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Bridging the Valuation Gap

A valuation gap between sellers and buyers is an extremely common challenge. Typically, sellers will want the highest possible price, while buyers want the lowest possible price. When a price gap cannot be closed, two common levers are frequently used: seller notes and rolling equity.

A loan provided by the seller to the buyer is called a seller note. With a seller note, the buyer agrees to pay the seller a portion of the purchase price in the form of a promissory note over time. This tool offers several benefits to the buyer, including flexibility in deal structuring and incentives for business continuity, and interest payments. However, a seller note places the seller at risk as these notes are almost always structured as subordinated loans with substantial risk of repayment in the event the buyer defaults in the future.

Rolling equity is an industry term describing the means by which a seller retains a minority equity ownership stake in the company post-sale. This approach can align the interests of both parties and can also provide several strategic advantages such as shared upside potential, smooth transitions, continuity, and alignment of interests. When rolling equity, sellers typically obtain an equity interest in the go-forward company at the same valuation as the buyer, which can further align the parties and help bridge the valuation gap. However, sellers will be minority owners when rolling equity and this has its own set of risks, including but not limited to lack of control.

When faced with a sale process that leads to a valuation gap that negotiations cannot close, these mechanisms (Seller Notes and Rolling Equity) can help bridge the gap and enable the parties to reach an agreement to consummate in a successful transaction. Leveraging these tools at the right time can unlock new opportunities and pave the way for a successful sale.

Have a great day everyone,

Max McFarland