Suppose you sell your company to a private equity firm. Part of the transaction involves you rolling over a small percentage of shares into the new deal pre-tax using an F-Reorganization. Although the percentage is small, the dollar amount is still multiple seven figures.
How can the private equity firm who bought your company screw you after you roll equity and go along for the ride? Does this happen often?
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No one is safe. Not even Apollo principals who co-invest with Apollo are safe from Apollo.
A lot of funds will have a 1.5x preference where they get paid 1.5x their investment before anybody else (i.e. rollover) gets paid.
You'll see some deals structured with preferred units (what PE firm gets) and common units (what management gets). These preferred units can get all sorts of sweet deals - priority repayment based on a preferred return multiple is a big one. They're getting paid before management at a specified multiple like mentioned above, or at a yearly %, often compounded monthly or quarterly, Oh, and they participate in the owner's returns "pari-passu" as well.
The logic is that the owner received a liquidity event with equity and the PE firm is "protecting" itself by getting paid before other investors. In reality, it's often financial engineering to cut a smaller check, keep management invested for the transition period then squeeze them out of any potential returns when it's exit time. If you don't have 51%, it ain't yours.
Yes and they certainly shoot themselves in the foot when they do it. I've heard from several fellow YPO and EO members about a few PE firms to avoid because of the aforementioned firms trying to be sneaky.
The majority of situations where the seller is or feels as though they were screwed is when the company doesn't do well. The majority of PE protections (e.g. - the 1.5x liquidation pref, etc.) are to protect on the downside but if the deal does well the seller's rollover catches up and everyone makes the same.
Now, that is just about the seller rollover / their returns on the rollover. There are a lot of ways to disadvantage a seller in the actual deal structure that can benefit the PE firm greatly.
In most middle market buyouts that I've seen, the sellers' rollover equity is pari passu with the PE firm (ie. they are on equal footing. The sellers have common shares, the PE firm has common shares, and so on and so on).
I would say most PE firms are not out to screw over the rollover investors, as the rollover guys are on equal footing with them and if the rollover is getting screwed, it means the investment is going poorly for the PE firm as well.
Management incentive plans (option pools) are a different story. These incentive options usually only have value once the PE firm has received their entire initial investment back (return of capital) and then start vesting based on time/how well the investment did.
This was the point I was going to make. A decent lawyer representing the equity holders rolling equity should always fight for the rollover to have the same rights as the PE investors.
People that rollover only get screwed if they don't negotiate correctly. I know in the LMM, I've seen and personally negotiated deals where people roll into common instead of preferred, which makes no sense, but it does happen.
In general the people that get screwed are ones who have common shares and are buried under debt and pref. When things go badly, those people (usually employees) always get burned.
Here is the thing fellas -- your reputation is EVERYTHING as a buyer. If you want to fuck people over for short term gains, its a choice and its been done. however realize PE is a long term game...
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