Finding the Pearl in the Oyster: Supercharging Ipos through Tax Receivable Agreements

By Grady, Christopher B. | Northwestern University Law Review, January 1, 2017 | Go to article overview

Finding the Pearl in the Oyster: Supercharging Ipos through Tax Receivable Agreements


Grady, Christopher B., Northwestern University Law Review


Christopher B. Grady

Introduction

A new form of initial public offering (IPO) has quietly proliferated over the last twenty years that can multiply pre-IPO owners' proceeds from the public offering by up to 20%.' These transactions enable owners to extract additional value from the IPO, without reducing the offering price,2 through the use of creative tax structuring. The pre-IPO owners "supercharge" the IPO by contracting with the newly public entity to pass back to the pre-IPO owners a portion of the tax benefits created by structuring the IPO in specific ways-monetizing the tax assets created in the IPO.3 These transactions are controversial in part because IPOs traditionally do not have tax implications,4 and the tax benefits are created, and transferred, in a convoluted manner. This Note will argue that many of these concerns are exaggerated and the elements of the "supercharging" transaction, which enable the monetization of the new tax benefits, are actually not much different than other forms of uncontroversial monetization.

The first supercharged IPO occurred twenty-three years ago:5 Cooper Industries, Inc. (Cooper) spun off its wire and cable manufacturing subsidiary, Belden, Inc. (Belden), as a separate publicly traded company.6 Unlike traditional IPOs where the pre-IPO owners, Cooper in this case, take their sale proceeds and move into line with other shareholders, Belden and Cooper entered into a tax receivable agreement (TRA).7 Under the basic terms of this agreement, Belden was obligated to pay Cooper 90% of the tax benefits it received as a result of the IPO.8 These tax benefits were tied to the amortization and depreciation9 of Belden's assets, with a possible payment schedule upwards of fifteen years.10 In short, Belden became contractually bound to pay Cooper large sums of money annually for a period of time that could significantly outlast Cooper's ownership stake in publicly traded Belden.

To better appreciate how TRAs affect the tax advantages of goingpublic transactions, it is useful to first understand the mechanics and the tax implications of traditional IPOs. Assume that a corporation wishes to raise capital by selling shares of stock to the public. The corporation will hire an investment bank or an underwriter to market its stock.11 In return for the stock, the corporation will receive cash from investors.12 Despite the exchange of large sums of money,13 a traditional IPO is effectively disregarded for tax purposes.14 After all, an IPO is simply an exchange of stock for cash: assets do not increase in value, services are not performed by the corporation or the investor, and no productive activity occurs.15 While the corporation would not experience any tax effects, any pre-IPO owners of the corporation who sold their stock in connection with the IPO would likely experience capital gains and corresponding taxation of those gains.16 After the IPO, there may be little in the way of ongoing relationships between the pre-IPO owners and the newly public corporation beyond the customary relationship enjoyed between shareholders and their corporations.17

In contrast, the pre-IPO owners of a supercharged IPO maintain a relationship with the company for up to fifteen years outside of the customary shareholder-corporation relationship.18 This difference is the result of a TRA between the pre-IPO owners and the company, which splits the value of the tax assets among the parties to the TRA.19 Often, these tax assets are created through unique aspects of the IPO process itself.20 In a standard supercharged IPO, the pre-IPO owners transfer their interests in an operating company (Opco) to a newly formed entity (Newco).21 Opco becomes a subsidiary of Newco.22 If properly structured, these transfers boost the value of certain assets for tax purposes by increasing or creating basis.23 Basis is generally equivalent to cost24 and is a concept used to track value in order to prevent double taxation on the same amount. …

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