Academic journal article Vanderbilt Law Review

Private Benefits in Public Offerings: Tax Receivable Agreements in IPOs

Academic journal article Vanderbilt Law Review

Private Benefits in Public Offerings: Tax Receivable Agreements in IPOs

Article excerpt


Traditionally, an initial public offering ("IPO") was a relatively straightforward transaction: pre-IPO owners sold shares of a company to the public, turning a privately held company into a publicly held company. In these traditional IPOs, the interests that the pre-IPO owners sold to the public represented shares in the whole publicly traded company. Recently, pre-IPO owners have found a way to keep a part of the value of the company for themselves through a new tax innovation, the tax receivable agreement ("TRA"), allowing pre-IPO owners to extract billions of dollars from newly public companies.1 Commentators have described TRAs as "underhanded,"2 "a one-sided relationship,"3 "a tax scheme . . . that does not pass the smell test,"4 and a "bizarre siphoning of cash,"5 and have stated that a TRA "drains money out of the company that could be used for purposes that benefit all the shareholders."6 When Hostess recently used a TRA in its IPO, commentators aptly described the transaction as "selling your Twinkie and eating it too."7

TRAs have steadily and rapidly become an integral part of the IPO market. Prior to 2005, TRAs were used in less than one percent of IPOs. The use of TRAs has steadily increased, and companies now use TRAs in over eight percent of IPOs.8 Although TRAs have received some media attention, and a few scholars have discussed TRAs in articles that more broadly focus on "supercharged" IPOs, no article has critically examined the various kinds of TRAs in depth.9 This lack of critical attention to TRAs has allowed both innovative and troubling aspects of these transactions to go undetected by the media, the government, and scholars.10

By taking the first deep dive into TRAs, this Article brings to light inventive and aggressive uses of TRAs. It explores the evolution of TRAs through what this Article calls three "generations" of TRAs, showing how each generation significantly expanded the ways in which pre-IPO owners can take value from public companies. As part of this analysis, it brings to light an important new category of TRA-the "third generation" TRA that very recently appeared on the IPO market. This new type of TRA is unlike its predecessors, which could only be used for companies with a specific tax profile, in that it can be used in virtually any IPO. This new development marks a turning point in the IPO landscape and greatly expands the potential use of TRAs in the IPO market.11 Because scholars have almost exclusively discussed TRAs in the context of supercharged IPOs, they have missed this new and expansive way that TRAs have been used outside the context of supercharged IPOs.12

How do TRAs work? As the name "tax receivable agreement" implies, a TRA is a contract between a public company and its pre-IPO owners that shifts tax assets from the newly public company to its preIPO owners, allowing pre-IPO owners to "keep" certain tax assets for themselves as the company goes public.13 The way this works is that tax assets reduce the amount of tax the public company owes each year that the public company has taxable income. Under a TRA, each year the public company uses certain tax assets to reduce its tax bill, the public company pays the amount of that benefit (or some portion of that benefit) to the pre-IPO owners.14 Although the tax assets technically stay with the public company, in substance, a TRA shifts the value of the tax assets to the pre-IPO owners by requiring the public company to pay the pre-IPO owners for the value of the tax assets as they are realized over time.15

What is the controversy over TRAs? Critics argue that TRAs transfer significant amounts of wealth from public companies to preIPO shareholders in ways that the public may not be able to understand because TRAs are complicated and involve "opaque secretive financial engineering."16 However, those who defend TRAs claim that without a TRA, public shareholders actually "rip off' pre-IPO owners because, the argument goes, the public does not pay full value for tax assets in an IPO. …

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