All Posts /
Startups & Venture Capital

Understanding Qualified Small Business Stock (QSBS)

Published on
29 Nov

A Valuable Tax Consideration for Founders and Early Investors

One crucial early exercise for founders, entrepreneurs, and early-stage startups, often given limited attention, is considering the long-term tax implications of the business’s corporate structure. These decisions around the corporate structure are driven by several considerations, some of which are non-economic in nature, which must be weighed and ultimately prioritized by the founders. However, in thinking through these issues, founders should understand the potential advantages of Qualified Small Business Stock (“QSBS”), which can be significant both for the founders and early investors. This article provides a high-level overview of QSBS, its eligibility requirements, tax benefits, and why it is an essential consideration for founders and startups. This article is also the first in a series of articles about QSBS designed to help deepen founders’ and early investors’ understanding of the advantages, requirements, and potential pitfalls of a corporation’s stock receiving QSBS treatment.

What is QSBS?

QSBS refers to shares of stock issued by a qualified small business that meets certain criteria outlined in Section 1202 of the U.S. Internal Revenue Code. QSBS is designed to encourage investment in small businesses by offering tax benefits to eligible shareholders upon the sale of their stock.

Eligibility Requirements for QSBS:

To qualify for QSBS status, the corporation issuing the stock and the shareholder must meet specific requirements. Some key eligibility criteria include:

  1. Business Structure: The corporation must be a C-corporation, not a pass-through entity like an S-corporation or LLC taxed as a partnership.
  2. Gross Assets Limit: The corporation must not have had “aggregate gross assets” in excess of $50 million at any time prior to or immediately after the issuance of the stock.
  3. Qualified Business Test: The corporation must meet certain tests related to the type of assets held and the business activities conducted. At least 80% of the corporation’s assets must be actively used in a qualified trade or business. In other words, certain excluded business activities, such as service-related businesses or businesses where the principal asset is the reputation or skill of its employees, are not eligible for QSBS status.
  4. Holding Period: The shareholder must hold the stock for a minimum of 5 years to be eligible for the tax benefits.

Tax Benefits of QSBS:

The primary tax benefit of QSBS is the potential exclusion of capital gains from federal income tax when the eligible stock is sold. The exclusion amount can be up to 100% of the qualified gain, subject to certain limitations. Such limitations include a dollar limitation whereby the gain excluded in any year by a shareholder from the sale of QSBS stock cannot exceed the greater of (i) $10 million (assuming there are no prior 1202 gains realized by the shareholder in that corporation) and (ii) 10 times the amount of cash or other assets contributed to the corporation in exchange for QSBS. Essentially, Section 1202 provides a QSBS shareholder with a $10 million minimum exclusion for gains triggered by the sale of QSBS.

Why QSBS is Important for Founders:

QSBS offers the most attractive tax benefits available to founders and early investors, including venture capital firms. In other words, if you’re a founder or early-stage startup and have any interest in raising capital in the future, particularly venture capital, you need to pay attention to this issue. By qualifying for QSBS status, founders and early-stage investors can potentially exclude a significant portion of their capital gains from federal income tax. This can lead to substantial savings and represents a valuable tool for optimizing financial returns.

Additionally, QSBS can be particularly advantageous for founders considering a liquidity event such as an acquisition or IPO. Planning early and structuring equity grants with QSBS eligibility in mind can ensure maximum tax benefits for both the company and its shareholders. To fully leverage QSBS, it is crucial for founders to work closely with an attorney and tax advisor to ensure their corporate and equity structures align with QSBS eligibility criteria. This is particularly important given that certain corporate actions (e.g., cashing out a founder) may cause a shareholder’s stock to be disqualified from QSBS treatment.

The Start-up and Venture Capital Practice Group at Riggs Davie PLC counsels founders, entrepreneurs, and investors through early-stage corporate structure decisions and opportunities for leveraging QSBS treatment. For more information about our services, please visit or contact the author by email at

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.