United States: The Up-C Structure In IPOs

Basic Features

The umbrella partnership - C corporation structure ("Up-C") is an indirect mode for an operating partnership to conduct an initial public offering ("IPO"). It derives its name from the Up-REIT structure, widely used by real estate investment trusts since the 1990s. An Up-C is composed of two entities: the parent company, which is a C corporation ("PubCo"), which will be organized as a holding company, and PubCo's subsidiary, which is the then-existing operating partnership, usually structured as a limited liability company or a limited partnership (a "Flow-through Entity"). The Flow-through Entity's capital structure will be modified by reclassifying the interests of its original owners ("Original Partners") into a new class of interests that is exchangeable for PubCo common stock. The Up-C structure makes it possible for the Flow-through Entity to undertake an IPO while maintaining its partnership status, principal assets and operating business. Private equity-backed and venture capital-backed companies generally favor the Up-C structure because these financial investors often use flow-through entities to hold their interests in portfolio companies. The Up-C structure is a convenient tool to offer the portfolio companies' shares to the public through an IPO.

Structuring the Up-C

  1. Pre-IPO. The Flow-through Entity begins as a limited liability company or partnership, which is owned by the Original Partners.

  2. PubCo formation. The Original Partners incorporate PubCo as a C-corporation. PubCo will have two classes of common stock. PubCo's Class A common stock ("Class A Shares") will be offered in the IPO. PubCo's Class B common stock ("Class B Shares") is held by the Original Partners, and it provides voting rights but no economic rights.



    The Original Partners are expected to recapitalize the Flow-through Entity by using a single class of units that can be subsequently exchanged for Class A Shares or redeemed for cash, typically at the option of PubCo. This recapitalization may be through a newly issued class of units or those units held by Original Partners (if they intend to partially exit from their investment in the Flow-through Entity).
  3. Post-IPO. Class A Shares are sold to the public through an IPO. PubCo is effectively a holding company, which has the Flowthrough Entity as its subsidiary. The Flow-through Entity continues to hold the principal assets and operate the business. PubCo's certificate of incorporation and bylaws are amended to provide that each Original Partner will receive one or more of the newly created Class B Shares that will vote along with the Class A Shares. Holders of Class B Shares participate in any stockholder vote on an as-exchanged basis. This enables the Original Partners to continue to exercise control over PubCo commensurate with their economic interests in the Flow-through Entity.

  4. Final structure. PubCo uses the IPO proceeds to purchase a controlling interest in the Flow-through Entity. The Flowthrough Entity, in turn, redeems partnership interests from the Original Partners. For tax purposes, this redemption is treated as a "disguised sale" or a direct purchase of partnership interests by PubCo from the Original Partners.

Rationale and Benefits of the Structure

Prior to the IPO, the entity's business was conducted through the Flow-through Entity, which is a pass-through structure and does not pay entity-level taxes. Through the implementation of the Up-C structure, the pass-through entity remains in place, and PubCo pays the Original Partners for the value of PubCo's tax attributes as those tax attributes are used after the IPO. Each time an Original Partner exchanges Flow-through Entity units for PubCo shares, PubCo will receive a "step-up" in the tax basis of its assets. This tax basis step-up is allocated to PubCo's share of the historic business' assets (based on their fair market value) and any excess is allocated to intangible assets (i.e., goodwill) that are amortizable over a 15-year straight-line basis ("Section 197 intangibles"). In order to implement the Up-C, PubCo, the Original Partners and the Flow-through Entity will have to enter into various agreements, such as a tax receivable agreement ("TRA"), an exchange agreement and a registration rights agreement.

Tax Receivable Agreement

The TRA typically requires PubCo to share tax savings with the Original Partners. The Original Partners and Pubco will customarily share an 85:15 split on the benefits from the tax basis step-up generated by PubCo's purchase of its interest in the Flow-through Entity and any net operating losses incurred. PubCo will pay the negotiated percentage (e.g., 85%) of the value of the actual state and federal income tax savings to the Original Partners.1 For tax purposes, these payments are treated as contingent installment sale proceeds, generating both additional step-up and deemed interest deductions for PubCo. The additional step-up has the effect of increasing the amounts of subsequent TRA payments.

An illustration of potential TRA economics is as follows:

The TRA may also provide for a lump sum payment to the Original Partners in case of a merger, asset sale or other form of business combination or change in control. The Original Partners are ordinarily not required to remain owners of the Flow-through Entity, and they remain entitled to receive any payments under the TRA should they choose to divest their ownership.2 The Up-C structure allows the Original Partners to maintain their interests in the Flow-through Entity, with its tax structure, and be subject to only one level of tax. The public stockholders are also benefitted by the Up-C structure through PubCo's resulting increased cash flow.

Exchange Agreement

PubCo's Class B shares will not be offered to the public. The exchange agreement, however, will provide the Original Partners with liquidity through a right to exchange Original Partners interests for the publicly traded Class A Shares on a one-for-one basis. In that case, a corresponding number of Class B shares fall away. In order to minimize any burdens on PubCo, the exchange agreement will specify some limitations for exchanges. The agreement may also limit exchanges in order to limit the effect of such exchanges on the trading market for the Class A Shares.

Registration Rights Agreement

When Original Partner interests are exchanged for Class A Shares, these securities will be "restricted securities" as defined in Rule 144 ("Rule 144") under the Securities Act of 1933, as amended, unless registered pursuant to an exchange registration statement or a resale registration statement. PubCo, the Original Partners, the holders of Class A Shares and those who hold securities that are convertible or exchangeable into Class A Shares may choose to enter into a registration rights agreement. This agreement will enable them to request that PubCo file with the Securities and Exchange Commission either a resale or an exchange registration statement for the sale of the Class A Shares.

Rule 144 Relief

On November 1, 2016, SEC Division of Corporation Finance staff (the "Staff") issued a no-action letter with respect to the required Rule 144 holding period and tacking of an Original Partner's holding period for the Flow-through Entity units. Rule 144(d)(1)'s holding period for the Class A Shares commences upon the earlier acquisition of the Flow-through Entity units if: (i) the Original Partners paid the full purchase price for the Flow-through Entity units at the time they were acquired from the Flowthrough Entity; (ii) the Up-C governing documents contemplate and provide the terms for the exchange of Flow-through Entity partnership interests for PubCo shares such that each Original Partner has the same economic risk as if it was a holder of the PubCo shares during the entire period such Original Partner holds the Flow-through Entity partnership interests; and (iii) no additional consideration is paid by the Original Partners for the PubCo shares. The holding period requirement is either six months or one year depending on the issuer's reporting requirements, and usually commences when a person acquires a security.

In effect, the Original Partners may choose to rely on Rule 144 in reselling their restricted Class A Shares instead of having PubCo file a registration statement.

In Acquisitions and Winding Up

An entity that relies on an Up-C structure can use cash or the PubCo shares as acquisition currencies. It can also use the Flowthrough Entity units. The sellers will contribute the target company to the Flow-through Entity in exchange for Flow-through Entity units that may, at some point in the future, be exchanged for PubCo shares. The sellers and PubCo will enter into a TRA. The sellers benefit from this pass-through structure, and the target company becomes a disregarded entity for tax purposes. This mode of acquisition benefits the sellers with tax deferral, a single layer of tax and liquidity through the ability to exchange.

An entity that relies on an Up-C structure may also choose to "unwind" such structure due to a continued decrease of PubCo's stock price, upon weighing the benefits against detriments or for change of control considerations. In doing so, its TRA provisions will often be accelerated and the dual class share structure is eliminated in order to gain full ownership of the Flow-through Entity.

To read the full article click here

Footnote

1 The Tax Cuts and Jobs Act reduced the general corporate tax rate from a maximum graduated rate of 35% to a flat rate of 21% for taxable years beginning after December 31, 2017. This lower rate decreases the value of the basis step-up, which, in effect, decreases the amount of TRA payments. Other impacts of tax reform on the Up-C structure include limits on the use of net operating loss carry-forwards, limits on interest deductions and bonus depreciation/expensing provisions.

2 In implementing the TRA, PubCo will have to make TRA payments and accurately disclose potential liabilities under the TRA. Additional accounting, modeling and compliance work is expected from PubCo.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2019. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions