The High Value of Losing Company
Did you know that sometimes a company can lose a lot of money and be worth a great deal? Sounds illogical, right?
Well, this is precisely the circumstances of companies that lose money consistently. The loss paradox of a losing company stems from the company's tax shield.
When a company makes a profit, it is required to pay tax; E.g., If the company earned 100 dollars, and the corporate tax rate is 10%, it will pay 10 dollars.
Suppose in the second year she loses 100 dollars. How much tax will the corporation pay in the second year? You guessed correctly - the company will not pay taxes because the tax is paid only for profits.
But what happens if the company loses 250 dollars in the second year? In this case - the tax authorities owe the company a tax. If we add up the profits for the first and second year, we find that the company has a cumulative loss of 150 dollars (250-100), called Equity Deficit. The tax authorities will not tax the company until the company is balanced in its multi-year profit. That is until the equity deficit disappears.
For example, in the third year, the company makes 50 dollars - it will not pay the tax this year - because its cumulative loss will be equal to 100 dollars.
The title of the blog, to remind you, was the high value of a losing company. So if it loses so much - where does the value of the company come from? Well - the answer is simple - from tax savings.
If the company earns an additional 50 dollars in the fourth year, it will not pay the tax this year because its cumulative loss will be equal to 50 dollars. Only when the company returns to a situation with incremental profit will the company pay taxes. For example - if in the fifth year the company will earn 200 dollars.
The title of the blog, to remind you, was the high value of a losing company. So if it loses so much - where does the value of the company come from? Well - the answer is simple - from tax savings. At the end of the second year, the company had an equity deficit of 150 dollars.
A sophisticated investor, who owns a profitable company, could have bought the losing company. Buying the company would have allowed him to reduce his company's profit, thus saving the tax. For example - if his company earns $ 400 a year, following the losing company's acquisition, his company's gains will be reduced to only 150 dollars (250-400). He will pay tax only on a profit of 150 and not on a yield of 400.
