How R&D Credits and NOLs Increase Company Value in a Transaction

How Tax Credits and NOLs Affect Valuation

At Alternate Tax Solutions, we get to work with great companies running the traditional startup model. These companies invest heavily in R&D and run at a loss for a number of years before obtaining profit or looking for strategic partnership or buyout. It is not uncommon for these companies to accumulate large amounts of Net Operating Losses (NOL) as they work towards profitability. It is important to understand how these NOLs, and R&D Tax Credit carryforwards work in a transaction and how they can help increase enterprise value.

In this post we'll cover:

How R&D Tax Credits are valuable as credit carry forwards
How buyer's analyze tax attributes in an M&A deal
Why sellers should know the value of their tax attributes
How much value a buyer can actually realize from these tax assets

R&D Tax Credits in a Transaction

We often get asked by founders and CFOs about the value of claiming R&D Credits when the company generates no taxable income. Our answer is twofold:

The company should examine whether or not they meet the criteria of a "qualified startup" so that they can use R&D Tax Credits to immediately offset payroll taxes
Unused R&D Tax Credits are carried forward and become a deferred tax asset

R&D Tax Credits just like NOLs become tax attributes in a transaction that will ultimately lead to an increase in Enterprise Value.

Why Credits Matter Even When You're Unprofitable

Many founders make the mistake of thinking R&D credits only matter when you have a tax bill. This couldn't be further from the truth.

In any M&A transaction, buyers are purchasing your future cash flows. Tax attributes like R&D credits and NOLs directly increase those future cash flows by reducing future taxes paid.

Value of NOLs and Tax Credits

Ultimately, these tax attributes will increase free cash flow to the firm since they will reduce taxes paid. However, it is important for Business owners need to know exactly how the calculation works.

In any detailed valuation exercise, an analyst would attempt to determine a value for the equity of a company by developing a discounted cash flow model (DCF). This method projects revenues, expenses, and profit into the future and discounts the value of these future cash flows back to the present. This exercise will ultimately determine what is known as Enterprise Value. Then, we can add back cash-on-hand and subtract debt to bridge to total equity value.

The Critical Point Sellers Miss

Here's the catch. The value of the NOL and Tax Credit attributes needs to be quantified and added to this equity value number!

As a seller, this is something you should be thinking about, as buyer's will know that these tax shields are a way to obtain accretive value. However, it will not be included in their DCF model!

Translation: If you don't quantify and present your R&D credits and NOLs properly, the buyer will value them at $0 or heavily discount them. But if you show up with proper documentation and valuation analysis, you can add hundreds of thousands to millions to your exit value.

Discounting The Tax Attributes

There's one big point we try to help our clients understand. NOLs and Tax Credits WILL NOT be considered at face value. This is due both to tax rules and the time value of money.

Section 382 and 383 Limitations

Section 382 and 383 of the tax code place limits on the amounts of NOLs and Tax Credits in the event of an ownership change, which is defined as 50-percent or greater change in ownership of five-percent shareholders over a rolling three-year period.

Section 382 limits the amount of NOLs that can be used in a single year. This amount is equal to:

Annual NOL Limitation = Equity Value × IRS Long Term Tax Exempt Rate

Section 383 limits the amount of credits that can be used each year, coordinating their use with the §382 limitation on NOLs.

Ultimately the amount of tax savings in each year will need to be discounted back to the present to determine present value.

Real-World Example: Company A

Let's look at a detailed example to understand how this works in practice.

Assume the Following for Company A:

Company Assumptions:

Projected Year end Revenue: $5,000,000
Projected Growth Rate: 3%
Historic Profit Margin: 20%
Discount Rate: 15%
Tax Rate: 21%
Cash: $500,000
Debt: $50,000
NOLs: $500,000
R&D Credit Carry Forwards: $500,000

DCF Model Results

This would produce a simplified DCF that looks like:

Value of Core Operations	Y1	Y2	Y3	Y4	Y5
Revenue	$5,150,000	$5,304,500	$5,463,635	$5,627,544	$5,796,370
EBIT	$1,030,000	$1,060,900	$1,092,727	$1,125,509	$1,159,274
Taxes Paid	$216,300	$222,789	$229,473	$236,357	$243,448
Unlevered Free Cash Flow	$813,700	$838,111	$863,254	$889,152	$915,827
Present Value of FCF	$707,565	$633,732	$567,604	$508,376	$455,328

Terminal Value:

Terminal Value Y5: $7,860,844
PV of TV: $3,908,229
PV all UFCF: $2,872,604
Enterprise Value: $6,780,833
Equity Value: $7,230,833

Adding Back Tax Attribute Value

After calculating the NOLs and R&D Credits the buyer will be allowed to use in each year, we find that the present value of the $500,000 in R&D Credits is $331,308. This is added back to the Terminal Value calc and increases the equity value of the business by 5%.

The Bottom Line: While you may not be able to use your R&D Tax Credits right away, they do have a definite value in the future.

The Math Behind the Valuation

Here's how the buyer calculates the present value of your R&D credits:

Determine annual limitation: Based on Section 383 and the purchase price
Project when credits will be used: Based on projected profitability
Calculate annual tax savings: Credit amount × Tax rate in each year
Discount to present value: Apply appropriate discount rate
Add to enterprise value: The result increases the purchase price

In our example:

$500K face value of R&D credits
Present value after discounting: $331K
You captured 66% of face value

Not bad! But this only happens if you have proper documentation and valuation analysis prepared.

Conclusion

In a five- or ten-year modeling exercise calculating the value of these tax attributes can become complicated and the items discussed above are only small pieces of the puzzle. The team at ATS is ready to help both business owners and buyers determine how these tax elements will work in a transaction.

Key Takeaways for Business Owners

R&D credits and NOLs have real economic value in M&A transactions, typically worth 50-80% of face value when properly documented
Buyers will analyze these attributes whether you do or not - so you might as well present them in the best light possible
Proper documentation is essential - undocumented credits get discounted by 70-90% or ignored entirely
Section 382/383 limitations apply but don't eliminate value - they just defer it over multiple years
Start preparing 12-24 months before sale - you can't create documentation retroactively

Action Steps

If you're considering selling your business in the next 1-5 years:

Now:

Calculate your R&D credit and NOL carryforwards
Ensure you have proper documentation and studies
Implement tracking systems for current-year activities

6-12 Months Before Sale:

Prepare tax attribute valuation analysis
Model the buyer's benefit under Section 382/383
Clean up any documentation gaps
Get a legal opinion letter on your tax positions

During Due Diligence:

Present your tax attributes as value drivers, not risks
Show buyers exactly how much they'll save
Demonstrate audit-ready documentation
Be prepared to address Section 382 limitations

Get Expert Help

Interested in seeing what your R&D Tax Credits are Worth?

At ATS, we specialize in helping business owners maximize the value of R&D credits and NOLs in M&A transactions. Our Strategic Valuation process includes:

Comprehensive R&D credit studies with audit-ready documentation
Section 382/383 analysis and limitation calculations
Present value analysis of tax attributes
M&A-ready due diligence packages
Buyer benefit modeling

We've helped clients add $500K to $5M+ in transaction value through proper tax attribute documentation and valuation.

Don't leave money on the table. The difference between properly documented and undocumented tax attributes can easily be 10-20% of your total purchase price.

Schedule a free consultation to discuss how we can help you maximize the value of your R&D credits and NOLs in your upcoming transaction.

How R&D Credits and NOLs Increase Company Value in a Transaction