Technical Question on EBITDA Earnout with Mgmt Rollover

Hi all,

I was wondering if a more experienced monkey could help me walk through what exactly happens to management's share of rolled equity throughout a PE's hold period if they want to implement an EBITDA earnout structure for, say, the first couple of years. 

 
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Lemme make sure I'm clear on the facts. For example, you buy a business for $100M and management rolls $10M. You also sweeten the deal with up to $20M in earnouts based on some future EBITDA-related milestones.

Initial S&U (let's say fund with $50M debt; ignoring fees):

Sources:
Sponsor equity: $40M

Term loan: $50M

Rollover: $10M

Uses:

Cash to sellers: $90M

Rollover: $10M

Initial cap table is $40M (80%) sponsor and $10M (20%) rollover.

If the business achieves its EBITDA targets, the sellers will receive another $20M which would be funded either through (i) cash on BS that was built during hold period (of which, the sellers actually own 20% of that cash but too bad) OR (ii) incremental equity or debt which will ultimately impact the go-forward capitalization and may dilute the sellers' future exit proceeds (e.g., sponsor calls capital to fund the earn-out, which dilutes the rollover on the cap table but results in the cash funds today).

Lemme know if I captured your point.

 

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