After publishing Why Founders Should Value Their Earnout at Zero, I got a wave of messages with some version of the same question:
"What about private equity roll-ups? They're not offering me an earnout, they're offering me a second bite of the apple. Isn't that different?"
Short answer: no.
What "A Second Bite of the Apple" Actually Means
Here's how the pitch usually goes. A private equity (PE) firm wants to roll up companies in your industry, so they first create a holding company to do it. Then that holding company goes out and acquires your business and others like yours, building one big holding company made up of businesses in your industry, one of them yours.
Let's say the holding company values your business at $100M.
The deal structure looks something like this:
They pay you, say, 70% of the deal value in cash at close, so $70M.
The other 30% gets "rolled over." Instead of cash, you receive $30M of equity in the new holding company that owns your business and the others they acquired.
Then let's say they find another 9 businesses like yours, each valued at $100M. Combined with your business, the holding company is now valued at $1B, and you own $30M of equity, a 3% ownership stake.
After 3 to 5 years, the PE firm sells the holding company, hopefully for a lot more than $1B. Let's say $3B. Now your 3% stake is worth $90M. Not bad for only forgoing $30M in cash when the company was acquired.
That's the "second bite of the apple." Your first bite was the cash when you sold your company to the holding company. Your second bite happens when the holding company itself sells.
It's a compelling pitch. It's also the same trap as an earnout, just dressed differently.
The Truth
Here's the part the pitch deck never shows you: nobody knows what that rolled equity is worth. Not you, not the PE firm, not anyone.
It could come back as a multiple of what you rolled. It could come back as roughly what you put in, except years late and after inflation has eaten away at it. It could come back as a fraction. Or the holding company could go bankrupt, or sell for less than its debt, and your equity comes back as zero.
Every one of those outcomes is on the table the day you sign. And which one you land on depends entirely on things you no longer control: when they sell, at what price, how much debt they pile on, how many other companies they buy and dilute you with, whether the market cooperates, whether a buyer even shows up, and on a clock you don't set. The day you sell, you hand the wheel to someone else.
That's the problem. It's not that the second bite is small. It's that it's a roll of the dice, and you're not the one rolling.
Personal Experience
When we sold Tatango to private equity, we received the full value of the company in cash upfront, no second bite of the apple, so I don't have any personal experience with this model. But from conversations with founder friends over the years, my sense is that the second bite of the apple does pay out something more often than an earnout does. An earnout is usually a binary miss. You don't hit the target, you get nothing. Rolled equity is real ownership, so unless the holding company goes bankrupt or gets levered into oblivion, you'll often get some check at the end.
But that's not actually where founders get hurt.
The Real Damage
Go back to the $100M business. The structure is $70M in cash at close, plus $30M rolled into the new holding company. The PE firm walks you through the model, and here's the line every founder hears some version of:
"We're offering you $70M cash, and in 3 to 5 years, the potential to earn another $90M, bringing the total value of the acquisition to $160M."
And I get why private equity pitches the acquisition this way. It's a fantastic story, and one that many entrepreneurs can't say no to.
Think about it. The business is worth $100M, and someone is offering $160M for it. What entrepreneur is going to say no to that deal?
That's the trap. The entrepreneur is deciding whether they'd sell their company for $160M, when the real question is whether they'd sell for $70M, with some potential upside, if they're lucky.
My Rule (Same as Before)
You can't put a value on something unknown. And the second bite is unknown, completely. So don't value it at all.
When evaluating an offer with a rollover equity component from private equity, value the deal at the cash you receive at close. That's the true value of the deal.
If a PE firm offers you $70M in cash plus $30M rolled into the platform, value the deal at $70M. If $70M isn't a number you'd sell your company for, don't take the deal. Treat the rollover as a lottery ticket, icing on the cake, found money. If it ever pays out, great. But you don't price it, and you don't sell your company on the strength of it.
Could the second bite materialize? Sure. I know founders who got a multiple on what they rolled and couldn't be happier. I also know founders whose rolled equity sat illiquid for 8+ years, got diluted through round after round of add-ons, and came back with a fraction of what they put in, years later than promised. And I know founders who got nothing at all.
That's the whole point. You can't tell in advance which one you'll be.
The Bottom Line
Cross out the rollover from any offer you're evaluating. Then ask:
If this were the entire deal, just the cash at close, no rollover, no second bite, would I still sign it?
If the answer is no, don't sign it. Because in this market, that's increasingly what the deal turns out to be.
If the answer is yes, then it's a great deal. And you never know, in 7 years you may even get another check in your mailbox. Just don't hold your breath, or be surprised when it's only a fraction of what you rolled into the deal.
Need Help Evaluating an Acquisition Offer?
I've been on your side of the table. Over the years I evaluated a lot of LOIs for my own company (some good, some bad, some really bad) before eventually selling in an all cash deal to private equity. If you want help thinking through an acquisition offer you received, click here to work with me.