Paul L. Caron

Wednesday, September 6, 2023

WSJ: Money-For-Nothing Lawsuits Against Private-Equity Founders Get Boost

Wall Street Journal, Money-for-Nothing Lawsuits Against Private-Equity Founders Get Boost:

The founders of giant private-equity firms have been paid billions of dollars over the years. Payouts tied to arcane tax deals that brought nearly a billion more are under scrutiny in a Delaware courtroom.

Private-equity titans Apollo Global Management and Carlyle Group CG paid insiders more than $900 million as part of the tax deals. These second windfalls have triggered litigation by investors alleging that the firms paid their founders for nothing in return.

Now, a judge’s ruling on a related case involving fellow private-equity giant KKR gives these lawsuits more heft and could trigger settlement talks between the firms and their investors.

The lawsuits involved so-called tax-receivable agreements, or TRAs. Firms with TRAs have a specific corporate structure that can create valuable tax assets for the company when founders and early investors sell their stakes after an initial public offering. Then the company and the sellers share the tax asset so both benefit.

The private-equity firms’ restructurings didn’t create any tax assets, yet the company paid the founders anyway, the lawsuits say. ...

Last month saw a potentially significant development in a TRA lawsuit, lawyers who have been following the cases say. That lawsuit is against GoDaddy, the website-hosting company, which was backed by KKR and other investors.

GoDaddy went public in a deal that was structured to generate more than $1 billion in tax benefits for the company and share them through a TRA. But GoDaddy had large losses and paid little in taxes. The company said it was unlikely to use all of the tax assets and carried potential payments related to them on its books at $175 million.

But in 2020, GoDaddy’s board approved a deal to send $850 million to the company’s founder and its private-equity backers, including KKR, to buy out the obligation.

Shareholders sued over the payment, and a Delaware judge bolstered their case a couple of weeks ago. “Everyone knew that the company was paying $850 million for a liability valued in the company’s public disclosures at $175.3 million,” the judge said, “But the voting directors held their noses and approved the transaction.” The judge denied GoDaddy’s motion to dismiss the case. ...

TRAs are generally used when businesses structured like partnerships or limited-liability companies go public. The publicly traded company has different sets of shares. The pre-IPO investors own shares in the original operating company while the new shareholders own stock in the publicly traded entity, which then owns shares in the operating company.

When the original investors sell, their shares become shares in the publicly traded entity. This triggers the creation of the tax asset, which can reduce the company’s tax bill.

With a TRA, those savings are mostly relayed back to the early investors, who must pay taxes on their sale. Nearly all TRAs split the tax assets 85/15 between the investor and company, in what is billed as a win-win for both parties.

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