When you sell your business, you may be asked to reinvest some of your proceeds in the acquiring company. This is called “rolling equity,” and it’s becoming increasingly common.
Sometimes it works out well, as it did for Perry Rosenbloom, who rolled some equity when he sold his vet clinic and ended up tripling his money. Other times rolling equity turns out badly, as it did for Mark Ferrier, who took 8% of his proceeds from selling Traffik and rolled them into his acquirer only to have the value drop by 92%.
Rolling equity means you are investing in the acquirer’s business, so it’s important to do your own reverse diligence on your acquirer. One of the most important questions to consider is how your potential acquirer is valuing their business. After all, if you’re being asked to buy their shares with your hard-earned proceeds, it’s worth taking a hard look at what you’re getting for your money.
This week we dropped an interview with Jason Swenk, who is a partner at Republix, where they buy marketing agencies for four to eight times earnings, paid 50% in cash and 50% in Republix stock. To calculate how many shares the selling owner gets, Republix values its stock at ten times earnings, meaning every agency they buy is accretive.
The Accretive Acquisition
In MBA-speak, an accretive acquisition increases the earnings per share of the acquiring company. For Republix, the moment they put the seller’s EBITDA on their P&L, it’s worth 10X rather than the 4–8 they paid for it. They get an instant return on their investment on day one.
For the seller, it’s the equivalent of going to a foreign country holding a weaker currency—you don’t get much for your money if your acquirer values their shares at a higher multiple than what they’re offering you.
Jason and his partners argue that Republix is worth 10 X EBITDA because they have crossed the eight-figure EBITDA threshold—and there may be some truth to that—so you have to be comfortable selling your shares to a company that is in the same industry, doing more or less the same thing, and taking forty to eighty cents on the dollar.
If you’re asked to roll equity, it’s reasonable to ask some tough questions about what you’ll get for your money. How is the acquirer valuing their company? If their valuation multiple is higher than what they are offering you, it’s worth asking why.
How Liquid Is Their Stock?
Further, you need to understand the liquidity of the shares you’re rolling. Can you negotiate “put” options, as Tyler Smith did at Skyslope or Randy Woods did at Valtech? Put options allow you to sell the equity you roll at a predetermined price. Without them, you become a minority shareholder in a company that may sell at some point in the future. That could be years or decades away, and you have little choice but to go along for the ride.
The interview with Jason provides a unique perspective inside the mind of a service business acquirer.
Clip of the Week
In this clip, Jason Swenk describes the questions he asks agency owners before buying their companies.
Quote of the Week
“We want to buy businesses where their clients view them as a trusted advisor.”
