A tax receivable agreement (TRA) is an agreement made between a company going public and its pre-IPO owners, allowing the owners to benefit from any tax savings that the company may receive in the future. In essence, a TRA is a financial tool that helps ensure that the company’s pre-IPO owners receive the benefits of tax savings that occur after the IPO.
The concept of a TRA is relatively new, and it is not well understood by many people. However, it has become increasingly popular in recent years, as companies going public seek to reward their pre-IPO owners while also maximizing tax savings.
Here is a brief overview of how a TRA works:
When a company goes public, it typically does so by selling shares to the public. The proceeds from this sale are used by the company to fund growth and expansion. However, the pre-IPO owners (usually the company’s founders and early investors) do not receive any direct benefit from this sale.
To address this issue, companies may enter into a TRA with their pre-IPO owners. The TRA provides for the payment of a portion of the tax savings resulting from certain transactions, such as the use of net operating losses, the exercise of stock options, or the payment of dividends.
The TRA typically works by creating a hypothetical scenario in which the company would have paid more taxes if certain events did not occur. The company then pays the pre-IPO owners a portion of the tax savings resulting from those events.
For example, if the company has a net operating loss carryforward of $10 million, and the pre-IPO owners are entitled to 50% of the tax savings resulting from the use of that loss, they would receive a payment of $5 million if the company has taxable income of $10 million in a future year.
In exchange for the TRA, the pre-IPO owners typically agree to provide the company with certain benefits, such as the right to receive shares of common stock or the right to vote on certain matters.
In conclusion, a tax receivable agreement is a financial tool used by companies going public to reward their pre-IPO owners while maximizing tax savings. It is a complex agreement that involves creating hypothetical scenarios and paying pre-IPO owners a portion of the resulting tax savings. While it is not well understood by many people, it has become increasingly popular in recent years.
