Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Tax Receivable Agreements for Exit Liquidity
Transcript
- Lucas: So there's this provision that's quietly become a fixture in exit agreements — especially for companies that have racked up significant net operating losses before being acquired. It's called a Tax Receivable Agreement, or TRA, and it's essentially a way for founders to get paid for the tax benefits they're handing over to the buyer. Luna: Right — because when a company with NOLs gets bought, the acquirer can use those losses to offset future taxable income. The TRA lets the seller share in that future tax saving. Lucas: Exactly. And the structure is pretty elegant on paper. The buyer calculates the tax savings they expect to realize from using the target's NOLs, then agrees to pay a percentage — usually 85 percent — back to the selling shareholders over time. So instead of negotiating a higher upfront price, the founder gets a contingent stream of payments tied to actual tax savings. Luna: I remember the first time I saw one of these up close. It was a $2.3 billion acquisition back in 2023 — the founder got about $80 million cash at close, and then a TRA that paid out roughly $30 million over five years. That was a huge piece of their total consideration. Lucas: And that's the appeal. In a competitive bidding process, a TRA can bridge the valuation gap without the buyer having to write a bigger check upfront. The buyer only pays if they actually realize the tax savings, so it's performance-based. For the founder, it's additional upside — and it's typically structured as ordinary income, not capital gains, which actually matters for tax planning. Luna: But there are risks. What if the buyer restructures or doesn't generate enough taxable income to use the NOLs? Then the payments never materialize. Lucas: That's the big one. The TRA is only as good as the buyer's future taxable income. And there's also the question of subordination — if the buyer runs into financial trouble, TRA payments are usually junior to debt and other obligations. Founders need to understand they're taking on counterparty risk. Luna: And the time horizon. These payments can stretch five, ten, even fifteen years. You're essentially betting on the acquirer's long-term profitability. Lucas: Right. And there's another wrinkle that doesn't get enough attention: the clawback provision. If the IRS later challenges the NOLs or the tax basis step-up, the buyer can demand repayment from the selling shareholders. That's a real risk, especially in industries where tax positions are aggressive. Luna: So the TRA is not free money — it's a contingent asset with real legal and financial complexity. But for founders who want to defer recognition of income, or who believe the acquirer will be profitable, it can be very attractive. Lucas: And it's becoming more common. A lot of private equity buyers have standardized TRA language in their acquisition agreements. I've seen them in everything from software roll-ups to biotech asset purchases. They're especially popular when the target has significant NOLs — which, in this environment, a lot of startups do. Luna: We're seeing it in IPOs too, not just M&A. Some companies with built-up NOLs are including TRA provisions in their IPO structure. The idea is that after going public, the company itself will use the NOLs, and the TRA pays out to pre ipo shareholders. Lucas: That's a newer development, and it's interesting because it effectively turns a corporate tax attribute into a source of liquidity for founders. Instead of selling shares in the IPO, they hold and get paid via the TRA over time. It's a way to avoid dilution while still getting cash. Luna: But it's also a signal to the market. If a company has a large TRA liability on its balance sheet, analysts will discount it — it's a future cash obligation. So there's a trade-off between founder liquidity and corporate transparency. Lucas: And that trade-off is especially relevant right now. I was looking at the IPO filing for that AI startup that just went public — the one everyone's been watching — and they disclosed a $1.2 billion TRA liability. That's a big number, and it's going to be a line item shareholders watch closely. Luna: That's massive. But it also tells you how valuable those NOLs are. For a company that was losing money for years, those losses are now a currency. Lucas: Exactly. And the TRA structure lets founders monetize that currency without having to sell shares at what they might consider a discount. It's a sophisticated tool, but it's not for every situation. Luna: When would you advise a founder to avoid a TRA? Lucas: If the acquirer is highly leveraged or in a cyclical industry where earnings are unpredictable, you're taking on real risk. Also, if the founder needs liquidity immediately — TRA payments are back-loaded by design. And if the tax basis step-up is uncertain — for example, if the company's NOLs have gone through a change of ownership and face Section 382 limitations — then the TRA might not pay out much at all. Luna: So it's a tool for patient capital. For founders who can afford to wait and who trust the buyer's ability to generate taxable income. Lucas: Right. And the best founders I've seen use TRA effectively are the ones who treat it as part of a broader liquidity plan — not a silver bullet. They combine it with secondary sales, earnouts, maybe a pre ipo loan. It's one instrument in a portfolio. Luna: Speaking of instruments, there's a related structure called a Tax Receivable Agreement Financing — where a third party advances cash to the founder based on the expected TRA payments, essentially a loan secured by the TRA. That's gaining traction too. Lucas: Yes, and that's even more complex because you're adding leverage on top of a contingent asset. The interest rates on those financings are typically high, and if the TRA doesn't pay out, the founder still owes the loan. It can magnify risk dramatically. Luna: So the takeaway is that TRA can be a powerful tool, but it requires careful due diligence — on the buyer, on the tax attributes, on the legal terms. And it's not something to sign without expert advice. Lucas: Absolutely. Founders should engage tax counsel and a financial advisor who's done TRA deals before. The boilerplate language is not standardized across firms, and small differences — like the definition of 'realized tax benefit' — can change the economics significantly. Luna: And one more thing — the timing. If you're considering an exit, start thinking about TRA early. The structure needs to be baked into the deal negotiations, not tacked on at the end. You need to know your NOL position, your tax basis, and your comfort with deferred payments before you enter the room. Lucas: Yeah, that's crucial. And if you want to learn more about structuring these agreements or see a real-world case study, we've linked to a detailed breakdown in the show notes. It's worth a read. Lucas: You know, this show only works because listeners like you support it directly. If today's episode was worth the price of a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It keeps us ad-free and independent. Luna: Yeah, we really appreciate it. It means we can keep digging into these niche topics without worrying about sponsors or clicks. Lucas: Exactly. So from TRA to NOLs to the fine print — we'll keep bringing you the mechanics behind the deals. Thanks for being here. Luna: Next episode, we're looking at how founders use contingent value rights — CVRs — to bridge valuation gaps in pharma exits. It's a different animal, but the same principle of aligning incentives post-close. Lucas: That's a good one. See you then.