VC Math 101: Why Founders & Early Stage Investors Should Think About QSBS Early and Often

By The Artemis Fund

Photo by Christina @ wocintechchat.com on Unsplash

The Artemis Fund believes technology can create prosperity for all. With offices in New York, Texas, and Nevada, Artemis leads seed rounds for companies creating resilient families, individuals, and businesses across the US.

A single decision early in your startup journey could save you millions. Yes, really!

Qualified Small Business Stock (QSBS) is a tax incentive designed to reduce or eliminate capital gains taxes on stock sales for those who build or invest in small businesses. Founders, who typically receive stock early, are well-positioned to benefit from QSBS.

Since QSBS eligibility starts when stock is issued, understanding this advantage early in your startup journey is critical. Structuring your company and stock properly from the start can unlock significant tax savings down the line.

First things first. In order to qualify, your company must:

• Be a C corporation (not an LLC or S corp).
• Be based in the US.
• Have less than $50M in assets when the stock is issued.
• Use at least 80% of assets towards qualified trade or business activities.
• Not be in any of the following categories: law, accounting, financial services, healthcare, engineering, consulting, athletics, performing arts, banking, financing, leasing, investing, farming, or hospitality.
• Issue the stock directly from the corporation. Secondhand purchases aren’t eligible, but common and preferred stock can qualify.

What are the benefits of QSBS?

• 100% Tax Exclusion on Capital Gains: By holding QSBS for at least five years, you can exclude up to 100% of capital gains (capped at $10M or 10x your investment). This could save millions in taxes at the time of a stock sale.
• Investor Appeal: QSBS also benefits investors, making your company more attractive to angels and VCs, and potentially improving funding opportunities.
• Tax Savings at Exit: Avoiding significant capital gains taxes during an acquisition or IPO allows founders to reinvest more into future ventures or personal wealth.
• Incentive for Long-Term Growth: QSBS encourages holding stock for five years, aligning with sustainable business building. In the case of shorter holding periods, rollover strategies may still apply.
• Strategic Tax Planning: QSBS can complement other tax-planning strategies (like estate planning or stacking exclusions via trusts) to maximize financial benefits.

How To Actually Acquire QSBS

The process can be complicated, so it’s important to do your research and consult both legal and tax professionals. Here’s a high level overview:

• Form a C corp: The state in which you incorporate your business can heavily influence regulatory compliance and your operational flexibility. See more below on state by state restrictions.
• Conduct a financial review: This is when you’ll confirm that your business’ assets don’t exceed $50M before and immediately after issuing the stock. We can’t say it enough- be sure to work with experienced financial advisors or auditors.
• Seek legal counsel: Engage a firm that specializes in securities law who can check for exemptions and prepare filings.
• Create stock documentation: Draft Stock Purchase Agreements (SPAs) to outline terms of sale and ownership.
• Gain board approval: Issuing stock must be approved by your board of directors.
• Issue stock: Make sure to document this process thoroughly.
• Monitor for compliance: You’ll need to conduct regular financial assessments to confirm your company’s asset value and ensure you continue to meet the QSBS qualifications.

QSBS in Action: What it Means for The Founder & The VC

Let’s look an example. In 2019, Sarah founded CareTech Innovations, a C corporation focused on reducing the burden of care on women. At incorporation, the company met all QSBS requirements, including having less than $50M in assets and using 90% of its resources for active business operations.

Sarah issued herself 10,000 shares of stock at a nominal value. Meanwhile, a VC invested $1M in CareTech Innovations for 10% equity (1,000,000 shares, at $1/share). The VC also ensured that the investment qualified as QSBS by meeting all the necessary requirements.

Over the next 6 years, CareTech grew rapidly, and in 2025, it was acquired by a major player in the femtech space for $100M.

Founder’s Outcome: The QSBS Advantage

Because Sarah held her QSBS for more than five years and met all other qualifications, she is eligible to exclude up to $10M of her capital gains from federal taxes. Assuming the acquisition value exceeds her cost basis, this means Sarah saves millions in taxes and can reinvest her proceeds into new ventures or personal goals without a significant tax burden.

Investor’s Outcome: Without QSBS vs. With QSBS

At the time of the exit, the VC’s 10% stake is now worth $10 million. The capital gains on this investment are $9 million ($10M exit value — $1M initial investment).

Scenario Without QSBS

• Capital Gains Tax Rate: 20%
• Tax Liability: $9M×0.20=$1.8M
• Net Proceeds: $9M−$1.8M=$7.2M
• IRR Calculation (6-year horizon):
  Annualized IRR = 42% (based on $1M growing to $8.2M over 6 years).

Scenario With QSBS

• The first $10M in gains is excluded from federal taxes.
• Tax Liability: $0
• Net Proceeds: $10M
• IRR Calculation (6-year horizon):
  Annualized IRR = 46.78% (based on $1M growing to $10M over 6 years).

By leveraging QSBS, the VC avoids $1.8M in taxes, boosting its IRR from 42% to 46.78%.

While the percentage increase may seem modest in this single example, the compounding effect of QSBS across a diversified portfolio of early-stage investments can significantly enhance fund-level returns over time.

What else do I need to know?

• State Taxes are Something to Keep in Mind: The benefits of QSBS apply to your federal taxes, but state taxes can vary widely. It’s important to speak to a tax professional to understand the state level implications depending on where you incorporate.

Image Credit: Adero Partners

• Capital Loss: If the business fails, the QSBS loss is considered a capital loss, which will have its own set of tax rules and limitations.
• Tax rate changes: The benefits of QSBS are tied to tax codes that can change at any time, so keeping an eye on legislation in terms of long term planning is a must.

By understanding the requirements and benefits of QSBS early in your entrepreneurial journey, you can position your company and your stock to maximize this unique opportunity. While the process involves careful planning and ongoing compliance, the rewards are well worth the effort, particularly for those committed to long-term growth and sustainable success. To dive deeper on this topic, we highly recommend checking out Sapphire Ventures’ comprehensive writeup.

Learn more about the companies in our portfolio on our website. If you’re a founder innovating in commerce enablement, fintech, or the care economy, pitch us here!

Disclaimer: Before making an investment decision of any kind, potential investors are advised to consult with their tax, legal, ERISA and financial advisors. Artemis Fund and its affiliated entities are not currently registered as investment advisers with the United States Securities and Exchange Commission or with any other U.S. Federal or state regulatory authority but will do so in the future to the extent such registration becomes necessary in compliance with applicable laws in the United States. Artemis Fund provides no guarantee with regard to the content and completeness of this material and does not accept any liability for losses which might arise from making use of this information. The opinions expressed in this material are those of Artemis Fund as of the date of this summary, unless otherwise specified, and are subject to change at any time without notice.