Business owners seeking a cheaper exit route should consider using tax receivable agreements (TRAs), which could help make initial public offereings (IPOs) a feasible alternative to merger and acquisition (M&A) deals, suggests an article in the November issue of the
Harvard Business Review
Dr Howard Jones and Dr Rüdiger Stucke of Sa?d Business School at the University of Oxford write that prospective sellers should make greater use of TRAs when seeking to dispose of their business.
“IPOs are an expensive exit route for company owners,” said Jones. “TRAs could be an effect way to reduce exit costs, in preference to other routes such as M&A, dramatically reducing the income tax paid on the company’s post-IPO profits.”
The article notes that underwriters in the US typically charge 5% to 7% of proceeds for an IPO and underpricing of shares takes a further 10% to 15%. Total costs of US$100m are not unusual for big deals so it is not surprising that many owners are keen to pursue other exit options.
“TRAs have been poorly understood and could be used to great benefit in many more IPOs,” added Jones. “Many view them with suspicion, thinking they are untested but in fact TRAs have been well-tested in IPO markets including in high profile IPOs. They are a favoured tool of investment banks and a standard method by which private equity firms take portfolio companies public. They deserve to be better understood.”
Under the terms of a TRA, a seller may receive payments for up to 15 years after an IPO. Jones’s and Stucke’s research shows that on average they total three times the cost of an IPO. Before the IPO the seller takes certain steps to ensure that the company will enjoy a higher tax basis after the IPO without creating and offsetting new tax cost for the seller.
“This can dramatically reduce the income tax paid on the company’s post IPO profits,” said Stucke. “The seller receives a large portion of the value of these future tax savings, generally payable over 15 years.
“They have a feature that has characterised M&A transactions for many years – namely that the delivery of tax benefits to buyers results in a higher price for sellers. Prospective sellers should consider TRAs as a way to make IPOs feasible alternatives to M&A deals.”
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