Rollover equity that changed the seller's answer

The situation

A buyer offered $9.0 million, all cash, for 100% of the shares of a business its founder had built over two decades. The offer reflected a fair multiple against the company’s trailing earnings, and the buyer’s advisors expected it to close quickly. It did not.

The problem

The founder declined the offer twice, and neither time did he counter with a higher number. What he said, each time, amounted to the same thing: he did not want to hand over the business and simply disappear the next day. He wanted some continued stake in what the company became under new ownership, not a bigger cheque for walking away from all of it. That is not a price negotiation a buyer can answer by raising the cash offer — the buyer’s acquisition facility was already fully committed at the $9.0 million level, and asking its lender for a larger facility, or a subordinated tranche, to fund a higher cash price was not a realistic option on this file’s timeline.

The numbers

The buyer’s counsel restructured the same $9.0 million headline value rather than increasing it: $7.2 million in cash at closing (80% of the total) and $1.8 million as rollover equity — shares in the buyer’s acquisition vehicle, issued to the founder instead of paid to him in cash. Under an ITA s.85(1) joint election, the parties elected an amount for the rolled shares equal to the founder’s adjusted cost base attributable to that portion — roughly $80,000, being 20% of a $400,000 total ACB — so no immediate gain was triggered on the $1.8 million of rolled value. That gain, $1,720,000, is deferred, not eliminated: it will be recognised only when the founder eventually disposes of the rollover shares themselves.

On the cash portion, the founder recognised an immediate gain of $6,880,000 ($7,200,000 less the remaining $320,000 of ACB), against which the lifetime capital gains exemption could shelter its usual $625,000 of taxable gain, subject to the founder’s shares otherwise qualifying under ITA s.110.6.

The rule that decided it

“Rollover equity” is not a term the Income Tax Act uses; the mechanism behind it is the s.85(1) election, which lets a taxpayer transfer eligible property to a taxable Canadian corporation in exchange for shares without immediately crystallising the gain on the portion taken as shares, provided the parties jointly elect in prescribed form. What governs the founder’s ongoing 20% stake once the rollover is complete is a separate instrument entirely: a unanimous shareholder agreement under CBCA s.146(1), giving the founder defined information rights and participation in a future sale, without a board seat and without the operational control he had exercised as sole owner.

What it would have cost otherwise

The buyer’s acquisition facility was already fully drawn against the $9.0 million structure; there was no room in it for another $1.5 million of cash without opening a new financing conversation the deal timeline could not absorb. Issuing rollover equity instead of raising the cash price let the buyer meet the founder’s actual objection — continuity and upside, not price — without adding a dollar of new debt or reopening the financing package it had already committed to closing on.

The tell

The tell was in what the founder’s counter-offers were not. A seller negotiating price sends back a number. This founder, twice, sent back a sentence about not wanting to simply disappear. Treating that as a price objection and responding with a marginally higher cash figure would have missed the point entirely; the fix the deal needed was structural, not financial, and the negotiating team only found it once it stopped assuming the objection was about the number on the page.

The outcome

The deal closed on the restructured terms: $7.2 million cash, $1.8 million rollover equity, and a unanimous shareholder agreement defining the founder’s ongoing rights as a 20% shareholder in the acquisition vehicle. The founder signed within a week of the revised term sheet being presented — the same total value he had twice declined, delivered a different way.

Takeaways

• • A seller who declines a fair cash offer without countering with a number is often not negotiating price at all — find out what the actual objection is before assuming a higher offer fixes it.
• • Rollover equity under an ITA s.85(1) election defers tax on the rolled portion and can close a price gap without adding cash or debt to the deal.
• • A founder's post-closing minority stake needs its own governance instrument — a CBCA s.146 unanimous shareholder agreement defines what rights actually survive the sale, and what does not.
• • Structure, not price, is often the tool that gets a reluctant founder to yes — and it can cost the buyer nothing beyond legal drafting time to offer it.

Sources

• • Income Tax Act s.85(1) — marginal note Transfer of property to corporation by shareholders.
• • CBCA s.146 — marginal note Unanimous shareholder agreement.
• • Treadstone Law — the section 85 rollover — a plain-language overview: “Only the portion of a deal paid in shares of the transferee corporation can potentially defer tax this way.” It does not cover the elected amount or rollover-equity mechanics; those come from the Act.