Monetizing Future Tax Savings: Tax Receivable Agreements

We consistently counsel parties to an M&A deal that results in a stepped-up tax basis in the assets of the target often has more value to a buyer than a transaction with no basis step up. The increased value lies in the increased depreciation and amortization deductions that the buyer can use to reduce its taxable income. Thus, taxable asset purchases, stock purchases with 338(h)(10) elections, and taxable purchases of partnership interests and disregarded entities all have the potential for reduced tax liabilities for the buyer.

Similarly, the purchase of the stock of a corporation with net operating loss carryforwards or other deferred tax assets creates value for a buyer. The buyer can, subject to certain limits, use those deferred tax assets to reduce the future taxable income of the target.

A seller and buyer often acknowledge the additional value attributable to the tax savings resulting from the stepped-up basis or deferred tax asset. However, placing a price on that value can be difficult due to uncertainties in the buyer's realization of the tax benefit. More recently, we are seeing the parties negotiating additional consideration attributable to tax attributes in the form of an agreement commonly called a "Tax Receivable Agreement." This type of agreement first came to light in 2007-2008 when the former owners of The Blackstone Group negotiated such an agreement as part of the IPO of that firm.

The concept of the Tax Receivable Agreement is simple–the buyer pays more consideration to the seller as the buyer realizes tax savings from the specific tax attributes. For example, if the Tax Receivable Agreement relates to stepped-up basis, the buyer would make payments as it depreciated or amortized the assets.

In the right circumstances, a Tax Receivable Agreement can be an important element of consideration in a transaction. For the seller, it is a mechanism that unlocks the value of tax attributes that it brings to the deal, either resulting from the structure of the deal or from the historic operations of the target. For the buyer, it represents deferred consideration financed by a lower tax bill.

If you are looking at a potential M&A transaction either as a buyer or a seller, you should consider using a Tax Receivable Agreement as part of the consideration package. The Kilpatrick Townsend Tax Team can help you analyze the utility of such an agreement and guide you through its negotiation and implementation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.