Private equity deal terms, in plain English

How to use this page

Selling a business to private equity means learning a new language on the buyer's home turf. The definitions below are grouped the way a deal unfolds: the roll-up basics, the process, the price and structure, the equity you keep and how it gets paid, and the tax terms. Each entry is short and in plain words. Where a term deserves a full page, there is a link. If you read nothing else, read the roll-up basics and the price terms, because those set your number before anything else is decided.

Roll-up basics

Platform

The first business a private equity firm buys in a given industry, which becomes the foundation it builds everything else onto. Platforms need strong management and real systems, and they earn the highest multiple in their industry. See selling to private equity.

Add-on

A business bought after the platform and folded into it, valued for what it adds to the group rather than as a standalone company. Add-ons earn lower multiples than platforms, often close to half, because the buyer is paying only for the increment.

Recapitalization (recap)

A reworking of who owns the business and how it is financed, rather than an outright full sale. In a majority recap the private equity firm buys most of the business and you keep a minority stake; in a minority recap you keep control and the firm takes a smaller piece. The word simply means the ownership and debt are being restructured.

Multiple

The number your adjusted EBITDA is multiplied by to set your price, written as something like 6x. It reflects your industry, your size, your recurring revenue, and above all whether you are a platform or an add-on. See what your business is worth.

The deal process

Letter of intent (LOI)

A short document a serious buyer sends that states the price, the rough structure, and the main terms. It is mostly not binding, except that it almost always grants the buyer exclusivity, so it is the document to negotiate hardest before your leverage drops.

Exclusivity

A period, often 60 to 90 days, during which you agree not to talk to any other buyer while this one completes its diligence. Exclusivity is the moment your negotiating power falls sharply, because you go from having options to having one buyer and a deadline.

Quality of earnings (QoE)

An audit-style study of your profit that the buyer's accountants run during exclusivity to confirm your EBITDA is real and test every add-back you claimed. If it finds your adjusted EBITDA is lower than you presented, the buyer often cuts the price, a move called a retrade. Clean books and defensible add-backs are the best protection.

Price and structure

EBITDA

Earnings before interest, taxes, depreciation, and amortization, a rough measure of the cash your business produces from operating. Buyers use it as the base for pricing because it strips out financing and paper write-offs that will change under new ownership.

Adjusted EBITDA and add-backs

Adjusted EBITDA is your EBITDA plus add-backs, which are costs that exist only because you own the business and would not burden a new owner. The main add-backs are your own above-market pay, documented personal expenses, and one-time costs; your price is a multiple of this adjusted figure, so each defensible add-back is worth its dollar amount times your multiple.

Working capital peg

A target level of working capital, meaning receivables and inventory minus what you owe suppliers, that must be in the business at closing, based on your recent history. If you deliver less than the target the price drops by the shortfall, and a peg set too high quietly hands money to the buyer, so it deserves close review.

Holdback and escrow

A portion of your price, often 5 to 10 percent, held in a neutral account for a year or two after closing to cover problems that surface later, such as a promise about the business turning out to be wrong. If nothing goes wrong, the money is released to you; if it does, the buyer draws on it. Representations and warranties insurance can shrink how much is held here.

Earnout

Part of your price paid later, and only if the business hits agreed targets after closing. Earnouts are common where the buyer is worried about a risk, like a large customer or an unproven growth claim, and they shift that risk onto you, since you are paid only if the targets are met. See earnouts and installment sales.

Seller note

Part of your price paid over time by the buyer, with interest, rather than in cash at closing, like a loan you extend to the buyer. It carries the buyer's credit risk, meaning you depend on the company staying healthy enough to pay you, and the interest is taxed as ordinary income.

Representations and warranties insurance

An insurance policy that covers the buyer if a promise you made about the business in the contract turns out to be wrong. It has become common above roughly $10 million of enterprise value, and because the insurer stands behind the promises, the buyer may hold back less of your money in escrow.

The equity you keep and how it gets paid

Rollover equity

The part of your price, usually 10 to 40 percent, that you take as a stake in the buyer's holding company instead of cash. It is illiquid, sits behind the lenders and the firm's preferred return, and can be worth a lot or nothing, so plan as if it were zero. See rollover equity.

Waterfall

The order in which cash is paid out when the company is sold or refinanced. Lenders are paid first, then the private equity firm's preferred return, and only then the common equity where your rollover usually sits, which is why the rollover is paid last.

Preferred return

A set return, often around 8 percent, that the private equity firm earns on its investment before common equity gets anything. It frequently compounds, growing larger every year the company is held, so it takes an ever-bigger slice off the top before your rollover is paid.

Payment-in-kind (PIK)

A return that accrues on paper and rolls up into the balance owed rather than being paid in cash. When a preferred return is PIK, it compounds quietly and grows the amount that must be paid ahead of your common equity, which reduces what reaches you.

Dividend recapitalization

When the company borrows more money to pay a dividend, mostly to the private equity firm, rather than to grow the business. It returns cash to the firm while loading the company with more debt that sits ahead of your rollover in the waterfall.

Second bite of the apple

The payout you hope to receive when the private equity firm sells the platform to the next buyer, on top of the cash from your original sale. It can be substantial if the group grew, but it is a bet, not a promise, and it has grown slower and less certain as firms hold companies longer.

Clawback

A provision that lets money already paid to you be taken back if certain conditions are not met, such as an earnout target being missed after an advance or a later adjustment going against you. Read any clawback closely, because it can reach money you thought was already yours.

Continuation fund

A newer structure where the private equity firm sells the company to a new fund it also manages, instead of to an outside buyer, so it can hold the business longer. For a rollover holder it can mean another delay before a real exit, and terms worth reading carefully.

Re-roll

When, at the next sale, you are asked to roll part of your proceeds again into the new owner's company rather than cashing out fully. It can extend your upside, but it also extends the years your money stays illiquid and at risk.

Drag-along right

A right that lets the majority owner force you to sell your stake when it sells, on the same terms. It keeps a small holder from blocking a sale, but it means you can be pulled into an exit you did not choose.

Tag-along right

A right that lets you sell your stake alongside the majority owner when it exits, on the same terms. You want this, because without it you can be left holding an even smaller and more illiquid piece after the firm has cashed out.

Good-leaver and bad-leaver

Clauses that decide what happens to your rollover if you stop working for the company. A good-leaver who retires, becomes disabled, or is let go without cause generally keeps the earned value; a bad-leaver fired for cause or quitting in breach can be forced to sell the stake back cheaply.

Tax and structure

Asset sale versus stock sale

Two ways to structure the deal. In an asset sale the buyer buys the individual assets and gets tax write-offs, which buyers prefer; in a stock sale the buyer buys your company's shares with no step-up. Most private equity deals with owner-run companies use a structure that gives the buyer asset treatment while letting you defer your rollover. See asset versus stock sale.

Personal goodwill

The part of a business's value that belongs to you personally, from your own relationships and reputation, rather than to the company. In the right circumstances you can sell it directly for capital-gain treatment, which can lower the tax, especially for a C corporation. See personal goodwill.

Depreciation recapture

When you sell equipment or vehicles you already wrote off, the gain up to the amount you depreciated is taxed as ordinary income, not at the lower capital-gains rate, under Section 1245. For a business with trucks and equipment this can be a meaningful ordinary-income bill in the year of sale.

F-reorganization

The standard tax structure for selling an S corporation to private equity. You form a holding company, drop your company under it, convert it to an LLC, and sell LLC interests to the buyer; the buyer gets a stepped-up basis and you get capital gain on the cash and deferral on the rollover. See the structure page.

Section 721 and Section 351 rollover

The two tax rules that let the rolled portion of your deal avoid tax at closing. Section 721 covers a contribution to a partnership or LLC; Section 351 covers a contribution to a corporation where the contributing group holds control. Both defer the gain rather than erase it, because your basis carries over to the new stake.

Installment sale

A way of reporting a sale where you are paid over more than one year, so the gain is spread across the years you receive the payments instead of all at once. It can smooth the tax, but large installment balances carry an added interest charge, and depreciation recapture is still taxed up front. See installment sales.

Qualified Small Business Stock (QSBS)

A rule under Section 1202 that can exclude a large amount of gain, up to the greater of $15 million or ten times your basis, from federal tax when you sell stock in a qualifying C corporation. It excludes fields like accounting and consulting and does not apply to S corporations or LLCs, so it turns on entity choices made years before a sale. See QSBS.

Non-compete and non-solicit

Promises you make not to start or join a competing business (non-compete) and not to take employees or customers with you (non-solicit) for a set number of years after the sale. Payments allocated to a non-compete are taxed to you as ordinary income rather than capital gain, so how much of your price is assigned here matters. See how a sale is taxed.

When a term does not apply to your deal

Not every term here shows up in every deal. A small all-cash sale to a single buyer may have no rollover, no waterfall, and no preferred return at all, which makes most of the equity section irrelevant to you. A business that was always an S corporation or LLC will never touch QSBS. And whether you meet an earnout, a seller note, or a continuation fund depends entirely on the buyer and the structure. Use this page to understand the terms that are actually in your documents, and skip the ones that are not; a definition you do not need is not a term to go chasing.

What to do next

Keep this page open next to your letter of intent and your draft purchase agreement, and look up each term as it appears rather than nodding past it. When a term carries real money, whether it is the multiple, the add-backs, the working capital peg, the rollover structure, or a tax choice, that is the moment to slow down and get advice. The deal page explains how the pieces fit together, the tax page covers what you keep, and the calculator turns the headline price into a real after-tax number. For a second read from a planner whose fee does not depend on whether you sell, the contact page explains how a first conversation works.