In a bold and controversial move that has sparked legal backlash, private-equity behemoths Apollo Global Management and Carlyle Group have paid insiders over $900 million in relation to contentious tax deals. The payouts, tied to tax-receivable agreements (TRAs), have led to a flurry of lawsuits from investors who assert that the firms compensated their founders excessively, without any tangible return.

The controversy surrounding these payouts has intensified following a recent judge’s ruling on a similar case involving KKR, another private-equity titan. The ruling, which held significant implications for TRA lawsuits, may potentially instigate settlement negotiations between the disputing firms and their investors. The TRAs under scrutiny are typically used when businesses structured like partnerships or limited-liability companies go public, creating valuable tax assets for the company when founders and early investors sell their stakes after an initial public offering. However, the lawsuits contend that the private-equity firms’ restructurings did not create any tax assets, yet the insiders were paid nonetheless.

Delaware Court Scrutinizes Private-Equity Titans’ Billion-Dollar Payouts

In the world of private-equity firms, founders have been handsomely rewarded for their efforts, with payouts reaching astronomical figures. However, an additional billion dollars, tied to complex tax deals, is now under scrutiny in a Delaware courtroom. The founders of renowned private-equity giants Apollo Global Management and Carlyle Group have been paid over $900 million as part of these tax deals, sparking contentious litigation by investors who claim these payments were for naught.

Tax Receivable Agreements Under Fire

The lawsuits focus on so-called tax-receivable agreements (TRAs), a corporate structure that creates valuable tax assets when founders and early investors sell their stakes post-initial public offering (IPO). The tax assets are then shared between the company and sellers. However, the recent lawsuits allege that, despite no tax assets being created by the firms’ restructurings, the companies paid their founders anyway.

Andy Lee, Chief Investment Officer of Parallaxes Capital Management, expressed confusion over why a company would pay for a non-existent asset. "If a tax asset wasn’t created, then there’s no value whatsoever," Lee stated.

GoDaddy Case Could Set Precedent

In a potentially significant development, a TRA lawsuit against website-hosting company GoDaddy, backed by KKR and other investors, could influence future settlement talks in similar cases. GoDaddy’s board approved an $850 million payout to the company’s founder and its private-equity backers in 2020, despite carrying potential payments related to tax assets at only $175 million.

A Delaware judge recently denied GoDaddy’s motion to dismiss the case, stating that everyone was aware the company was overpaying for a liability valued at $175.3 million. This ruling could potentially lead other companies in similar situations into settlement talks.

Apollo and Carlyle Lawsuits

In the case of Apollo, a lawsuit alleges that founders Leon Black, Josh Harris, and current CEO Marc Rowan arranged for their firm to pay $570 million to themselves and other insiders as part of a restructuring. Carlyle’s restructuring and payout mirrored Apollo’s, with payments of $344 million made to insiders.

Investors argue that no tax assets were created in either case, meaning the firms received money from their companies and shareholders for nothing in return.

A Win-Win Turned Sour

TRAs are typically used when businesses structured as partnerships or limited-liability companies go public. The original investors sell their shares, which then become shares in the publicly traded entity, triggering the creation of a tax asset. This can reduce the company’s tax bill, and with a TRA, those savings are mostly relayed back to the early investors.

However, when Apollo and Carlyle restructured, no tax bill was created for the pre-IPO shareholders, and no tax asset was created for the company. Despite this, the companies paid insiders for their TRA rights as part of the transactions.

Key Takeaways

These lawsuits underscore the importance of transparency and accountability in financial transactions, particularly within the private equity space. The scrutiny surrounding TRAs and the payouts connected to them could lead to significant changes in how these agreements are structured and managed. This could potentially protect shareholders from potential losses while maintaining the integrity of the financial markets.