business. All equity owners earn a return on their investment. In this case, the brothers parlayed their $2 million equity rollover into nearly $10 million.


Equity rollovers can also bring risk. PE investors generally operate with a more leveraged capital structure than family-owned firms or entrepreneurial firms. While added leverage boosts equity returns, risk increases as well. For the PE firm considering this business as one in a portfolio, the risk/return ratio might be more suitable to the buyers than to the sellers with this being their only investment.

PE firms love to promote success stories, particularly the instances where an owner made more on the second sale than in the initial sale. A seller doesn’t typically hear about the disasters. A seller considering a rollover should ask for the capital structure pro-formas, and detailed financial pro-formas the PE firm has created to support such a capital structure and financial projections.

For those considering a rollover, the following four questions should be asked:

  1. Taxes — Will the transaction enable a tax-deferred rollover?
  2. Corporate governance — What say does the seller have in ongoing strategic, operating, and financial decisions?
  3. References — How has the PE group behaved in partnership with previous sellers?
  4. Debt — Does the higher leverage require personal guarantees of the debt in what will most likely be a more leveraged business?

To roll or not to roll

Our clients are generally entrepreneurs or families who have built successful businesses over many years or decades. When they finally reach the difficult decision to sell, most sellers do not contemplate retaining a piece of the business. It is not because they have a negative view of the business, but because they have poured so much of their lives into their businesses that retaining any involvement — financially, operationally, or emotionally — conflicts with their decision to sell. Those owners should seek a strategic buyer who wants to own a 100% of their businesses.

For those owners rolling over equity need to fully appreciate that while they are partnering with the PE group “buying” their company, the seller’s influence over important decisions may be minimal. Compatibility with the new owner with regard to strategy, expectations, culture and performance metrics are important to asses before becoming partners. It is important to be comfortable with the decision-making rules of the governance agreement. Some PE firms expect a hidden form of return (fees) that often doesn’t show up until the deal is being documented:

  1. Management fees
  2. Finders fees
  3. Administrative fees
  4. Breakup fees
  5. Transaction fees
  6. Origination fees

All the fees above contribute to a skewing of the returns among the parties. PE firms will argue these expenses are non-recurring and therefore shouldn’t affect value in a future sale, but they are real cash expenses that alter the return profile of the two parties. Asking for a complete schedule of proposed fees earlier in the process will reduce unpleasant surprises further down the road.

Getting professional advice in advance and during discussions with PE firms or other strategic buyers is a must if you want to avoid disappointments down the road. So, the answer to the question, “Should I roll over equity in the buyer’s company”?

It depends.

Gary Miller is CEO of GEM Strategy Management, Inc., a M&A consulting firm that advises small and medium businesses throughout the U.S. and represents business owners on how to maximize the value when selling their companies or buying companies and raising capital. He is a frequent keynote speaker at conferences and workshops on mergers and acquisitions. Reach Gary at 970-390-4441 or

Sooner or later you will probably want to sell your business

The Denver Post | BUSINESS

By GARY MILLER | | GEM Strategy Management

PUBLISHED: May 26, 2019 at 6:00 am

Every company will need a growth story.

Many business owners come to that point in their lives when they know it is time to sell their company. Whether their decision is due to health, fatigue, boredom, burnout or retirement, the fact remains they want out. At that point, the composite characteristics and attributes of each business paints a picture that is viewed by the business community, competitors, creditors, employees, suppliers, customers and potential buyers. That picture can tell a story of dynamic growth, sedentary stability, or decline. It should be the story of a thriving company culture, perceived opportunity, and growing enterprise value.

More often than not, owners are not prepared for the rigors of a robust due-diligence process brought on from potential buyers eager to hear the “success” story – causing many deals to fail. We advise clients to think like buyers and ask themselves . . . “what do buyers look for when buying a business”?

Gary Miller

When investors screen for and perform due diligence on businesses, they spend an inordinate amount of time analyzing the products or services, market size, competition, pricing dynamics, customer experience, financial history, proformas, and strength of the management team. They do this because these are the important factors that will help them preserve capital and earn an acceptable return on investment.

A strategic business plan including a growth plan need not be about “hockey stick” projections. In fact, it doesn’t necessarily mean getting bigger; rather, it means getting better. And, in that regard, every company should have a growth story showing the ability to analyze and overcome adversity and continue on a positive growth path.

In corporate finance language, getting better means improving the present value of future cash flows. The set of strategic actions should increase cash flows, extend their duration, and/or improve predictability. Changing the trajectory of these factors by making strategic decisions makes the business better.

Seven Actions that Improve Business Value

  1. Strengthening relationships with customers
  2. Diversifying suppliers
  3. Investing in technology to improve efficiency
  4. Putting redundant systems in place
  5. Making customer experiences easier, more efficient, and productive
  6. Accelerating new product or service offerings
  7. Expanding into new channels and geographies for growth or diversification.

Investing in a capable team, efficient processes, and systems that allow the business to operate independently of any one person further achieves the goals and improves the business value. The market place is dynamic, and competition makes it difficult, if not impossible, to generate superior returns on capital indefinitely unless owners and managers watch for growth opportunities.

Growth affects culture, opportunity and value

Orienting a business toward growth can empower the workforce and attract greater talent. Managers take direction from their owners and, without a directive or incentive to “think outside the box”, the future will look like the past. In our engagements, we often encourage owners to install retention plans that incentivize key employees to stay with the company through a transaction.

In almost every case, we find that aligning interests serves as a catalyst for new ideas and creates a sense of urgency. It is no surprise that cost savings are easier to find, and expansion opportunities become more attractive to managers when they perceive that owners are receptive to new ideas. Plus, it is more fun than just repeating yesterday, and that dynamic alone makes it more interesting to employees. Making this a priority ahead of, rather than during a transaction, can help the value accrue to the current owner rather than the new one.

Creating excitement for the future of the business has an added benefit. During the sale process, information is shared through statements of facts (i.e. memorandums, data sites, etc.) and through communication with management (i.e. management presentations). While it is important that the former is organized to position the business positively, the latter offers the best opportunity to form an emotional connection with the buyer. When managers have the opportunity to share their excitement in the future and can inspire a buyer’s confidence, the perception of risk decreases, and the perception of
value increases.

Regardless of how it is expressed, at the end of the day, value is a function of the perceived future cash flows of the business. To illustrate the impact of growth on valuation for example, if a business is growing at 2% annually, assuming $2.5 million in operating profit and a cost of capital of 10%, the discounted cash flow analysis implies an intrinsic value of $21.75 million. Growth in cash flow, either as a result of lower costs, increased prices, or greater volumes, drives values higher.

Developing the growth plan

A good growth plan will separate revenue growth into achievable actions that have been vetted through data and analysis. The plan might include current market penetration, product or service extensions, geographic expansion, complementary acquisitions, or potential price increases. The size of each opportunity and the likelihood of success will only be limited by competition, customer demand, and business infrastructure.

Given the limited resources of middle market or small businesses, the capability to size each opportunity accurately may not exist internally. Using a third party skilled at customizing market studies and consumer research to the specific needs of a business can give owners the valuable information needed to prioritize initiatives efficiently.

Likewise, the cost structure can be affected by focusing on and continuously monitoring the cost of growth. Revenue growth by definition will provide leverage on fixed costs, while pricing, the use of new technology, and process improvements can drive down variable costs. Combined, revenue growth and operational cost improvements drive greater future margins and higher value. Increasing shareholder value is never easy and there is generally no “silver bullet.”

Rather, success requires a combination of initiatives, and by breaking down each of these growth strategies into actions, the numbers or results can follow. Business planning is a dynamic process with no target end point.

Those organizations that prioritize continuous improvement and consistent growth will be best positioned to maximize shareholder value.

As you prepare to sell your business, remember what Rod Stewart said almost 50 years ago. “Every Picture Tells a Story”. As a business owner, you can determine how your business picture will look. The picture you paint will ultimately determine your business’s enterprise value.

Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or to buy companies and raise capital. He can be reached at 970-390-4441 or

How to retain employees during the labor shortage

The Denver Post |  BUSINESS


PUBLISHED : April 28, 2019 AT 6:00 AM | UPDATED: April 25, 2019 at 12:52 pm

America’s labor shortage is approaching epidemic proportions. Across the country, more jobs are available than workers to fill them. The unemployment rate has dropped to a nearly two-decade low. Businesses are complaining of worker shortages, arguing they could do more, sell more and build more if they could just find skilled employees.

According to the Department of Labor, at the end of January 2019, the U.S. economy had 7.6 million unfilled jobs, but only 6.5 million people who looking for work. It was the 11th straight month the number of job openings was higher than the number of job seekers. This shortage has translated into higher wages to retain and attract workers, which increases employers’ costs of doing business.

What can a business do to attract and keep skilled employees? In addition to paying competitive wages, many business owners are considering adding retention and performance programs for their most valuable employees. One such program is called a Phantom Stock Plan.

What is Phantom Stock?

A phantom stock program is a form of long-term incentives used by businesses to award employees for improved company value without actually giving away equity. As a result, no dilution occurs for shareholders. It is a type of deferred bonus offered to key employees, where the future payout is tied to appreciation in the equity or market value of the sponsoring company. The term “phantom stock” may be used broadly or narrowly since no formal or statutory definition of the term exists.

Some companies use the term phantom stock to denote any type of plan for which employees must wait until a future date to receive the promised financial value. More narrowly it indicates a plan that is intended to mirror restricted stock awards or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock. But actually, it is a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth in company value or both.

Phantom stock may also be known by such terms as phantom shares, simulated stock, shadow stock or synthetic equity. Participants in phantom stock plans are expected to view the company’s objectives through the same lens as the shareholders. These types of plans can help attract employees and retain and differentiate a company’s value proposition from its competition. Phantom shares do not result in owner equity dilution because actual stock is not being transferred to the participant.

Seven good reasons to consider a Phantom Stock Plan

  1. Phantom stock helps align goals between business owners and their key employees for growing the business. Most owners want great talent that thinks like an owner and can execute a business plan. If a company is
    focused on growth, employees are the most critical assets for this growth objective.
  2. Phantom stock helps create value by turning other long-term incentive plans into growth drivers.
  3. Phantom stock helps a company compete for employees who have the ability to be growth catalysts for businesses.
  4. Phantom stock plans can retain employees because employees must wait until a future date to receive the financial value of a promise given today.
  5. Phantom stock plans demonstrate fairness because they share value with those who help create it by protecting both the shareholder and the employee interests.
  6. Phantom stock plans are linked to the same business objectives as the owners.
  7. Phantom stock plans form long-term incentives used by businesses to award employees for improved company value. As a result, it is a type of deferred bonus where the future payout is tied to appreciation of the equity, or market value of the sponsoring company.

The term “phantom stock” may be used broadly or narrowly since there is no formal or statutory definition of the term. More narrowly it indicates a plan that is intended to mirror restricted stock awards, stock appreciate rights (SARs) or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock but are actually a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth goals of the company.

Types of Plans

In general terms, three types of phantom stock arrangements are available. They are not mutually exclusive; a company could have just one type or all three depending on its objectives.

1. Full Value Phantom Stock Plan is a deferred cash bonus arrangement that creates a similar result as a restricted stock plan. The sponsoring company determines a “phantom” stock price through an internal or external valuation of the company. Employees are awarded some number of phantom shares that carry specific terms and conditions. At some point, key employees will receive a cash payment equaling the value of the original shares plus appreciation of the stock.

For example, assume an employee receives 100 phantom shares with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock and pay the employee the full value. Let’s assume that the share price appreciates to $18. The company will pay the employee $1,800 as a cash distribution. This $1,800 reward is taxed at ordinary income rates.

2. Performance Phantom Share Plan is a type of plan contains two distinct performance-based elements. First, employees must achieve certain pre-determined performance targets. If they do, they are awarded phantom shares. The number of shares may vary by employee and by the degree to which the targets were achieved. Financial targets might include such measures as Pre-tax Income, EBIT or EBITDA.

The second, performance element relates to the potential improvement in value that may come through phantom stock value appreciation. Once awarded, the phantom shares may still be subject to vesting schedules or other restrictions. The tax effect to employees is identical to that of full value phantom stock.

For example, let’s assume an employee receives 100 phantom stock options (PSOs) with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock price and pay the employee any positive difference between the original price and the appreciated price. Assume the share price grows to $18 from $10. The company will pay the employee $800 (the increased value).

3. A Phantom Stock Option Plan, also known as a Stock Appreciation Rights (SARs) plan, is a deferred cash bonus program that creates a similar result as a stock option plan. As with the previous two plans, the sponsoring company determines a phantom stock price through an internal or external valuation of the company. Employees are awarded some number of phantom options that carry specific terms and conditions. Should the company phantom stock appreciate over time, employees will receive a cash payment equaling the difference between the original price and the appreciated price.

Most business owners and CEOs intrinsically understand the principle, “the more value you help create, the more reward you will receive”. They know that sharing value through long-term incentive plans is essential to capturing the loyalty and commitment of top achievers.

Fairness might best be summarized as follows: Successful companies share long-term value with high performers because it builds trust and confidence between ownership and its employees.

Regardless of which plan(s) are chosen, employers have the opportunity to eliminate or greatly reduce employee turnover among key personnel. The cost of adding these plans are minimal at best. The increase in performance and longevity of employees is self- liquidating when the cost of employee turnover and the increased profits and value added from incremental growth are analyzed.

Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or how to buy companies and raise capital. He can be reached at 970-390-4441 or