Tax Geek Tips You Ought To Know
A PUBLICATION OF THE BALLARD SPAHR TAX GROUP
OCTOBER 2014
THE LESSONS OF UP-C IPOS FOR EVERYONE
The Up-C IPO structure (sometimes called Supercharged IPO structure, or the barnesandnoble.com structure)
is a method of taking a company public using an LLC. Use of this structure allows the pre-IPO owners to
receive a higher purchase price for their interests than they would have received if the IPO had been undertaken
using a traditional structure.
You may say to yourself, I’m neither the owner of a company that will go public, nor an adviser to one, so why
would I care? The answer is that the Up-C IPO structure offers several important lessons to anyone engaged in,
or advising as to, business transactions:
Lesson 1: Using a structure that allows buyers to receive a tax benefit often allows sellers the ability to
negotiate to receive a higher purchase price.
Lesson 2: There are few circumstances in which an LLC would not make sense as the initial choice of
entity.
Lesson 3: The effect of taxes on the bottom line (i.e., dollars paid or dollars received) is best realized
when discussed early and understood by the non-tax advisers.
Traditional IPO
Until relatively recently, it was commonly accepted that companies desiring to go public should be C
corporations.1
1
While it may be possible for interests in an LLC to be publicly traded, the capital markets generally expect publicly traded
companies to be state law corporations. In addition, in most cases, the tax advantages typically associated with LLCs will be lost
because a publicly traded LLC will be treated for U.S. federal income tax purposes as though it were a corporation (subject to
some exceptions).
Diagram of Traditional IPO Structure:
Pre-IPO owners sell stock to public
PRE-IPO
OWNERS
SHARES
OF IPO CO
CASH
End result
PRE-IPO
OWNERS
PUBLIC
IPO CO
PUBLIC
IPO CO
Up-C IPO
The Up-C IPO structure2 is premised on the following basic principles of tax law:
• Buyers want a tax basis step-up with respect to the assets of the business they are purchasing.
• Tax deductions resulting from a stepped-up tax basis are tax benefits with a value.
• Buyers will pay more for a company with a stepped-up tax basis in assets than for one with no such
stepped-up tax basis.
Diagram of Up-C IPO Structure:
Beginning structure
Simplified steps
End result
PUBLIC
PRE-IPO
OWNERS
PRE-IPO
OWNERS
LLC SUB
2
MEMBERSHIP
INTERESTS
IN LLC SUB
CASH
LLC SUB
IPO CO
PUBLIC
IPO CO
LLC SUB
The Up-C IPO structure gets its name from the UPREIT structure for REITS. In the early ‘90s, the real estate industry began
placing partnership under REITS when taking the REIT public. The Up-C IPO is similarly based on a structure under which
an LLC/partnership is placed under IPO Co.
The public shareholders purchase their shares in IPO Co for cash. IPO Co uses the proceeds received in
the IPO to purchase interests in LLC Sub from the pre-IPO owners. LLC Sub has a “Section 754 election”
in place—which generally means that a buyer that purchases interests in it is able to obtain tax deductions
associated with a stepped-up tax basis. The pre-IPO owners need not sell all their interests in LLC Sub at the
time of the IPO in order to convey tax benefits to IPO Co.3 This feature offers a major tax deferral benefit
for the pre-IPO owners over what would generally be available to them as C corporation shareholders.4
Typically, the pre-IPO owners enter a tax receivables agreement (TRA), pursuant to which IPO Co pays them
85 percent of the tax benefits realized relating to the tax basis step-up.
Further Consideration of Lessons for All:
Lesson 1: Using a structure that allows buyers to receive a tax benefit often allows sellers the ability to
negotiate to receive a higher purchase price.
It is estimated that TRA payments associated with an Up-C IPO can result in an additional 10
to 20 percent in cash proceeds to the pre-IPO owners over the life of the sale. Outside the IPO
context, any time a buyer receives a stepped-up tax basis, it is due in part to the fact that the seller
owned the business in a manner or structure that allowed a stepped-up tax basis to be achieved
upon purchase. This should not be overlooked in discussions of the purchase price to be paid to
sellers.
Lesson 2: There are few circumstances in which an LLC would not make sense as the initial choice
of entity.
While there are some circumstances in which a C corporation may make sense (for example, as a
vehicle for investment by a non-U.S. investor), there are very few such circumstances. Generally,
a purchase/sale of an LLC will result in a stepped-up tax basis to the buyer. By contrast, there
are limited circumstances where this is true of a purchase/sale of an interest in a corporation.
Furthermore, converting from an LLC to a corporation may often be done without triggering
income taxes. This is not true of a conversion of a corporation to an LLC.
Lesson 3: The effect of taxes on the bottom line (i.e., dollars paid or dollars received) is best realized
when discussed early and understood by the non-tax advisers.
Up-C IPOs are based on relatively straightforward and settled tax law. One of the first IPOs using
this structure involved barnesandnoble.com in 1999. However, it wasn’t until a few years later
that the Up-C IPO structure became more commonly used. There likely are many reasons for the
delay in the structure being used on a more frequent basis. That said, in the authors’ experiences,
using tax considerations to negotiate better business terms is most successful when tax lawyers are
involved in discussions sooner rather than later, and further where the non-tax advisers and relevant
parties have a clear understanding of the tax considerations.
3 IPO Co obtains a stepped-up tax basis (which results in tax deductions) in the shares of LLC Sub’s assets upon its initial
purchase of any LLC Sub interest in the IPO, and upon any subsequent exchange of LLC Sub’s units for IPO shares.
4 The units they own in LLC Sub are exchangeable for shares of IPO Co at any time they choose. While the future exchange
will be taxable, this feature permits tax deferral without the tax complexity of an installment sale.
The above discussion addresses the tax issues and structuring involved only at a high level.
Please consult members of the Ballard Spahr Tax Group for further discussion.
Saba Ashraf
Partner
[email protected]
Tel 678.420.9372
Atlanta
Christopher A. Jones
Associate
[email protected]
Tel 215.864.8424
Philadelphia
Jeffrey R. Davine
Partner
[email protected]
Tel 303.299.7312
Denver
Wendi L. Kotzen
Partner
[email protected]
Tel 215.864.8305
Philadelphia
Wayne R. Strasbaugh
Partner
[email protected]
Tel 215.864.8328
Philadelphia
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