Closing the Gap is our five-part series from John Barton on the structures that bridge the distance between a seller’s view of value and a buyer’s price: where each fits, where each breaks, and the one thing to get right before you sign.
Earlier in this series
- Part 1 – Why the Gap Is About Risk, Not Value
- Part 2 – Why Earn-Outs Break Down and What Protects Your Payment
- Part 3 – Vendor Loans, and What It Costs to Finance Your Own Sale
You keep a slice of the equity and get paid again when the buyer exits. The upside is real. It is also now someone else’s upside to deliver.
In Brief
A retained stake leaves you holding a minority position, commonly ten to forty per cent, cashed out when the buyer sells.
What are you actually holding? Equity in a company you no longer control, usually sitting behind the debt the buyer borrowed to acquire it. The second bite can be worth more than the first. It can also be worth nothing.
What decides the outcome? Whether your shares sit in the trading business or the holding company carrying the debt, how far you dilute before the exit, and whether you can force a sale or only be dragged into one.
What about the tax? Structure decides it. Where the buyer ends up with 80 per cent or more and you take shares in the acquirer, scrip for scrip rollover may defer the tax on the rolled portion. Keeping a slice of your own company generally will not qualify.
This is the one bridge that closes the gap because you agree with the buyer rather than because you have insured them against being wrong. They think the business is worth more under their ownership. You keep a piece and find out.
Private equity is where it lives. The buyer wants you invested. You want a share of the multiple they sell at.
What you are actually holding
Your slice is the most volatile part of the capital structure. If the buyer borrowed to acquire the business, that debt ranks ahead of you, and the business has to clear the bank before your shares are worth anything. In a good outcome that gearing multiplies your return. In a poor one it removes it entirely.
Then you dilute. Buy-and-build strategies issue equity, incentive pools get created, acquisitions need funding. Each round cuts your percentage unless you put more money in, and most sellers neither can nor want to.
And the exit is theirs to time. Five-year plans run seven. Until they sell, your holding cannot be turned into cash at any price.
The terms that decide it
Where your shares sit. Equity in the trading company and equity in the holding company that carries the acquisition debt are different instruments with the same name. Ask which one you are getting, and get the answer in writing.
Drag and tag. Drag-along lets the buyer force you into their sale. Tag-along lets you join it. You will be offered the first as standard. You need the second, plus a put that gives you a way out if they never sell.
Pre-emptive rights, information rights, a seat. Without the first you dilute at whatever price they set. Without the second you learn how your investment is doing once a year. An observer seat beats neither, and a board seat beats both.
Leaver provisions, if you are staying on. Whether your shares are bought at value or at cost when you leave is usually buried in a definition of “bad leaver” written by the buyer.
The tax is a structuring question
Keep a slice of your own company and you have sold the rest, with tax payable on what you sold and no relief on what you kept. Roll into the acquirer instead, in a transaction where they end up with 80 per cent or more of the original company, and scrip for scrip rollover may let you defer the gain on the scrip portion. Any cash you also take is taxed as it falls.
Rollover defers, it does not forgive. Your new shares inherit the old cost base, so the whole gain comes back at the second exit. It may not even be the best answer, since the small business concessions can be worth more than a deferral. Decide it with your adviser before the structure is agreed, because afterwards there is nothing left to structure.
The retained stake is the only bridge where the buyer’s optimism and yours point the same way, which is exactly why it gets accepted without being read. Price the downside first: a minority holding, behind debt, in a business run by someone else, on their timetable.
Next in the series: the holdback, the narrowest of the five bridges and the one most likely to sprawl.
The information on this website is general in nature and is not intended to constitute financial, legal, or tax advice. It does not take into account your objectives, financial situation, or needs. You should seek appropriate professional advice before acting on any content. While we draw on our experience as business owners and corporate advisors, our insights are not a substitute for tailored advice.
