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Leveraged Partnership

  • A leveraged partnership structure allows a seller to transfer most of the economic interest in a business in exchange for cash without triggering current taxes
  • The seller must find a strategic or financial partner to form a partnership
    • Substantially all of the economics (i.e. up to 90%) and effective control of a business can be allocated to the purchaser.
    • The seller receives cash proceeds through a leveraged distribution by the partnership.
  • In the typical structure, the seller guarantees the debt of the partnership in an amount equal to the cash distributed to the seller.
    • To reduce the costs associated with financing, (i) the purchaser can provide the financing (so long as the seller guarantees its repayment) or (ii) the purchaser can be a co-guarantor so long as the seller indemnifies the purchaser for any costs it bears as guarantor.
  • If an affiliate of the seller were to guarantee the debt, the affiliate's asset value would generally only need to be approximately 25-30% of the total amount of debt guaranteed, allowing the remaining 70-75% of value to be distributed to the seller (provided there is sufficient equity cushion in the partnership and the guarantee is unlikely to be called).
  • The seller's tax gain is deferred, in general, until such time as (i) the seller exits the partnership, (ii) the assets of the partnership contributed by the seller are sold, (iii) the debt is repaid, or (iv) the guarantee no longer exists.
  • The seller can retain a put right on its residual equity interest to ensure liquidity for exit and the purchaser can have a call right after a certain time period to compel such exit.
  • This structure also has the potential to give the seller a tax-deferred exit after seven years.
  • In sum, a properly structured leveraged partnership provides substantial tax-deferred cash with relatively low tax risk and minimal economic exposure to the business being sold.
  • Precedent transactions: Georgia Pacific/Chesapeake, LIN Television/NBC

Transaction Structure

leveraged partnership structure
  1. Sub and Partner form LLC(1)
  2. Sub contributes Business assets to the LLC in exchange for (1) a cash payment equal to, for example, 90% of the value of the contributed Business assets, and (2) a 10% equity stake in the LLC.
  3. Partner contributes assets in exchange for a 90% equity stake in the LLC.
  4. The LLC incurs debt (secured by the LLC's assets) in an amount equal to 90% of the contributed Business assets and distributes the cash to Sub tax-free (see step 2.2 above).
  5. Sub guarantees debt of the LLC equal to the amount of cash Sub receives.(2)
  6. Sub distributes 70-75% of cash to the seller.
    • Sub should be respected, for tax purposes, as guarantor of the debt with assets equal to only 20-25% of the value of the guarantee.(3)
    • The remaining 25-30% cash may be loaned to Seller in exchange for a Seller note.
  1. LLC and Partnership are used interchangeably (the structure is a partnership for U.S. tax purposes).
  2. FASB Interpretation 45, issued in November 2002, requires that the guarantor (i) recognize a liability for the guarantee's fair value and (ii) fully disclose the guarantee in financial statements.
  3. Provided that the reliable cash flow generated by the LLC assets and the equity cushion in the LLC make the guarantee unlikely to be called.
Benefits   Considerations
  • Tax-deferred disposition in exchange for cash and an equity stake in the partnership.
  • Seller-retained equity can be very small (10%).
  • Partnership debt is non-recourse to Seller (i.e. recourse solely to Subsidiary which only has sufficient assets to cover 25-30% of the guarantee).
  • Seller retains upside to the extent of its partnership equity participation.
  • Seller may retain put rights to finalize the sale.
    • Possible right to flip-in to Purchaser equity securities.
  • Potential for tax-deferred final exit after seven years.
  • Debt guaranteed by Seller of Subsidiary is treated as Seller debt by credit ratings agencies, if cash-settled, at least to the extent of Seller's exposure (e.g. 25-30%).
  • Guarantee must be recognized as a liability (at fair value) and fully disclosed in financial statements.(1)
  • Purchaser is likely to seek a call right to terminate the JV after a certain period of time, which would limit the length of the Seller's tax deferral.
  • Final exit may trigger meaningful taxable gain.
  • Economic risk that guarantee could be called upon default of the debt (mitigated by (i) cash flow of Business, (ii) equity cushion in the partnership, (iii) Subsidiary holding assets worth only 25-30% of the guarantee, and (iv) protective rights of Seller against partnership actions which could impair its credit).
  • Purchaser cannot receive tax basis step-up that would otherwise improve valuation of Business contribution.
    • Conversely, Seller does not have a taxable sale.
    • Alternatively, special tax allocations could be used to compensate Purchaser (to a certain extent) for lost basis step-up, but at a cost to the Seller.
  1. FASB Interpretation 45, issued in November 2002, requires that the guarantor (i) recognize a liability for the guarantee's fair value and (ii) fully disclose the guarantee in financial statements. "Fair value" is to be measured by the premium received by the guarantor for issuing the guarantee or the amount of premium which would be required by the guarantor to issue the same guarantee in a standalone arm's-length transaction with an unrelated party. Required disclosures of the guarantee include the term, origin, maximum potential future payments, surrounding events or circumstances, nature of any recourse, and assets held as collateral.

Bottom Guarantee

To reduce Seller's credit exposure on the guarantee, a "bottom guarantee" structure can be utilized.

bottom guarantee structure
  • LLC would borrow an amount greater than needed to fund the distribution, thereby creating excess cash for deployment in the JV.
  • Seller would guarantee all remaining amounts in excess of the first losses on the entire borrowing.
  • The partnership must borrow more than 90% of the value of the Business so that Sub will still be able to guarantee debt equal to the cash it receives, while not bearing the "first losses" on this debt.
  • The excess cash can be utilized for normal working capital needs of the JV, or to fund acquisitions or capital expenditures.
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