Tax Receivables Agreements (TRAs) are becoming the next big thing in mergers, acquisitions (M&A), and initial public offerings (IPOs).

Think of them as a way for pre-IPO owners or sellers to cash in on future tax savings, turning tax perks into real money they can use. That’s why they’re becoming such a big deal in financial transactions.

Understanding TRAs is not only helpful but critical for any investor, business owner, or anyone involved in corporate finance. Let’s break it down.

What’s A Tax Receivable Agreement (TRA)?

A TRA is a deal between a company and its pre-IPO owners or sellers. It allows them to tap into future tax savings, often tied to depreciation, amortization, or net operating losses, turning tax benefits into real financial value.

When pre-IPO owners trade in their partnership units for company shares, something interesting happens, a tax-friendly ‘step-up’ in asset value. This step-up boosts the tax basis of the company’s assets, leading to bigger tax deductions over time. That step-up leads to bigger tax deductions, which means lower tax bills and that’s where the TRA comes in. The company agrees to share these savings with the original owners.

TRAs are especially common in Up-C structure IPOs, where pre-IPO owners get paid based on actual tax savings. But they’re also popping up in private M&A deals, where buyers and sellers need a creative way to settle differences over tax assets.

How Do TRAs Affect A Company’s Value?

TRAs can boost a company’s value, but they also add complexity. Lower income taxes mean more profit which should be great news, right? But there’s a catch. The company also has to share some of those savings with TRA holders, which adds another layer of complexity.

Figuring out a company’s worth when a TRA is in play isn’t as simple as crunching a few numbers. You have to look at its earning potential, expected tax savings, and future TRA payment obligations. While TRAs add value, they also make valuations trickier.

How Is A TRA’s Value Determined?

Here are some of the biggest factors that influence the value of a TRA:

1. Future profits

A TRA’s value largely depends on how much taxable income a company is expected to bring in. More profits mean bigger tax savings. But predicting future earnings isn’t straightforward, it takes smart financial modeling and a fair amount of forward-thinking.

2. The step-up effect

The step-up is probably one of the most important pieces in the valuation puzzle. It’s like the foundation of a TRA. Pre-IPO owners often swap their partnership units for shares, which boosts the tax basis of the company’s assets, leading to larger tax deductions.

3. Tax rates and policy changes

The lower the tax rate, the lower the value of a TRA. Tax rates go a long way in determining TRA benefits. The biggest winners are always companies in high-tax areas. Staying ahead of policy shifts is key because a few changes in tax laws can really shake things up.

4. Risk factors and present value

There’s no guarantee that future TRA payments will pan out as expected. Several risks come into play, including:

• Credit risk – Can the company afford to make TRA payments?
• Timing risk – When will the tax benefits materialize?
• Regulatory risk – Will tax laws stay the same?

All these factors affect how we calculate the present value of a TRA today.

TRAs In M&A Deals

TRAs have turned into a valuable tool in M&A negotiations. Buyers and sellers don’t always see eye to eye on the value of tax assets, what one side sees as a goldmine, the other might dismiss as uncertain. A TRA helps bridge this gap by ensuring sellers get paid only if the expected tax savings come through.

Here’s why that works:

• Buyers don’t have to overpay for uncertain tax benefits.
• Sellers can still capture long-term value from tax savings without upfront disputes.

Making deals smoother and more appealing for both buyers and sellers.

How TRAs Create Long-Term Value

For companies preparing for an IPO or a major transaction, a TRA is almost like an ace up your sleeve. It means both pre-IPO owners and sellers can have a say in the company’s future tax benefits.

TRAs also allow tax assets that might otherwise sit idle to be put to work. Depreciation, amortization, and net operating losses. Instead of letting them go to waste, TRAs convert them into financial benefits.

Conclusion

• TRAs let pre-IPO owners and sellers benefit from future tax savings, adding financial value to transactions.
• They impact business valuation by influencing future cash flow and tax obligations.
• Several factors affect a TRA’s value, including income projections, tax rates, and associated risks.
• When it comes to M&A deals, TRAs help smooth out valuation disagreements by linking payments directly to real, measurable tax savings.
• A well-designed TRA keeps everyone on the same page, aligning incentives, adding stability, and making the company more appealing to investors.

With TRAs becoming more common in today’s deals, knowing how they work isn’t just nice to have, it’s a must. Whether you’re buying or selling, understanding TRAs can give you a real advantage when it comes to negotiating and making smart investment moves.