The Rise of the Up-C and TRA in IPOs

At first reading, it may sound complicated and perhaps a little ominous. 

However, while it is likely complicated, recent trends in going public can enhance the value for both the new public shareholders and the legacy business owners alike.

Up-C structure

The Up-C structure derives its name from the UpREIT transaction that became popular in the late 90’s. With limited exceptions, a business desiring to become a public company must be taxed as C corporation (C Corp). As a result, many businesses that have historically been taxed as a partnership convert to a C Corp prior to executing the initial public offering (IPO). This conversion can be accomplished in a variety of tax free transactions. However, the very nature of a tax free transaction causes the C Corp to have carryover tax basis in the business assets. Therefore, conversion from partnership to C Corp causes the built-in gain of the assets of the business to go from a single level of taxation to a double level of taxation (taxed at C Corp level and upon distribution at the shareholder level).

In the Up-C transaction, a new C Corp is formed as the vehicle to raise capital from the public market. The C Corp uses the IPO funds to purchase a portion or all of the legacy partners’ interests in the partnership. Provided that the partnership has made the IRC Sec. 754 election, the C Corp will receive a step-up in tax basis of the partnership assets pursuant to IRC Sec. 743(b). Often the most significant asset that is stepped-up is the business goodwill. For tax purposes, goodwill is an IRC Sec. 197 asset that is amortized over a 15-year period. Therefore, if the goodwill step-up is $150 million, the C Corp will be able to shield $10 million of income from taxation each year for the next 15 years.

While this tax shield will provide for additional cash flow from earnings, the public markets have traditionally not given credit for this attribute in valuing the stock price. In part, this may be caused by traditionally valuing businesses based on pretax income. Additionally, shareholders have not typically identified the value of the reduction in earnings and profits caused by the tax amortization of the stepped up assets. Based on the above example, if the C Corp generated $10 million of income that was 100% offset by the amortization, the C Corp’s earnings and profits would be zero. Therefore, if the C Corp distributed out to its shareholders the $10 million cash generated by the operations, it would be a return of capital rather than a dividend subject to tax at the shareholder level. Effectively, the Up-C structure causes the built-in gains of the business to only be subject to one level of taxation, in contrast to when the partnership merely converts to C Corp as discussed above.

TRA  - Tax Receivable Agreement

The tax receivable agreement (TRA) is a contract between the legacy partners who sold their partnership interests and the new public C Corp that acquired the interest to share the value of the tax benefits that arose from the step-up on the sale of the partnership interests. Typically, the legacy partners will receive 85% of the tax savings from the step-up and the C Corp will retain 15% of the value.  A TRA liability is recorded by the C Corp for the 85% of tax savings that are payable to the legacy partners.

Interestingly, as the public shareholders typically don’t account for the value of the tax shield from the step-up, they similarly appear to disregard the TRA liability when valuing the stock of the C Corp. 

Step-up on Steroids

As mentioned, the C Corp records a TRA liability for the future payments required pursuant to the TRA. This liability is payable to the legacy partners as the C Corp receives the benefits from the actual tax savings from the step-up. As a result, the C Corp performs a with and without step-up calculation of its income tax return to determine the TRA liability currently payable to the legacy partners. As the TRA is a component of the original purchase of the legacy partners' partnership interest, this payment constitutes additional purchase price of the partnership interest. When this payment is made an additional step-up occurs. Effectively, there is a step-up on the step-up payments. The additional step-up is amortized over the remaining number of years from the original purchase transaction. For example, if a TRA payment related to goodwill is made one year after the original transaction, then the period of amortization for the additional step-up is 14 years.


There are numerous disclosure requirements needed in the S-1 filed prior to an IPO. Pro Forma statements are needed to identify the impact of the transaction as if this structure had been in place from the beginning of the period being presented in the S-1. An estimate of the maximum TRA liability, maximum and minimum annual TRA payments, and the present value payment of any termination of the TRA is required to be disclosed. The TRA typically provides for a termination payment to the legacy partners if there is a change in control of the C Corp that requires an estimate of all the future TRA payments at present value for the period reported in the S-1.

Traditionally, the legacy partners receive super voting shares in the new public C Corp and, therefore, retain control of both the legacy business and the C Corp. As a result, the transaction for accounting purposes is not recorded using the purchase accounting rules and no step-up occurs for book purposes. This inherent difference between the book asset basis and the tax asset basis creates a significantly deferred tax asset. An evaluation of the future income is required to determine if there will be sufficient income to utilize this deferred tax asset. This analysis may determine that a valuation allowance is required against the deferred tax asset.

While the most significant asset that is stepped-up is often goodwill, a valuation of all of the business assets is necessary to determine the step-up on an asset-by-asset basis. If other assets are stepped-up, it is necessary to evaluate when this additional basis would be realized for tax purposes.

The above discussion was predicated on a single sale of the legacy partners' interests. However, the C Corp could have multiple rounds of funding and purchases of partnership interests. Additionally, many transactions allow for future exchanges of the legacy partners' interests for stock of the C Corp. Each of these subsequent sales or exchanges would result in new tranches of step-ups that have to be layered into the calculation to determine which tranch's step-up is producing the tax savings and therefore entitled to the TRA payment.


Despite the complexity and onerous reporting requirements, the value generated for both the legacy partners and public shareholders can be so significant that more and more businesses are pursuing this IPO strategy. However, to take full advantage of these benefits it is critical that the S-1 process, the post IPO TRA accounting, and early termination calculations take these additional complications into account.