The Effect of Taxes on the Value of Start-Ups

The effect of tax on the value of a company does not present too much difficulty as long as the company is profitable and ungeared (i.e., without debt). In case of leverage, the tax effect is quantified under the notion of tax shield, which is widely discussed in the literature. The case of not-yet-profitable companies is generally treated as a simple extension in most textbooks. This article shows that the calculation of the tax value for these companies needs special consideration, especially if the company is to reach profitability only with a certain probability. Unlike the case of profitable companies, the value diminishing effect of taxes for start-ups is much stronger than the tax rate itself. The article also takes a look at the effect of diversification within a company. Until now, diversification has generally been regarded as a pure risk aspect that might be rewarded with a lower cost of capital. This article exhibits how diversification has a direct effect on value by improving the tax value.