In Equity Rollovers, Which Rights Can Investors Expect?

In an equity rollover, a selling equityholder in an M&A transaction often reinvests some or all of its stake into the post-closing business rather than cashing out fully at the sale. Rollover investors are minority holders in the new structure, and they occasionally negotiate for minority protections. These protections can include preemptive rights, tag-along rights, put rights, and rights of first refusal (ROFRs), or rights of first offer (ROFOs), on transfers by the majority equityholders. But which of these rights are rollover investors most likely to actually receive?

We polled the M&A partners in Goodwin’s Private Equity practice to find out. The results show that investors almost always receive preemptive and tag-along rights. But they rarely get put rights or ROFRs/ROFOs on transfers by the majority equityholder.

The Logic

Preemptive rights and tag-along rights are standard because they protect the rollover investor’s stake from dilution and provide a path to exit that’s often difficult for minority investors to achieve on their own.

• Preemptive rights entitle a holder to participate in future equity issuances and to maintain its percentage ownership, subject to certain limitations. Without them, dilution erodes both the rollover investor’s share of future growth and the “skin in the game” that majority equityholders (especially private equity sponsors) want from rollover holders, particularly management.
• Tag-along rights let a minority holder sell alongside the majority equityholder on the same terms. For privately held equity with no public market to trade on, tag-along rights are a rollover investor’s primary path to liquidity, and selling together often maximizes price and terms for everyone.

Put rights, ROFRs, and ROFOs are rare because they cut against the objectives of the typical sponsor-backed investment and can create practical or procedural complications.

• Put rights let a holder force the company, or another specified party, to buy back its stake. That is a solo exit the sponsor doesn’t share, exactly the misalignment rollovers are structured to avoid. Put rights are also hard to honor in practice: Companies rarely keep enough cash on hand to fund a buyback, and borrowing to finance one is unattractive and often times impractical.
• A ROFR lets a holder match a bona fide offer for another investor’s equity. A ROFO gives the holder a first chance to buy another investor’s equity before a sale. Aimed at the majority equityholder’s stake, either right puts a hurdle in front of an exit, and few rollover investors could afford to buy out a majority equityholder anyway.

What This Means in Practice

For majority equityholders (especially private equity sponsors), the survey offers a benchmark: Extend the rights the market treats as standard, be thoughtful about the ones the market doesn’t, and focus the drafting where the real negotiation happens.

When a rollover investor asks for put rights or a ROFR or ROFO on majority equityholder transfers, it helps that practice has largely settled the question. These rights are rare for structural reasons rather than as a matter of hard bargaining, and pointing to settled practice and the reasoning behind that usually resolves the request without straining the relationship. Some situations do warrant flexibility, however. The structural objections carry less force when a stake is large enough to resemble a significant co-investment, or when a ROFO covers fellow minority holders rather than the sponsor’s own stake.

Preemptive and tag-along rights are different. Extending them costs a sponsor little and has real upsides. They give a rollover investor confidence in the partnership and keep everyone focused on the same outcome. Most of the give-and-take is in the drafting, where both sides have a legitimate interest in the details. For preemptive rights, a key question is scope: Which issuances should be carved out of preemptive rights? For tag-along rights, a key question is protection for selling equityholders: When a minority holder sells alongside the sponsor, what protections should that minority holder expect to receive in that transaction?

Of course, the rights discussed here are not the whole story. Information rights determine what a minority holder knows about the business between closing and exit. And the treatment of equity on departure (what gets repurchased, at what price, and under what circumstances) is often where the most money moves for management rollover holders and where clear terms at signing spare both sides of disputes at exit. Rollover investors should consider where to spend their negotiating capital on these terms relative to others where settled practices are likely to create uphill battles.