Monetizing a Privately Held Business: A Comprehensive Guide to Transition, Wealth Stewardship, and Legacy

The decision to monetize a privately held business represents not merely a financial transaction, but the culmination of years—often decades—of vision, effort, and enterprise. For most business owners, this transition is singular: it is unlikely to be repeated, and therefore demands exceptional care, foresight, and deliberation.

We wanted to create a resource for you that breaks a very complex process down into some of its constituent parts. You may be exploring these concepts for the first time, and the time to do that is now—not at the proverbial bargaining table.

1. Assembling the Advisory Team

No prudent business owner should attempt this complex transition alone. The prospective buyer will undoubtedly be a veteran of innumerable transactions and know exactly how to take advantage of first-time business owners…both emotionally and financially. The monetization of a privately held enterprise requires the guidance of a carefully chosen, highly qualified team of professionals—each bringing distinct expertise to bear on the legal, financial, tax, and banking aspects of the process.

A complete advisory team typically includes:

• A wealth advisor, experienced in M&A and capable of leading the team of other experts that drive the ideal outcome for the business owner. They’ll need to be skilled at integrating liquidity event proceeds into a comprehensive, goals-based wealth management strategy tailored to personal, family, and legacy objectives. They will engineer pre-liquidity strategies to minimize personal tax and estate tax burdens. Techniques such as grantor trusts, spousal limited access trusts, installment sales, and charitable lead trusts can reduce taxes while transferring wealth efficiently. Additionally, structuring philanthropic contributions pre-sale can also amplify tax benefits and fulfill legacy goals.
• An experienced transaction attorney, who can structure the sale to protect the owner’s interests and ensure a clean and enforceable transfer of ownership.
• An estate planning attorney, skilled in wealth transfer strategies designed to preserve family assets and minimize tax exposure.
• An investment banker, who specializes in transactions at the size and niche of the business owner’s business. Their role is to create and manage a formal bidding process where multiple prospective buyers are competing with one another. A competitive process will drive the value of the deal higher and push the terms of the deal in a more favorable direction to the business owner.
• A certified public accountant (CPA) with expertise in transaction work, tax structuring, and financial reporting to facilitate transparency and optimize after-tax outcomes.

This collective of professionals is essential not only to complete the transaction efficiently but to safeguard the broader purpose of the liquidity event: long-term personal and family prosperity.

2. The Question of Emotional Readiness

Beyond financial readiness, emotional preparedness is perhaps the most underestimated element of a successful business transition.

For many owners, the enterprise represents far more than an asset; it is an extension of identity, a source of daily purpose, and a means of contribution to employees, clients, and community. To separate from this role without preparation can lead to a profound sense of dislocation and loss.

Thus, owners are strongly encouraged to contemplate the following:

• What purpose will replace the energy, structure, and fulfillment previously derived from the business?
• How will time, ambition, and personal capacity be redirected in the years following the transaction?
• Is the intended lifestyle, philanthropic interest, or second career clearly envisioned and integrated into the wealth strategy?

Experience tells us that failure to address these questions can result in post-sale dissatisfaction, even when financial outcomes are favorable. Emotional clarity is as essential as financial certainty.

3. Evaluating the Equity Roll

Almost every transaction involves a requirement (or at minimum an offer) to “roll” equity into the buyer’s new entity—typically presented as an opportunity to share in potential future appreciation of the business under new ownership. Typical equity rolls involve a 20% to 30% reinvestment of the equity into ownership interest of the acquiring company.

While appealing in principle, equity rolls carry both promise and risk:

Potential Advantages:

• The possibility of a second liquidity event at a higher valuation. The trite and over-used metaphor you’ll often hear is “second bite at the apple.”
• Continued participation in the growth and profitability of the business.
• Alignment with the new ownership group, potentially enhancing personal influence over the enterprise’s direction.

Key Considerations and Risks:

• Loss of control: Post-sale, the majority interest and operational decisions rest with the buyer; minority shareholders may have limited rights or influence.
• Liquidity constraints: Rolled equity is typically illiquid and subject to long holding periods, deferring access to capital that could otherwise be redeployed or diversified.
• Obligations to remain involved: Business owners who retain equity may be expected—or contractually required—to continue contributing time or expertise, potentially delaying personal or retirement plans.
• Increased exposure to restrictive covenants: Equity rolls often expand the scope and duration of non-compete or non-solicitation agreements.

Remember, put another way—an equity roll means you, the business owner, are deciding to invest millions of dollars in a company which you’ve only just encountered at a price that they set. For these reasons, business owners should insist upon transparency regarding the assumptions behind any pro forma valuation of the rollover entity, the waterfall of proceeds in future events, and the potential for dilution. At times, independent valuation or fairness opinions, along with careful scrutiny by experienced legal and financial counsel, are strongly advised to avoid misleading impressions of the economic benefit of rolling equity.

In addition to these economic and strategic considerations, business owners must exercise great caution regarding the legal terms embedded within the rollover agreement itself. These documents often contain complex provisions—such as forced sale rights (“drag-along” clauses), dilution protections (or the lack thereof), capital call obligations, and ambiguous valuation methodologies—that can materially disadvantage the minority rollover shareholder. Without sufficient contractual safeguards, the business owner’s rolled equity may be subject to unfavorable future financing rounds or subordinated to new classes of preferred stock, eroding its value over time. Moreover, some agreements may impose obligations to provide additional capital infusions or accept reduced exit valuations under conditions outside the business owner’s control.

Equally concerning is the issue of valuation representation at the time of the equity roll. It is not uncommon for buyers to present business owners with optimistic or even inflated projections of the new entity’s post-transaction value, which may not fully account for the risks of integration, market conditions, operational setbacks, or capital structure changes. The headline valuation figure assigned to the rollover equity often reflects assumptions favorable to the buyer’s investment case—not guarantees of actual realizable value for the minority business owner.

Further complicating this matter, the post-closing capital structure may differ materially from the business owner’s expectations. For example, new debt financing, management incentive pools, or future preferred share issuances can dilute the ownership percentage or claim seniority over the rolled equity, reducing its ultimate economic worth. In some cases, the rolled equity may hold a subordinated position in the liquidation waterfall, meaning that proceeds from any subsequent sale or recapitalization may flow first to other investors, lenders, or preferred shareholders.

4. Restrictive Covenants

These provisions, often binding for several years, can materially limit the business owner’s ability to re-enter the market, advise others, or recruit former colleagues. Owners must consider these carefully: such clauses may seem routine, but they can unexpectedly constrain personal or professional aspirations in the future.

These contractual provisions can significantly shape a business owner’s post-sale freedom and earnings, and yet many business owners first encounter them at the negotiating table, rather than during early-stage planning.

Restrictive covenants are a natural and necessary part of most middle market M&A transactions. While they may feel intrusive or overly broad, they serve a legitimate business purpose for the buyer and are an expected feature of institutional deals. But that does not mean they are boilerplate. Business owners should view them as negotiable within reason, and as a key component of the deal’s structure—not just legal fine print.

Let’s explore what restrictive covenants are, how they typically appear in middle market deals, and what you should watch for.

What Are Restrictive Covenants?

Restrictive covenants are clauses in a sale agreement designed to protect the buyer’s investment by limiting certain actions of the business owner after closing. The most common forms include:

• Non-compete clauses: Prevent the business owner from starting or joining a competing business for a defined period and within a specified geographic area.
• Non-solicitation clauses: Prohibit the business owner from poaching customers or employees from the company post-sale.
• Confidentiality agreements: Restrict the disclosure or use of proprietary information acquired during the business owner’s tenure.

What to Expect in the Middle Market

Key characteristics often include:

• A non-compete period of 3–5 years.
• Geographic limitations tied to where the company currently operates or where it anticipates growth.
• Broad non-solicitation terms covering customers, suppliers, and key employees.
• Confidentiality clauses with no expiration—protecting sensitive information indefinitely.

These restrictions are often mirrored in the business owner’s employment or consulting agreement if they’re staying on post-sale, making it doubly important to evaluate how all documents interact.

Legal Enforceability and Negotiation Leverage

While restrictive covenants are common, they must be reasonable to be enforceable. Courts in most jurisdictions will evaluate them based on time, geography, and scope. A five-year global non-compete, for example, may be struck down if the business operates solely in the U.S. Southeast.

That said, business owners with strong leverage—due to strategic fit, limited competition, or multiple suitors—may negotiate narrower scopes, shorter durations, or carveouts that allow for passive investments or future advisory work in adjacent industries.

It’s also essential to coordinate closely with legal counsel to ensure that the terms are clearly defined and do not unintentionally restrict post-sale activities beyond what is reasonable.

Tax Considerations

Restrictive covenants can carry hidden tax implications. In certain structures, a portion of the purchase price may be allocated specifically to the non-compete or other restrictive provisions. This allocation may be taxed as ordinary income, rather than at favorable long-term capital gains rates. Sophisticated buyers may prefer this treatment for amortization purposes, but it can significantly affect a business owner’s after-tax proceeds. This is an area where tax and financial advisors should be brought in early.

5. Earn-Outs

One element you will undoubtedly see arise in negotiations is the “earn-out.” While this structure can provide a bridge between a business owner’s valuation expectations and a buyer’s risk tolerance, it is not without complexity.

Middle market companies often have concentrated client bases, founder-centric operations, or untested scalability—each of which can pose risks to a buyer. Earn-outs allow buyers to hedge these risks while giving business owners a chance to “prove out” the value of what they’ve built.

For clients operating in the middle market, earn-outs can play a pivotal role in determining not only financial outcomes but also the emotional and operational contours of post-sale life.

What Is an Earn-Out?

An earn-out is a contractual provision in a merger or acquisition deal in which a portion of the purchase price is contingent upon the future performance of the business. In practical terms, the buyer pays a portion of the total price at closing and agrees to pay the remainder based on the achievement of specific financial or operational targets over a defined period, commonly 12 to 36 months post-close.

Key Benefits of an Earn-Out

• Bridging the Valuation Gap: Earn-outs can reconcile differing perspectives on the company’s true worth, enabling a deal that might otherwise stall.
• Tax Timing Flexibility: Because earn-out payments are typically received in future tax years, they may allow for better income tax planning.
• Incentive Alignment: When business owners remain active in the business post-sale, earn-outs can align interests, ensuring both parties work toward the same performance milestones.

Caveats and Risks

• Lack of Control: If you’re no longer running the company but your payout depends on how it performs, your influence over those outcomes may be minimal.
• Ambiguous Metrics: The definition of “performance” can be a minefield, leading to tension—or litigation—even with honest disagreements.
• Legal Complexity: The earn-out provision must be carefully drafted, with clarity around accounting standards, dispute resolution, and covenants.
• Payment Risk: If the business underperforms or is mismanaged post-close, the earn-out might never materialize.

Emotional Considerations

Perhaps less frequently discussed—but no less important—are the emotional realities of an earn-out. Business owners often feel a deep personal connection to the company they’ve built, and the post-sale period can be fraught with disillusionment. If the earn-out targets are missed, some business owners feel cheated. And if business owners are still involved in the business, the transition from owner to employee can feel like an emotional comedown.

Designing a Thoughtful Earn-Out

For earn-outs to be effective, several elements must be addressed with great care. We like to see clearly defined performance metrics and calculation methodologies. It’s important to establish regular reporting and audit rights—and to get early clarity about P&L segregation. Earn-outs featuring gross revenue are often preferred to EBITDA based earn-outs since business owners may not be in control of their P&L post-sale. We also like to see provisions that prevent the buyer from materially altering operations in a way that would sabotage the earn-out.

Earn-outs are widely regarded as the most heavily litigated realm of middle market M&A. When drafting the purchase agreement, you may have the chance to outline a dispute resolution mechanism, preferably one that avoids litigation.

6. Working Capital Adjustments

In the middle market—few steps are more prone to misunderstanding than the calculation of working capital at closing. For entrepreneurs and families who have built their companies over decades, the final stages of a transaction can feel like crossing a finish line. But too often, post-closing disputes over working capital turn a victory lap into a prolonged negotiation.

What Is a Working Capital Adjustment?

At its core, a working capital adjustment is a mechanism designed to ensure that the business is delivered to the buyer with a “normal” level of net working capital—typically defined as current assets (excluding cash) minus current liabilities (excluding debt). Buyers expect the business to have enough liquidity to operate from day one without requiring an immediate cash infusion.

To operationalize this, the buyer and business owner agree on a target working capital number, usually based on historical averages. After closing, the buyer prepares a “true-up” calculation comparing the actual working capital delivered with the agreed target. Any difference results in a post-closing payment—either from the business owner to the buyer or vice versa.

Why Disputes Arise

Even with the best intentions, working capital adjustments are fertile ground for disagreement. Several common causes include:

• Definition Discrepancies: Buyers and business owners may disagree on what constitutes working capital. Are deferred revenues excluded? Should inventory reserves be adjusted? The purchase agreement must define these terms precisely—but often doesn’t.
• Methodological Inconsistencies: The target working capital is often calculated on a historical accrual basis, but post-closing adjustments are prepared using buyer-specific accounting policies or procedures. This mismatch can materially impact the calculation.
• Timing and Seasonality: Many middle market businesses are seasonal. If the target is calculated on a 12-month average but the deal closes during a seasonal trough or peak, the delivered working capital may appear artificially low or high, respectively.
• Lack of Preparation: Business owners sometimes delegate too much of the calculation to the buyer post-closing, failing to perform a rigorous pre-close working capital analysis of their own. This cedes control and opens the door to surprises.

Best Practices for Business Owners

To reduce the likelihood of conflict—and to preserve deal value—business owners should consider the following proactive steps:

• Conduct a detailed working capital analysis early in the sale process, ideally with input from a transaction-savvy accountant or advisor. Understand the company’s working capital trends and seasonality and document any unusual historical events that could skew averages.
• Scrutinize the working capital definitions and adjustment mechanism in the purchase agreement; resist boilerplate language.
• Push for consistency between the method used to calculate the target and the one used post-close.

Buyer Dynamics

It’s also important to recognize that buyers (particularly private equity sponsors or strategic acquirers) are often highly motivated to recover value through the working capital true-up. This doesn’t necessarily reflect bad faith—but business owners should go in with eyes open, backed by advisors who know how these battles are typically fought.

In the middle market, where businesses are less standardized and financials more nuanced, working capital disputes are not just common—they’re almost expected. But they don’t have to be costly.

7. Employment Agreements

In middle market mergers and acquisitions, the signing of an employment agreement is rarely a mere formality—it is often a strategic component of the entire deal structure. For business owners, particularly founders or senior leadership at the heart of a company’s value proposition, understanding the purpose and implications of post-sale employment agreements is essential to both financial planning and personal readiness.

Why They Matter

Buyers in middle market deals are not just acquiring hard assets or customer contracts; they are often buying into a culture, a strategy, and the expertise of key personnel. In this context, employment agreements serve two primary functions:

1. Retention: Buyers typically seek to retain the leadership team to ensure business continuity and to reduce integration risk.
2. Performance Alignment: Employment agreements often tie compensation to business performance post-closing, sometimes via earn-outs or equity rollovers.

What Business Owners Should Expect

As a business owner, you should anticipate that the buyer will request—or require—you to sign an employment agreement as a condition of closing. These agreements may include:

• Defined roles and responsibilities post-close
• Compensation structure (base salary, bonuses, equity participation)
• Term of employment and termination clauses
• Non-compete and non-solicitation provisions
• Change of control or severance protections

While these provisions can appear straightforward, they deserve careful scrutiny. The terms of your post-sale employment can dramatically affect not only your compensation, but also your autonomy and quality of life following the transaction.

Negotiating Leverage

Business owners often underestimate their leverage in negotiating these agreements. If your leadership is seen as vital to the company’s future value, especially during a transition, your negotiating position is stronger than you may think. Working with experienced legal and financial advisors is critical to maximize both economic and non-economic terms.

Watch for Common Pitfalls

There are several areas where employment agreements can pose hidden challenges:

• Vague Performance Metrics: If your compensation is tied to performance benchmarks, make sure those benchmarks are clearly defined and reasonably achievable.
• One-Sided Termination Rights: Agreements that allow the buyer broad discretion to terminate “for cause” can effectively negate your expected compensation.
• Restrictive Covenants: Overly broad non-compete or non-solicit clauses may limit your professional opportunities for years after departure.
• Equity Roll Considerations: If your employment agreement is tied to a retained equity interest, understand how your continued employment affects the vesting, valuation, and liquidity of that interest.

8. Navigating Tax Allocation

In middle market mergers and acquisitions (M&A), the way the purchase price is allocated among various asset classes can have a profound impact on the business owner’s after-tax proceeds. Yet, many business owners enter negotiations unaware of how these allocations are proposed, negotiated, and ultimately agreed upon.

We want to demystify the tax allocation process, highlight the financial stakes for business owners, and offer guidance for high-net-worth individuals preparing to sell a closely held business.

What Is Tax Allocation?

In a taxable sale of business assets (or a deemed asset sale via an IRC §338(h)(10) or §336(e) election in a stock deal), the purchase price must be allocated among various asset categories for tax purposes. These categories correspond to Internal Revenue Code classifications, ranging from cash and receivables to tangible property and goodwill.

This allocation determines the character of gain or loss recognized by the business owner — for example, whether it’s taxed as ordinary income (at higher rates) or as long-term capital gain (at preferential rates). It also affects the buyer’s future depreciation and amortization deductions.

For business owners, the distinction between capital gain and ordinary income can result in a tax differential of 10%–25% or more, depending on federal and state tax treatment.

The Market Norms and Leverage Dynamics

In lower to middle market deals, purchase price allocations are often proposed by the buyer. Buyers seek to maximize their own tax benefits — often preferring allocations to short-lived, depreciable assets like equipment or customer lists, which allow for quicker write-offs.

Sophisticated business owners, however, should not accept a buyer’s proposed allocation as a given. A properly advised business owner can and should negotiate allocations to favor capital assets (like goodwill and going concern value), which receive more favorable tax treatment. Your negotiating leverage, of course, will depend on the competitiveness of the sale process, the structure of the deal, and the timing of when allocation discussions begin.

Binding Agreements: Form 8594 and IRS Scrutiny

In asset sales and stock sales treated as asset sales, both parties must file IRS Form 8594, which reports the agreed-upon allocation. Discrepancies between buyer and business owner filings can raise red flags with the IRS. Thus, getting alignment — and memorializing the allocation in the purchase agreement — is not only prudent, but necessary.

Pitfalls to Avoid

• Accepting the buyer’s initial allocation as non-negotiable
• Deferring allocation discussions until after price and terms are finalized
• Overlooking the interplay between allocation and state tax exposure
• Failing to model the after-tax proceeds under different allocation scenarios

Example: A Tale of Two Allocations

Consider a business owner with $20 million of goodwill and $5 million of fixed assets. If the purchase price is heavily allocated to fixed assets and customer intangibles, the business owner could face significant ordinary income from depreciation recapture and §1245 gain. By contrast, an allocation more heavily weighted toward goodwill — if negotiated properly — may convert much of the gain into capital gain.

Even in the context of a rollover equity component, the allocation can materially affect the business owner’s tax basis in the new entity and the future tax treatment of that stake.

Planning Considerations for the High-Net-Worth Business Owner

Owners of closely held businesses should involve their tax and wealth advisors early in the sale process — ideally before a letter of intent (LOI) is signed. Here’s why:

• Early structuring advice allows for proactive allocation strategies, including the potential for installment sale treatment, pre-sale gifting, or charitable planning.
• A sophisticated advisor can help quantify the impact of different allocations on your net proceeds and advise your legal counsel on targeted language in the purchase agreement.

Conclusion

In middle market M&A deals, tax allocation is not a footnote — it’s a core element of value. For high-net-worth business owners, understanding and influencing how the deal is structured from a tax allocation perspective can mean millions of dollars in tax savings.

Do not leave this issue to chance or to the buyer’s advisors. Bring your financial and tax team into the conversation early, and ensure your interests are as well represented in the allocation discussion as they are in the price negotiation.

9. Escrows and Holdbacks

In the world of middle-market mergers and acquisitions, it is common—and increasingly expected—for a portion of the sale proceeds to be temporarily withheld following the close of a transaction. These withheld amounts, typically referred to as “escrows” or “holdbacks,” serve as financial safeguards, ensuring that the business owner’s representations and warranties are upheld and that post-closing adjustments can be resolved amicably.

For successful entrepreneurs preparing to transition from business ownership to liquidity, it is essential to understand how these mechanisms function, what they protect against, and how they can impact your post-sale financial picture.

What Are Escrows and Holdbacks?

Escrows and holdbacks refer to portions of the purchase price that are withheld for a period—often 12 to 24 months—after the transaction closes. These funds are intended to cover any potential liabilities or breaches that may surface during that period. Although the terms are sometimes used interchangeably, they can differ slightly:

• An escrow is typically held by a third-party agent (often a bank or law firm) and governed by a formal escrow agreement.
• A holdback is usually retained directly by the buyer and may involve slightly less formal administration.

In either case, the net effect for the business owner is the same: a portion of the agreed-upon sale price is not delivered at closing.

Why Buyers Require Them

From a buyer’s perspective, escrows and holdbacks are a means of protecting themselves from undisclosed liabilities, such as tax issues, legal claims, customer disputes, or inaccuracies in financial statements. Even in well-run companies with clean books, buyers are inherently cautious—especially in founder-led businesses where much of the institutional knowledge resides in the mind of the business owner.

Escrows give buyers time to confirm that everything represented in the purchase agreement holds true post-closing. They also serve as a mechanism to offset post-closing purchase price adjustments tied to working capital or debt calculations.

Typical Terms and Amounts

While terms vary widely based on deal size, industry, and the negotiating leverage of each party, some broad patterns have emerged:

• Escrows typically range from 5% to 15% of the purchase price.
• The escrow period often lasts 12 to 24 months.
• Some escrows are subject to “caps” (maximum liability exposure) and “baskets” (minimum thresholds before a claim can be made).
• In recent years, “representation and warranty insurance” has become more common and can, in some cases, reduce or eliminate the need for large escrows.

It is critical to negotiate these terms carefully with experienced legal and financial advisors. Seemingly small changes in language can have very meaningful financial implications.

The Role of Representation and Warranty Insurance

In deals above a certain size—typically $30 million and up—buyers and business owners often explore the use of rep & warranty insurance to shift the risk of post-closing claims to a third-party insurer. When used effectively, this insurance can significantly reduce the size of the escrow and accelerate full payment to the business owner. However, policies can be expensive and may not cover all types of breaches, so professional guidance is critical.

Closing Thoughts

To achieve a successful outcome—measured not only in economic terms but in personal, family, and legacy fulfillment—you must approach the sale of your business with both technical expertise and thoughtful reflection. We at Rockwood are here for you and ready to illuminate the considerations that matter most at each stage of the journey, from preparation through post-sale.