Tax Deals Can Cause Conflicts

One strange piece of market inefficiency is that public markets supposedly undervalue tax assets.1 So a private equity firm will sometimes take a company private and then run it in a way that generates lots of tax deductions, lots of tax credits and net operating losses and depreciation and amortization that will offset future taxable income. And they will look at the company and see that it has, say, an operating business worth $100 and tax assets that will generate $5 per year of tax savings,2 and they will be happy.

But then they will want to take it public, and they will go to public investors and say “how much would you pay us for this company,” and the public investors will say “$100,” and the private equity firm will say “sure the business is worth $100, but we’ve got all these tax benefits, like $5 per year of tax benefits, surely that’s worth like $125 total?” And the public investors will say “no, we don’t understand taxes, we don’t care about that stuff, we’ll pay you $100.”