(Reuters) – Top TPG traders will require the buyout company to pay them the cash value of the tax savings it expects to receive, currently estimated at $ 1.44 billion, in the years following its initial public offering (IPO), according to a regulatory file. .
The practice is popular with buyout companies that have gone public since Blackstone Inc rolled it out when it went public in 2007. Private equity firms argue that the arrangement is justified to reward their partners. Critics say it robs their public shareholders of the value they should have earned.
Robert Willens, a tax expert and professor of finance at Columbia Business School, said there is a risk that IPO investors may not fully appreciate the value of the private equity firm transferred to its founders due to the complexity of the process involved.
“Public investors might be paying too much for the action, it is difficult for them to understand the implications,” Willens said.
A spokesperson for TPG declined to comment.
The tax advantages that TPG will benefit from derive from its reorganization as it goes public. By buying back the interests of its founders in its operating partnership, TPG expects an increase in its tax base, allowing it to benefit from deductions for depreciation and amortization that reduce its taxable income, the file says.
TPG entered into a “tax debt agreement” with its founders to pay them 85% of the cash value of those tax savings, according to the filing.
The Fort Worth, Texas-based company said the value, currently set at $ 1.44 billion, “may differ significantly” when the tax savings are realized. He added that he expects the payments he will have to make under the agreement to be “substantial” and that they could have a “significant negative effect” on his cash position.
TPG revealed on Tuesday that it forecast a value of $ 9.5 billion when it went public, so the tax debt deal would transfer around 15% of that value to TPG’s main traders, mainly founders David Bonderman and Jim Coulter and Managing Director Jon Winkelried.
Bonderman and Coulter are already billionaires, and the estimated payment of $ 1.44 billion would further increase their fortunes. Forbes estimates Bonderman 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 debt agreement payments on time, TPG will be charged interest equal to the one-year LIBOR rate plus 5%, according to the filing. And in the event of a change of control, such as its founders relinquishing their dual class shares, TPG will owe them the remaining estimated value of the tax savings.
This has happened over the past two years when the founders of peer KKR & Co Inc, Apollo Global Management Inc and Carlyle Group Inc gave up voting control by turning companies into companies with only one class of shares.
This triggered a payment of $ 560 million to the founders of KKR under their tax debt agreement, which the New York-based company said it would pay in the form of shares.
The founders and executives of Apollo secured a payment of at least $ 584 million over four years in the same manner under its tax debt agreement when the company announced last year that it would eliminate its structure at double class, according to regulatory documents. The executives chose to receive the payment in cash rather than in Apollo shares.
A source familiar with the matter said the payment was only worth half the value of the accumulated tax benefits owed to the founders, who agreed to forgo the other half for the sake of Apollo shareholders.
Carlyle was the first of the large publicly traded private equity firms to ditch the special voting rights for its executives in 2019. The change triggered a cash payment of $ 346 million over five years for Carlyle executives. under its tax claim agreement, according to regulatory documents.
The use of tax debt agreements by private equity firms caught the attention of US lawmakers in 2007, when Blackstone revealed in its IPO documents that its executives could receive tax benefits totaling 863 , $ 7 million over the next 15 years under the agreement.
However, the US Congress never enacted a bill that would have taxed payments made through tax debt agreements as ordinary income. The use of tax debt agreements has grown in popularity and some private equity firms have used them to extract value from holding companies that they have made public.
“Private equity firms rely heavily on expensive tax lawyers for their holding companies. So it’s no surprise that they also use convoluted tax tricks to their direct advantage, ”said Ludovic Phalippou, professor of finance at Said Business School at the University of Oxford.
Report by Chibuike Oguh in New York; Editing by Greg Roumeliotis and Matthew Lewis