Case 081Leveraged buyoutsCore
In a buyout, the founder rolls over part of his stake and management gets options that vest only above a value hurdle. What does the founder receive at three exit values, and how do rollover and options differ?
1The situation
A sponsor buys Himshital Cold Chain, an invented refrigerated warehousing company, with Rs 1,000 crore of equity. The founder, who stays on as chairman, rolls Rs 150 crore of his sale proceeds back into the new company and owns 15%; the sponsor puts in Rs 850 crore for 85%.
The operating team, the CEO and four executives, put in no money. They hold options over a pool equal to 8% of the equity at exit, which vests only if exit equity value is at least Rs 2,000 crore. When it vests, the pool dilutes the founder and sponsor pro rata.
2Your task
What does the founder receive if exit equity is Rs 1,000, 1,800 or 2,500 crore, what does management receive, and how do the two instruments differ in what they reward?
Quick check
At an exit equity value of Rs 2,500 crore, what does the founder receive?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The founder receives Rs 150, 270 and 345 crore at the three exit values; management receives nothing, nothing and Rs 200 crore. Rollover is ordinary equity: the founder gains and loses rupee for rupee with the sponsor, so he shares the downside. The options cost management nothing and pay only above Rs 2,000 crore, so they reward upside alone. The cliff at Rs 2,000 crore also creates a zone where the founder and sponsor are worse off at a higher exit value.
Step 1What is the difference between rolling over and holding options?
Think of a family selling its restaurant to a chain. If the family keeps a slice of the business, they win or lose with the chain. If the chef is promised a bonus only if sales double, the chef has nothing at stake, but earns nothing unless the target is hit. Rollover is ownership with money at risk; options are a claim on the upside with no money at risk. The founder's rolloverReinvesting part of the sale proceeds into the buyer's new company, taking ordinary shares alongside the sponsor. makes him a smaller version of the sponsor. Management's options make them care only about getting past the hurdle.
Step 2How do the payoffs work at each exit value?
Take the pool out first, then split the rest by ownership. Below Rs 2,000 crore the pool is worth nothing, so the founder simply gets 15%; above it, he gets 15% of the 92% left after the pool. At Rs 1,000 crore he gets his Rs 150 crore back, 1.0x. At Rs 1,800 crore he gets Rs 270 crore, 1.8x, the same multiple as the sponsor. At Rs 2,500 crore management takes Rs 200 crore and the founder gets 15% of Rs 2,300 crore, Rs 345 crore, 2.3x.
| Exit equity, Rs crore | Management pool | Founder | Sponsor | Founder multiple |
|---|---|---|---|---|
| 500 | 0 | 75 | 425 | 0.50x |
| 1,000 | 0 | 150 | 850 | 1.00x |
| 1,800 | 0 | 270 | 1,530 | 1.80x |
| 2,500 | 200 | 345 | 1,955 | 2.30x |
Step 3What goes wrong at the hurdle?
The pool vests all at once, so value jumps between holders. At Rs 1,999 crore the founder gets Rs 299.8 crore and the sponsor Rs 1,699 crore. At Rs 2,000 crore management takes Rs 160 crore, the founder drops to Rs 276 crore and the sponsor to Rs 1,564 crore. Between Rs 2,000 and about Rs 2,173 crore, a higher sale price leaves the founder and sponsor worse off than a sale just below the hurdle. A sponsor could rationally prefer a lower bid, and management will push hard for any bid just above Rs 2,000 crore. That is a governance problem built into the plan.
Real plans soften the cliff with a ratchetA vesting schedule where the share of the pool management earns rises in steps or smoothly as returns pass successive hurdles., for example vesting a quarter of the pool at 2.0x, half at 2.5x and all of it at 3.0x, or with options struck at a price so they pay only the gain above it. The design question is the same in each: reward management for value above the sponsor's target without making any range of outcomes perverse.
Step 4Why would a sponsor want both instruments?
Rollover keeps the founder's knowledge and relationships tied to the business and signals that the seller believes the price was fair: a founder who refuses to roll anything is telling you something. Options hire the operators who must deliver the plan and point them at the sponsor's return target. The founder's incentive is to avoid losses as much as to chase gains; management's is almost entirely about the upside, which can tilt them toward risk. A good answer names both effects and says which behaviour each instrument buys.
Where candidates lose it
Candidates treat rollover as an incentive like options, or say both simply align management with the sponsor. The point of the question is that one has money at risk and one does not, so they align people with different parts of the outcome.
The second loss is applying the founder's 15% to the full exit value after the pool has vested. Options dilute every shareholder, so the founder's share must be taken after the pool comes off the top.
What the interviewer asks next
- Redesign the pool as a ratchet that removes the dead zone. What would you propose?
- The founder asks for a liquidation preference on his rollover. How does his payoff change?
- Why might a sponsor insist the CEO also invests some of his own money?
- How do the options change the sponsor's IRR at Rs 2,500 crore?
Asked at Citi, Mergers and Acquisitions, New York, 2026 (Wall Street Oasis): Talk about the mechanics of an LBO. What is the difference between management rollover and incentives.
Company names and figures are illustrative.