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📰 Today's topic: The tax trick most angel investors don't know about

Let’s be honest for a second, shall we? 

Most people get into angel investing for the financial upside. And that’s totally fine.

If that is your primary goal, you might not know about a tax benefit baked into the asset class that makes the upside even better.

It's called QSBS - Qualified Small Business Stock. And if you're writing checks into early-stage startups without thinking about it, you might be leaving serious money on the table.

What the heck is QSBS?

QSBS is a section of the U.S. tax code (Section 1202) that lets early investors exclude federal capital gains taxes on qualifying startup investments - up to $10 million in gains. 

Not deferred. Excluded.

The basic requirements: invest in a U.S. C-corporation worth less than $50 million in assets at the time of investment, and hold the stock for at least five years before a liquidity event.

That's it. If Google buys your portfolio company after six years and your $5k check grew into a $500k gain, you could owe zero federal taxes on that. 

(State taxes still apply in most states, but Florida and Nevada residents - you're really winning here.)

Why QSBS exists

QSBS has been around since 1993, right as the early dot-com era was kicking off. 

The government wanted to encourage investment in high-growth small businesses, so they created a policy that basically said: back an early-stage company, hold for the long haul, and we'll reward you.

Outside of certain real estate structures, there's nothing quite like it in the U.S. tax code.

Eric Bahn, GP at Hustle Fund, found out the hard way. When he sold his first company, he didn't know about QSBS, didn't file the right paperwork, and paid a ton in federal taxes he didn't have to. 

It's the kind of lesson that stings. Sorry, Eric.

What to check before your next check

Ask every founder: what's your entity structure? If it's not a U.S. Delaware C-corp, you don't qualify. LLCs don't get the same treatment, so that gap hurts when a company actually exits.

Most serious startups are already structured correctly, but if you find one that isn't, ask them to convert. Services like Stripe Atlas make it pretty painless.

One more nuance: if you're investing via a SAFE, there's active debate about when the five-year clock starts - at SAFE signing, or when it converts to equity. Get a tax advisor involved, because it matters more than you'd think.

The bottom line

QSBS shouldn’t necessarily dictate which companies you invest in. 

But it should definitely be a factor in how to make sure you get the most out of the returns you realize.

For any new angel building a portfolio of $5k checks, it’s worth a one-hour conversation with a tax professional before the next deal closes.

– Brian from Angel Squad

🪽 Angel Investors Come from Everywhere

Spoiler alert: You don't need to be in Silicon Valley or have a trust fund to be a great angel investor.

Nathaniel Houghton | Dallas, Texas

Founder + VC + Go-to-Market Expert

Founding Account Executive at Lorikeet, co-founder of Incendium, and co-founder of the Congo Leadership Initiative. Deep experience as both founder and VC with go-to-market expertise for early-stage B2B companies.

Why this matters: Nathaniel's been on both sides of the table – building companies and investing in them. He knows the difference between founders who can talk a good game and founders who can actually execute go-to-market strategies that work. Plus, his Congo Leadership Initiative shows he thinks beyond just Silicon Valley opportunities.

Nathaniel is in our angel investing community, Angel Squad. Small Bets subscribers can grab a 30 day guest pass to join them.

Overheard in SF…probably

“User retention doesn't matter when you're building for the next billion users. Current users are just beta testers for our real audience: Gen Alpha.”