TRAs have become increasingly common in recent years, especially during Initial Public Offerings (IPOs) and corporate transactions. They play a crucial role in managing tax liabilities and optimizing cash flows.
A Tax Receivables Agreement (TRA) is a powerful financial tool that can help you unlock significant value from your tax assets. If you are a company seeking to maximize the value of your tax assets, understanding and utilizing a TRA could be a key part of your strategy.
What is a Tax Receivable Agreement?
So, what is a TRA? A tax receivables agreement (TRA) is a contract where a company agrees to share tax savings with another party, usually the pre-IPO owners. These savings often come from tax benefits like depreciation, amortization, or net operating losses (NOLs).
For example, when a company’s assets are revalued during an IPO or acquisition, it often leads to “step-up” benefits. These benefits create deductions that reduce taxes over time.
A TRA allows the original owners to claim a percentage of these savings, usually around 85%, while the company keeps the rest.
The Role of TRAs in Corporate Tax Strategy
TRAs help bridge valuation gaps during acquisitions or IPOs. In an acquisition, the buyer and seller might disagree on the value of tax assets. A TRA helps by allowing the seller to keep future tax benefits without making the buyer pay more upfront.
From a cash flow perspective, TRAs turn uncertain future tax benefits into clear, predictable assets. This helps companies manage their tax obligations and plan for future expenses. The TRA framework ensures companies can make the most of their income tax receivable without hurting their financial position.
Benefits of Using Tax Receivables Agreements
Tax Receivables Agreements (TRAs) offer several advantages to businesses:
- Increased Valuation: TRAs can raise your company’s value by turning tax assets into cash flows that might be ignored in traditional valuations.
- Aligning Interests: TRAs align the interests of pre-IPO owners with those of the company and its shareholders. The pre-IPO owners benefit from future earnings, keeping them invested in your company’s success.
- Liquidity: Pre-IPO owners can receive future payments from the TRA or sell their TRA rights in the growing secondary market, providing them with extra liquidity.
Risks of Using Tax Receivables Agreements
While TRAs have benefits, they also come with risks:
- Complexity: TRAs can make financial reporting more complex, requiring careful management and ongoing tax review.
- Payment Delays: If your company doesn’t generate enough taxable income, TRA payments may be delayed, stretching out over a longer period and affecting cash flow expectations.
- Bankruptcy Risks: In case of financial trouble or bankruptcy, TRA claims are often subordinated, meaning TRA holders might not get the expected payments.
Real-World Applications and Examples of TRAs
TRAs are most commonly used in IPOs involving an Up-C structure. This setup gives a “step-up” in the tax basis of assets during the public offering, leading to significant tax savings over time. These savings are then shared with the pre-IPO owners through a TRA.
In addition to TRAs, companies often list taxes receivable on their balance sheets, representing tax refunds expected from overpayments in previous years. These receivables also play a role in a company’s tax strategy, further enhancing liquidity and cash flow management.
TRAs are also common in mergers and acquisitions (M&A), where the value of tax assets can be a point of disagreement. In these deals, a tax receivable agreement can act as contingent payment, allowing the seller to benefit from tax attributes as they are realized.
Maximizing Corporate Value with Tax Receivables Agreements
A tax receivables agreement is a key part of corporate tax strategy, offering both financial and strategic benefits. TRAs help companies unlock value from their tax assets, allowing pre-IPO owners and companies alike to optimize tax savings and cash flows.
If your company is planning an IPO or acquisition, understanding tax receivable agreements (TRAs) and how they fit into your strategy can provide long-term benefits. We recommend that businesses consult financial experts to assess if a TRA is right for their unique needs. As TRAs become more common in corporate finance, they will likely play an even bigger role.
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