The Takeaway: A Q&A With Tom Goldrick and Michael Mulkerin on Tax Receivable Agreements
How big is the market for tax receivable agreements, or TRAs?
There are approximately 170 public TRAs outstanding, which various industry stakeholders have estimated to have a value between $25–$45 billion, depending on each company’s stock price at the time of crystalizing the tax basis step-up underlying most TRAs.
In terms of market participants, a few years ago, there were only a few middle-market asset managers seeking out TRAs as investments. Transactions were generally not brokered, and there may have only been one buyer at the table. However, the number of interested and knowledgeable investors has increased significantly in the past couple of years. The prevalence of TRAs in the news and as part of the most recent IPO cycle raised more awareness about the asset class. Now, investors interested in tax assets, and specifically TRAs, range from mega-funds down to middle-market managers and family offices, with certain investors looking for more debt-like returns and others looking for enhanced returns beyond those of equities.
What does a typical sale process for a TRA look like?
It can be a relatively short process that spans anywhere from two to five months. Initial valuations are typically priced on public information. However, ultimately, historical tax benefit and payment schedules, tax returns, and GAAP/tax bridges will likely be requested as part of the diligence phase. To the extent that holders already have this information, the timeline shrinks. Conversely, if these items need to be requested separately or management input is required from the public company, this can push towards the longer end of the timeline. Keep in mind that the underlying companies are public, so much of the information on the company itself is already public, and there is also typically analyst coverage, which is why the sale process is shorter than that of an entire business.
What challenges does the TRA market face?
We think the biggest challenge right now is that sponsors, individual holders, and founders historically have not been aware that there is a strong appetite in the market for tax assets and, as a result, are not actively considering whether it’s better to hold the TRA themselves or sell it to an investor. In addition, there’s always some level of reticence to transact in nascent markets because both buyers and sellers like to point to market precedents in making their decisions. With the secondary market growing, there’s more evidence around market pricing, which we expect to provide a positive feedback loop of providing pricing confidence for both buyers and sellers.
How do you see the TRA market evolving?
We think we’ll see a few things. First, we’d expect the number of primary TRA issuances to continue to rise as the IPO market rebounds. Second, there will be more secondary transactions in TRAs as private equity holders from the most recent IPO boom approach the end of their funds’ lives or exit out of the remaining post-IPO equity.
The big variable for a TRA market expansion hinges on a de-coupling from IPOs, though. There are huge amounts of tax assets being created on a daily basis for which there is minimal liquidity. For example, we think there is an opportunity for more sponsors to capture incremental value in regular way exits by monetizing tax assets sitting in their portfolio companies. Additionally, many public companies with deferred tax assets (DTAs) could put a TRA in place and monetize their DTA balances as part of a soft financing or as a hedge to ensure they lock in the value of the DTA today. Certain deferred tax assets have short amortization periods, which could provide more opportunity for TRAs to span a wider spectrum of durations and yields, thereby increasing the investor audience.
So, what’s The Takeaway?
TRAs are trending towards becoming mainstream as investor interest continues to increase.
There is still a lack of general information about this market, as well as a lack of awareness by holders of how an investor prices a TRA, considering the various risks inherent in both the instrument and the underlying company.
Houlihan Lokey can help holders understand how investors are looking at and pricing TRAs and advise on optimal monetization strategies.
