Mar 30, 2023 · 38m · capital-allocators
Andy Lee – Empty Rooms: Investing in Tax Assets at Parallaxes Capital (Capital Allocators, EP.305)
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In this episode of Capital Allocators, host Ted Seides interviews Andy Lee, founder and Chief Investment Officer of Parallaxes Capital, to explore the niche asset class of Tax Receivable Agreements (TRAs). Lee explains the technical mechanics, risk-return profiles, sourcing hurdles, and market expansion of monetizing stranded corporate tax assets.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 15.6% of the talking time here. How this is scored →
Ted as informed peer 4.4 Guest teaching 5.1 Guest disagreement 0.0 Ted pushing back 0.6
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 15:12 Rejecting NOL underwriting and seller valuation assumptions
Andy firmly rejects underwriting NOLs, highlighting the unrealistic bullishness of sellers and noting that market participants fundamentally fail to understand tax asset deferral.
Hardest push from Ted ▶ 8:44 Challenging the NOL premise for profitable IPOsTed directly challenges Andy by observing that large consumer names like Shake Shack are not unprofitable businesses with net operating losses, pressing him to explain the underlying asset.
Biggest teaching moment ▶ 8:56 Explaining Up-C step-up asset creationAndy educates Ted on the mechanics of Up-C transactions and how pre-IPO founder sales create amortizable step-up tax deductions completely distinct from operating losses.
Ted holds their own ▶ 6:42 Synthesizing TRA cash flow securitizationTed demonstrates sharp structural comprehension by precisely synthesizing how future corporate tax savings are bundled into cash-flow yielding investment vehicles.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Introducing Andy Lee and Tax Receivable Agreements | 3 | 2 | 0 | 0 | Ted opens with background context on Andy's firm and prompts him to share his unconventional academic and professional path. Andy provides biographical background on attending college early and discovering TRAs. | |
| Understanding the Fundamentals of Tax Receivable Agreements | 5 | 6 | 0 | 1 | Andy explains what a Tax Receivable Agreement is and why public markets misprice tax assets. Ted synthesizes the concept as securitization of cash flows, which Andy clarifies by specifying their role as secondary purchasers. | |
| The Up-C Structure and Step-Up Tax Assets | 5 | 6 | 0 | 1 | Ted points out that companies like Shake Shack are not unprofitable NOL businesses. Andy educates Ted on the Up-C structure inherited from Up-REITs and how step-up basis assets generate amortizable deductions. | |
| Sector Differences and Venture Capital Adoption | 5 | 5 | 0 | 1 | Ted asks why specific sectors avoid or adopt TRAs and inquires about market sizing. Andy details lack of venture capital awareness, REIT/MLP yield structures, and the post-2021 market expansion to thirty billion dollars. | |
| Return Drivers, Tax Rate Sensitivity, and Credit Fundamentals | 5 | 6 | 0 | 1 | Ted presses Andy on the concrete sensitivity to tax rates and credit risks. Andy breaks down the linear math formula behind tax rate shifts and explains how TRA credit underwriting relies on large-cap, low-LTV dynamics. | |
| Step-Up vs. NOL Underwriting and TRA Mechanics | 5 | 6 | 0 | 1 | Ted explores the difference between NOLs and step-ups, as well as servicing mechanics. Andy explains why step-ups are more resilient to earnings drops and explains the standard 85/15 tax savings split and IRS audit dynamics. | |
| Sourcing Strategies and Creative Counterparty Outreach | 4 | 4 | 0 | 0 | Ted asks how Parallaxes engages busy founders and executives who may not care about dormant tax assets. Andy details non-traditional sourcing methods including targeted LinkedIn ads, athlete Cameo videos, and entering 5K road races. | |
| Due Diligence, Duration Underwriting, and Pricing Negotiations | 4 | 5 | 0 | 1 | Ted asks about the due diligence and valuation discount negotiation. Andy explains their CLO-like pre-underwriting across two hundred names, the 15-year duration necessity, and being direct about cost of capital. | |
| Exit Strategies and Structural Competitive Moats | 4 | 6 | 0 | 0 | Ted inquires about exit options and competitive barriers. Andy lays out a blueprint modeled on music/pharma royalties and details five structural moats protecting their niche from institutional competitors. | |
| Tax Regulatory Policy, Firm Structure, and Strategy Focus | 4 | 5 | 0 | 0 | Ted asks about tax policy risks, team scalability, and potential adjacency expansion. Andy argues the tax code mechanisms are century-old precedents and emphasizes maintaining strict strategic focus. |
Statements from this episode (22)
Parallaxes Capital's portfolio includes Shake Shack, RE/MAX, and Duff & Phelps
“Names in our portfolio that some might recognize include the likes of a Remax, a Shake Shack, a Duff and Phelps.”
Public equity investors fail to properly value corporate tax assets
“It's primarily a function of the fact that public equity investors oftentimes don't ascribe much, if any, value to tax assets. If you think about a business, they might look at it on a revenue growth basis or an EBITDA multiple, both of which don't capture the…”
TRAs are primarily created by private equity for their portfolio companies
“It's primarily done by private equity firms in the context of their portfolio companies, and it runs the gamut of industries from the likes of Bumble to GoDaddy all the way to Shake Shack, my personal favorite.”
Up-C TRAs originated from the 1980s Taubman Up-REIT structure
“This technology really came from the real estate world from the up REIT. The first up REIT was created in the 19 eighties via Taubman shopping centers, and subsequent to that T.R.A.s inherited that technology when corporations started going public.”
Creating TRAs obstructs valuation realization for Master Limited Partnerships
“MLPs trade at such a premium because of the valuation Metric that they are oriented towards, that the creation of a TRA would actually be an obstruction to the realization of that overall value.”
VCs underappreciate tax assets by prioritizing growth over profitability
“Venture capitalists who back these companies oftentimes don't fully appreciate the value of tax assets because many of the corporations are not oriented to being profitable. They're more oriented towards growth. And as such, the adoption in the venture capital…”
The 2021-2022 IPO/SPAC boom drove a surge in VC TRAs
“As a result of the flurry of both IPOs as well as SPACs in 21 and 22, there was a significant uplift in terms of number of TRAs created that were shared by both growth equity firms as well as venture capital firms”
The TRA market opportunity grew from $7B in 2017 to $30B
“In 2017, the market opportunity was, call it, seven billion dollars on the back of euphoric equity markets, and more importantly, adoption by private equity sponsors. That number is now closer to thirty billion dollars.”
Between 25 and 40 companies go public with TRAs annually
“So on an annual basis, there are, call it, 25 to 40 IPOs with TRAs, depending on the IPO market.”
TRAs sit as unsecured obligations behind debt but ahead of equity
“It sits behind indebtedness, so it's an unsecured obligation ahead of preferred equity as well as common.”
TRAs resemble early 2000s pharma and 2010s music royalties
“It reminds many of what pharmaceutical royalties were in the early 2000, but whereas where musical royalties were in the 2010. Long data, annuity-like cash flow streams.”
TRA issuers average $400M+ in EBITDA with under 2x leverage
“I think the item across the industry that is not well understood is that they are oftentimes IG or near IG names, and they oftentimes are large scale and with access to public markets. And so on average, we see the industry being approximately 400 plus of EBIT…”
NOL TRAs are highly correlated to underlying company economic performance
“Net operating losses are incredibly challenging for us to underwrite because our entire value prop to many of our investments were endowments and foundations is that we seek to deliver an uncorrelated return. A net operating loss TRA is incredibly correlated t…”
Step-up TRAs can absorb 80% earnings drops without payment cuts
“Where we are more focused on is the step-up TRA, primarily because for many of the names that we are underwriting, they can see almost a 60 to 80% drop in their earnings metrics, might that be an EBITDA-oriented metric, and see no changes to their overall paym…”
Tax assets are never lost but only deferred, impacting IRR, not MOIC
“Often the one thing that people fail to understand is you never lose a tax asset, you merely defer it, which has the impact on your IRR, but not necessarily changing your MOIC on an opportunity.”
Companies typically pay 85% of realized TRA tax savings to holders
“The company would file its corporate tax filing if and when they filed that taxes and they are able to utilize the deductions that a TRA assets are able to deliver them, they would then pay 85% of those savings to the holder of the TRA.”
Domain complexity prevents intermediaries from operating in the TRA market
“I would say there are no intermediaries in the space that we deal in as a function of a number of things. Domain expertise as well as the size of each underlying opportunity prevents many intermediaries from engaging in earnest on this space.”
Parallaxes Capital uses personalized athlete Cameo videos to source TRA deals
“We also have done things such as cameos, where we have sought to understand who their favorite sports team, might that be college or pro, and by doing so, picking their favorite athlete and sending them a personalized cameo with that athlete, suggesting that t…”
TRA profitability requires underwriting 15-year corporate survivability
“For us, seven years is oftentimes the window through which we receive the majority of our cash flows. But in order for us to make not just a return of capital, but a return on capital, we really need the year eight through 15 cash flows to have a profit. And s…”
The average TRA investment opportunity ranges from $15M to $20M
“The average opportunity is between 15 to twenty million dollars.”
The issuing company itself is the primary competitor for its tax assets
“Our biggest competition that has always been there It's not a third party. It's really the company itself. They have not only the lowest cost of capital, they also have asymmetric information even relative to us as it pertains to what they view their tax asset…”
Regulatory tax changes would harm major asset classes before impacting TRAs
“All we are is a factoring items that have existed in tax code for almost a hundred years and are protected by lobbies, including the real estate lobby. We fundamentally follow the same principles that many of these that have been well Honed in tax code, and so…”