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The
practice has been popular with buyout firms going public since
Blackstone Inc deployed it in its IPO in 2007. Private equity
firms argue the arrangement is justified in rewarding their
partners. Critics say it strips their public shareholders of
value that should have gone to them.
Robert Willens, a tax expert and professor of finance at
Columbia Business School, said there was a risk that IPO
investors may not fully appreciate how much value in the private
equity firm is being transferred to its founders because of the
complexity of the process involved.
"Public investors could be overpaying for the stock, it is hard
for them to understand the implications," Willens said.
A TPG spokesperson declined to comment.
The tax benefits TPG will enjoy stem from its reorganization as
it goes public. In acquiring the interests of its founders in
its operating partnership, TPG expects to see a step-up in its
tax basis, allowing it to take depreciation and amortization
deductions that reduce its taxable income, the filing shows.
TPG has entered into a "tax receivable agreement" with its
founders to pay them 85% of the cash value of these tax savings,
according to the filing.
The Fort Worth, Texas-based firm said that value, currently
pegged at $1.44 billion, "may materially differ" by the time the
tax savings will be realized. It added that it expects the
payments it will have to make under the agreement to be
"substantial" and that they could have a "material negative
effect" on its cash position.
TPG disclosed on Tuesday it expects to be worth $9.5 billion in
its IPO, so the tax receivable agreement would transfer an
estimated 15% of that value to TPG's top dealmakers, primarily
founders David Bonderman and Jim Coulter and Chief Executive Jon
Winkelried.
Bonderman and Coulter are already billionaires, and the
estimated $1.44 billion payout would boost their fortunes
further. Forbes pegs Bonderman's and Coulter's net worth at $4.5
billion and $2.6 billion, respectively.
If it does not have enough money to make the tax receivable
agreements payments in time, TPG will be charged interest equal
to the one-year LIBOR rate plus 5%, the filing shows. And if a
change of control occurs, such as its founders giving up their
dual-class shares, TPG will owe them the remaining estimated
value of the tax savings.
This happened in the last two years when the founders of peers
KKR & Co Inc, Apollo Global Management Inc and Carlyle Group Inc
gave up voting control by turning the firms into corporations
with a single class of stock.
This triggered a $560 million payment for KKR's founders under
their tax receivable agreement, which the New York-based firm
said it would pay in the form of stock.
LAWMAKER SCRUTINY
Apollo's founders and executives secured a payout of at least
$584 million over four years in similar fashion under its tax
receivable agreement when the firm announced last year it would
eliminate its dual-class structure, regulatory filings show. The
executives elected to receive the payout in cash rather than
Apollo stock.
A source familiar with the matter said the payout was worth only
half the value of the accrued tax benefits owed to the founders,
who agreed to forego the other half in the interest of Apollo's
shareholders.
Carlyle was the first among the major publicly listed private
equity firms to get rid of special voting rights for its
executives in 2019. The change triggered a $346 million cash
payout over five years for the Carlyle executives under its tax
receivable agreement, regulatory filings show.
The use of tax receivable agreements by private equity firms
attracted U.S. lawmaker scrutiny in 2007, when Blackstone
disclosed in its IPO filings that its executives could receive
tax benefits totaling $863.7 million over the next 15 years
under the arrangement.
However, U.S. Congress never passed into law proposed
legislation that would have taxed payments made through tax
receivable agreements as ordinary income. The use of tax
receivable agreements expanded in popularity, and some private
equity firms used them to extract value from portfolio companies
they took public.
"Private equity firms use expensive tax lawyers a lot for their
portfolio companies. It is therefore not surprising that they
use convoluted tax tricks to their direct benefit as well," said
Ludovic Phalippou, a finance professor at the University of
Oxford's Said Business School.
(Reporting by Chibuike Oguh in New York; Editing by Greg
Roumeliotis and Matthew Lewis)
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