As Arizona-based web holding company GoDaddy moves ahead with its plans for an IPO, the unique and complex “Up-C” IPO structure utilized by GoDaddy has gotten increasing attention. Companies that have traditionally been partnerships favor the structure, but the concept and its practical application are still not as widely understood as they could be.
In an exclusive interview with IFLR1000, John LeClaire (pictured), co-chair of the private equity practice at Goodwin Procter, put forth a detailed analysis of how the Up-C IPO works, the benefits of using the structure, and the prospects for its wider use in the capital markets.
IFLR1000: Briefly, how does this structure work and what is the rationale for it?
LeClaire: A partnership generally can’t be a public company, so to execute an Up-C IPO a corporation is formed to sell stock to the public. The corporation uses the IPO proceeds to buy an interest in the operating partnership. To illustrate simply, picture a partnership that has 70 shares and wants to sell a 30 percent stake to the public. The principals create a corporation, the corporation sells stock with a value equal to 30 percent of the value of the overall business, and the corporation invests money in the partnership to buy 30 shares. The actual execution of an Up-C is much more complicated than that, but that’s the basic idea.
IFLR1000: So what happens after the IPO?
LeClaire: After the IPO, when the legacy owners who own the partnership shares want liquidity, they swap their partnership shares with the public company for public company stock and then sell the stock in the market. That exchange gives the public company a tax write-up that shelters its taxable income in the future. The public company pays out a portion of these tax benefits in cash to the legacy owners whose exchanges created the write up. The amount of the write up is based on the value of the public company’s stock at the time of each exchange, and the payout is made over time as the tax benefits kick in. Public companies using Up-C structures also pay legacy owners for other tax assets they may contribute. What’s notable is that the cash payments to the legacy owners are in addition to the returns they realize by selling stock, and they are taxed at capital gains rates.
IFLR1000: Which market participants have favored or relied on the Up-C IPO the most?
LeClaire: In most corners of the growth economy, there’s a relatively low level of awareness about the Up C structure. To date, the structure has been used mostly in large deals with very sophisticated sponsors. And in the middle market in particular, company sale rather than IPO has been the preferred means of exit. A key question is whether the prospect of doing an Up-C IPO will change that.
IFLR1000: GoDaddy has been in the news a great deal. Do you see the structure becoming more common?
LeClaire: The use of the Up-C IPO is getting a bit more widespread, or at least the structure is becoming more well known. The structure requires a certain set of facts, but it’s conceptually available for any company out there in the market in tax pass through form, and over the past decade or so, an increasing number of growth companies are pass throughs. Historically, businesses that were partnerships for tax purposes converted into corporate form to go public. The key point of an Up-C IPO is that the operating company stays a partnership.
IFLR1000: Let’s talk, briefly, about the broader market context and the criteria that private equity investors bring to the table.
LeClaire: The Up-C IPO structure is really complex, so a small amount of cash benefit probably would not justify it. We’ll see if use becomes more widespread. The question is part of the larger topic of pass throughs generally – in the growth economy, companies increasingly favor the pass through form, and private equity investors need to have sharp skills in dealing with pass throughs and knowing the opportunities and pitfalls. Being a partnership has benefits and detriments throughout a company’s evolution. Most of the benefits arise at the time of a liquidity event. But if you don’t stay a partnership throughout your evolution, you can’t do an Up-C IPO structure when it’s time to go public.