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Business News/ Special Report / The Tax Whiz With the Strangest Hustle on Wall Street

The Tax Whiz With the Strangest Hustle on Wall Street

Investing in tax deals requires smarts and lots of patience.

Lee, 33 years old, founded Parallaxes Capital in 2017, creating a fund that seeks to turn TRAs into a new asset class by creating a secondary market for investors.

Andy Lee is the king of a lucrative niche in the financial markets. Being king isn’t easy.

Andy Lee is the king of a lucrative niche in the financial markets. Being king isn’t easy.

Lee invests in tax receivable agreements, increasingly common arrangements that put cash into the pockets of early investors in companies. Not many investors know how they work, and a surprising number of people don’t even know they have them.

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Lee invests in tax receivable agreements, increasingly common arrangements that put cash into the pockets of early investors in companies. Not many investors know how they work, and a surprising number of people don’t even know they have them.

That gives Lee an opening to buy up the cash flows from TRAs, as they are known, at a discount and count his winnings as they pay off. To get to that point requires deep knowledge of taxes, investing and the law, plus lots of persistence. To close a recent deal, Lee needed to obtain wet signatures, meaning handwritten, from as many as 114 people in seven days. “I want to punch myself in the face," Lee said. “It’s not rocket science, but there aren’t many people in finance who like to do this kind of thing."

Lee does. He has an average of 32 conversations a week in hopes of drumming up deals. He has pursued prospective sellers to extreme ends, once running a charity 5K race in hopes of pitching a deal to its guest of honor, a TRA holder.

Lee, 33 years old, founded Parallaxes Capital in 2017, creating a fund that seeks to turn TRAs into a new asset class by creating a secondary market for investors.

“In a relatively small and not super well-known space, Andy is by far the biggest fish in that pond," said Albert Chang, head of M&A, tax and structuring advisory at RBC Capital Markets.

Lee often starts with cold outreaches to people with TRAs who are surprised to hear from him. One company founder responded to Lee’s pitch with a cry laughing emoji. “I don’t know what a TRA is, so probably not for me," the founder said.

Lee had the public financial filings to prove the founder had a TRA and a price Parallaxes would pay for its future cash flows. Through thousands of conversations and one-on-one deals like these, Parallaxes has invested more than $300 million across four funds. It is currently raising two more.

As Lee pitches TRA holders, he educates potential investors. “I got the deck sent to me and at first I didn’t really understand what this was," said Gilbert Calderon, chief investment officer at M4 Capital Management, a single-family office in Chicago known for buying esoteric investments. M4 eventually signed on.

Other early investors included endowments that understood TRAs because they were themselves beneficiaries. One family office sold its own TRA payment rights to Parallaxes. It took a stake in the firm’s first fund instead of cash.

Parallaxes’s first two funds have returned about 15% annually, according to investors. Later funds have done better because some companies whose TRA rights they owned were acquired and the TRAs were paid out early.

TRAs are mostly used to unlock tax advantages when businesses structured as partnerships or limited-liability companies go public. The pre-initial-public-offering investors maintain an interest in the original operating company while the new shareholders own stock in a new publicly traded entity, which then holds shares in the operating company.

When the original investors sell, their stakes in the operating company become new shares in the publicly traded holding company. This triggers the creation of the tax asset, which can reduce the company’s tax bill.

A TRA splits those savings with the early investors, offsetting some of the tax bill from their sales. Nearly all TRAs split the tax assets 85/15 between the investor and company, in what is billed as a win-win for both parties. These payments to pre-IPO owners usually stretch over 15 years.

Parallaxes offers TRA beneficiaries cash up front in exchange for those potential future payments. The deals are similar to upfront payments for structured lawsuit settlements or winning lottery tickets that pay off over time. In its median deal, Parallaxes offers a TRA holder about $4 million and typically anticipates getting back 2.5 times its investment.

Investors like TRA cash flows because they have tax advantages over bonds and aren’t highly correlated to public markets. But if a company doesn’t produce big-enough profits or if tax rates go down, the TRA payouts could take longer or be less than expected. The biggest threat to a TRA is bankruptcy.

Lee started college at 16, attending the University of Illinois Urbana-Champaign, where his father had received a Ph.D. in computer science and his mother a master’s degree in accounting with a focus on taxes. Lee graduated with a job offer to join Citigroup in New York as an analyst.

But his father would only cosign Lee’s lease in New York if he earned a graduate degree. Lee chose the same accounting master’s his mother did because it required little in-person attendance and had an open-book final exam.

At Citigroup, Lee worked on a transaction where Cloud Peak Energy, a coal producer spun off from mining company Rio Tinto, pushed its former parent to sell its TRA obligation at a steep discount. Lee realized that Cloud Peak was essentially paying 36 cents for every $1 of cash flow that would accrue under the TRA.

Lee left Citigroup for private-equity firm Lone Star Funds, where he was tasked with coming up with new investment ideas. He pitched a fund that would invest in tax receivable agreements. His bosses at Lone Star, with $86 billion under management, balked at the small size of the market.

Lone Star encouraged him to start his own fund, and some of the firm’s partners were among his first investors, Lee said.

Then the hard work of finding investments began. Building substantial positions in specific TRAs can mean tracking down dozens of people and persuading them each individually to sell their TRA rights.

The firm finds people in public filings and plans its sales pitch. Lee likes to take people on walks with Taco, his five-year-old Corgi. He will hire athletes to make short Cameo videos to nudge deals over the line. One Duke University alumnus got a message from Jay Williams—star point guard of the school’s 2001 national-champion, men’s basketball team—imploring him to sell his TRA.

Parallaxes is now pursuing deals that dwarf the size of its first fund. But with more money comes more potential headaches, such as the deal provision that had Lee chasing the 114 people behind 34 beneficiaries to a TRA. Parallaxes had seven days to get a majority of each entity’s owners to sign a document acknowledging the deal. Lee and his team got it done.

Write to Ben Foldy at ben.foldy@wsj.com

The Tax Whiz With the Strangest Hustle on Wall Street
The Tax Whiz With the Strangest Hustle on Wall Street
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