Tax Implications of an LBO

Just to recap/confirm, the tax implications of an LBO are as follows:

  • Capitalization of transaction fees - amortized over 5-7 years, offer tax shield
  • Fixed asset and intangible asset write-up - higher asset base for D&A schedule, offer tax shield
  • Goodwill can no longer be amortized (correct?)
  • Goodwill impairment charge will not serve as a tax shield (correct?)

Additional NOL considerations:
- Can someone clarify the limit on NOLs that can be transferred in an acquisition... also how is the annual NOL utilization cap determined?

Any additional potential to realize a tax benefit from an LBO? What are some tax benefits sponsors look for/look to realize in an LBO?


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Comments (11)

Aug 18, 2009 - 10:22am
The amount of NOLs can be claimed in full by the acquiror, but the amount that can be utilized per year depends on the adjusted long term federal tax-exempt rate ( You multiply the rate by the total amount of NOLs acquired for an annual utilization limit. As for the rate, I'm not sure whether you use the latest month or an average of the last 3 months...someone feel free to correct me on the specifics.

It's the highest month of the last three months.


Just found this in another thread....

The link says:

The Long Term Tax-Exempt Rate for a particular month, used under Internal Revenue Code section 382 to compute the annual limitation on the utilization of corporate net operating loss carryovers following any "change in ownership" during such month, is equal to the highest Adjusted Long Term Rate for that month and the prior two months.

So if TargetCo has $100M of NOLs, NewCo inherits all 100M of NOLs but is limited as to the how much it can utilize in a given year, in this case 4.58%, so NewCo can only use 4.58M of NOLs for the first year? Its a little unclear what the 4.58% caps, is that an annual cap? That seems really low... at that rate any transactions will limit NOL utilization for about 20 years.

Aug 18, 2009 - 4:09pm

I just realized that I made a typo in my original post. You multiply the Long Term Tax-Exempt Rate by the equity purchase price, not the total amount of NOLs acquired, for the the annual utilization limit.

Elan, you are correct about the tax shields resulting from debt financing fee amortization and asset write-ups. And yes, goodwill is not amortizable. As a side note, I don't believe the impairment of goodwill is tax deductible either (mainly because goodwill does not exist on a tax basis and only on a GAAP basis).

If there are additional tax benefits from an LBO, I can't think of any off the top of my head. Honestly, the majority of the tax shield comes from the debt itself.

Aug 18, 2009 - 4:35pm

Obviously if you get a tax benefit from asset write-up and none from goodwill, you want to maximize asset write-up. What are the specific guidelines on this? What is the accepted methodology to getting to the asset write-up value?

Aug 18, 2009 - 4:50pm
Obviously if you get a tax benefit from asset write-up and none from goodwill, you want to maximize asset write-up. What are the specific guidelines on this? What is the accepted methodology to getting to the asset write-up value?

From what I understand, you just write up your assets to what the accounting firms determine as fair values. From a modeling perspective, it's usually just a percentage allocation of the excess equity purchase price over book...complete assumption.

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Aug 18, 2009 - 5:09pm

I know the accountants feeds you that figure... I was just wondering if a PE shop has their own method for ball parking this when initially modeling a deal.

Nov 2, 2009 - 8:45pm

Sorry for digging this up, but a basic question on the NOL ceiling. Is the ceiling that is calc'd (LT Tax-Exempt Rate * Equity Purchase Price) the ceiling of the NOL that can be used through the entirety of the NOL, or is it just for the first full year of acquisition?

For example... I have a company with a $15mm NOL as of 12/31/08, tax-exempt rate is 4.16%. We are building the acquisition for a 12/31/09 completion date, and the FY ended 12/31/09 will have negative taxable income of $700k. So the balance of the NOL at acquisition will be $15.7mm (NOL ceiling is ~$1mm based on equity purchase price). For the year ended 12/31/10, we have taxable income of $500k - we will write down the NOL and pay zero taxes. Year ended 12/31/11, we have $1.4mm in taxable income. In this situation, am I limited to the $1m, or can I offset the entire taxable income and pay zero taxes?

Thanks for the answers.

Nov 2, 2009 - 10:55pm

You are limited to $1M every year in the carryforward, which cannot exceed 20 years from when the NOL is first realized. You can also carry back those 382 limited NOLs back 2 years for a potential tax refund. NOLs can offset taxable income in a 2 year carryback and 20 year carry foward, subject to 382 limit upon a change in control as you have correctly stated.

Nov 2, 2009 - 11:02pm

Thanks thadon - appreciate the insight.

One last question regarding the valuation impact of a NOL. I am factoring the NOL into my DCF and LBO analysis. For the DCF, at the end of year 5 (2014), there is still a decent-sized balance on the NOL (~$8mm). Does the NOL typically get valued in the DCF or no? And what about the LBO... is it generally just ignored?

AND... one last one (I keep thinking of these questions as I type them up). In my LBO, we are scheduled to exit in 2015. However, we pay off all debt at the end of 2013, meaning a cash balance is accrued in 2014 and 2015. Will I generally add this cash balance to the exit valuation (2015 EBITDA at 7.5x) to determine the sponsor's IRR? (I know net cash is typically added to EV to get equity, but just want to ensure this is the correct way to calc IRR).

Thank you.

Nov 2, 2009 - 11:41pm

Well, Goldman Sachs is trying to buy tax credits from Fannie Mae to reduce their 2009 taxable income resulting from their best year in their entire history, so yes any tax savings should certainly be captured in any type of analysis.

For your analysis, your NOLs (depending on materiality, % of purchase consideration) may be the deciding factor in your go/no-go decision so you MUST capture it in your analysis. You may actually be able to sell it with IRS approval, so it could be a tax synergy in your deal and may affect the final purchase price.

For ease of math checking, I suggest valuing the NOLs separately (adjacent tab in spreadsheet), and I just plug the discounted NOL value into my BEV DCF model at the end, just before backing out interest bearing debt from BEV to get to equity value. But it depends on how your superiors like it. You also have more flexibility on what discount rate to use, though I suggest using the WACC, not cost of equity.

The excess cash build accrues to the equity sponsor, so it should be captured in the final IRR calculation, in the actual year realized, due to time value of money effects. Why don't you just show the excess cash build in each year realized, and just use the excel IRR function with a 20% guess to get your IRR?

I won't add the cash balance from 2014 and 2015 into your exit valuation, because that basically increases the exit multiple, and you ignore the REAL impact of time value of money/discounting of the excess cash build (if you're discounting), so be careful.

Also, in reality, after your model is done and you decide on entry price, at close, the lawyers will make post closing purchase price adjustments which is based on SH equity or normalized net working capital (expressed as % of revenues). If there is excess WC/SH Equity, purchase price for buyer will go up pursuant to terms in merger agreement, and if there is too little cash/SH Equity, purchase price for buyer will come down, so you'll have to re-run your model again to adjust the entry purchase price for these post-closing adjustments, and this will also affect your IRR.

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