QSBS

What is QSBS and Why Does It Matter?

Qualified Small Business Stock (QSBS) refers to stock issued by eligible small businesses that offers significant tax advantages to investors under Section 1202 of the Internal Revenue Code. If the stock qualifies, investors may exclude up to 100% of capital gains from federal taxes upon selling their shares, subject to certain conditions. Maintaining QSBS status is critical as it can make your company more attractive to investors and provide substantial financial benefits to shareholders.

QSBS compliance matters to all stockholders, including founders, because:

Tax Savings on Capital Gains: Founders holding significant equity may exclude up to 100% of capital gains from federal taxes upon a liquidity event, subject to caps under Section 1202.

Increased Attractiveness to Investors: QSBS compliance makes the company more appealing to current and future investors due to potential tax advantages.

Maximizing Valuation on Exit: The tax benefits of QSBS can positively influence deal valuations and negotiations during an acquisition or liquidity event.

Encourages Long-Term Growth: The five-year holding period requirement aligns all stakeholders toward long-term success rather than short-term gains.

Alignment of Interests: Ensuring QSBS compliance aligns the financial goals of founders and investors, fostering trust and collaboration.

Ongoing Requests for Information from Post-Seed Companies

As part of our commitment to supporting OCV’s company’s growth and ensuring compliance with Qualified Small Business Stock (QSBS) regulations, OCV retains the right to request information periodically to document the maintenance of QSBS status. These requests are fundamental to protecting QSBS eligibility and ensuring transparency.

Investor Right to Information

Under the covenant agreement outlined in investment terms, post-seed companies are required to provide ongoing information to document compliance with QSBS provisions. This right may appear differently depending on the term sheet format signed. For example:

Specific QSBS Provisions: Some term sheets may explicitly outline provisions requiring commercially reasonable efforts to maintain QSBS status and periodic reporting obligations.

General Investor Rights: In other cases, term sheets may include broader provisions granting major investors (e.g., those who meet a specified investment threshold) general information rights, inspection rights, first refusal rights, co-sale rights, and pre-emptive rights. These rights may implicitly or explicitly include the ability to request information related to QSBS compliance.

Regardless of the language, the right to request information ensures that transparency is maintained and compliance with QSBS regulations is documented effectively. The specific provisions governing these rights should be reviewed in your company’s signed term sheet and investment agreements.