And what precisely is that tax asset? A TRA is a bond-like instrument, often created in conjunction with an IPO or a merger. It provides a company’s pre-IPO equity holders, like founders, board members, and PE sponsors, with payments derived from the company’s future tax benefits related to the depreciation and amortization of the company’s assets.

You might ask, do public investors factor them into valuations of these companies? No, not really. TRAs are largely ignored by public investors, which seems a bit surprising considering the cash flows that they are taking out of the company.

But Andy Lee, founder and CIO of Parallaxes, says that public investors don’t care about TRAs because they are mostly passive investors like mutual funds that are valuation agnostic — they buy to replicate indexes and follow mandates, and are not deviating based on price, nonetheless a TRA. (Technology doesn’t always make markets more efficient…)

So, rather than leaving these tax assets unvalued and unappreciated by public investors, pre-IPO owners hold on to these assets for themselves. However, these TRAs don’t typically provide their first payout for four years, and don’t see payments ramp up for a few more years.

Someone like Lee comes in around years four to six and gives TRA holders a pitch that goes something like this: your TRA has given you a meager payout thus far, if any, and you’ll likely have to wait another decade to receive the balance of the payouts from this tax asset that you might not have realized you had before I called. I’m willing to give you cash for it today at this price, and it’s off your hands.

Sometimes they sell, and that’s allowed Lee to build Parallaxes Capital around that TRA trade. For now, Parallaxes is the only firm dedicated to the space, and the most active player in it by far. But the market size is growing, and competition might with it: Parallaxes estimates that the market has grown from about $8bn when they began in 2017 to about $30bn this year.

They’re also increasingly common in private markets deals, an opportunity for TRA investors.

TR-nay to TR-yay

For now, the majority of Parallaxes’ deals are with public companies, but Lee says that he sees their prevalence in private transactions growing in the near term, as a way to reduce friction and bring M&A deals to close faster.

Lee compared it to disputes over representations and warranties (R&W): they are a highly contentious aspect of M&A negotiations that delayed transactions and created more work for each counterparty, until R&W insurance become widespread. That reduced the workload for all parties as buyers became more comfortable with seller representations once they had insurance, resulting in quicker negotiations.

He says TRAs are a similarly contentious element of deal processes, where sellers and buyers often struggle to agree on a price for the tax asset, which is difficult to value due to the high level of income projections involved in estimating future payouts, in addition to other considerations like possible changes in the tax code.

Lee says that Parallaxes simplifies the process by offering an additional buyer and facilitating price discovery for the TRA, which could shorten negotiations between sellers and buyers by introducing a third-party that can ascribe value to the TRA on a standalone basis.

Lee also said that the strategy would most likely fit into a broader ABF portfolio, but that he has resisted partnering with a larger player due to a desire to remain independent.

Lee departed Lone Star Funds to start Parallaxes, and the new firm closed fund VI dedicated to TRAs earlier this year. The long-term goal, he says, is to continue building the strategy and taking share in the nascent market, eventually leading to a publicly listed vehicle in the next five to eight years.

He compares his strategy to what NASDAQ-listed Royalty Pharma has done with pharmaceutical royalties, with a market cap over $15bn and leading market share in what was a niche asset class.

When we asked Lee about what the underwriting process was like in the TRA market, he said that the tricky part isn’t determining whether it’s a good or bad investment, because there’s no such thing to him, based on his training.

“There are only bad prices — we’re willing to price anything, we just need to get paid for it. The hardest part is convincing people to do the deal at the price we want to do the deal at.”