Qualified Small Business Stock – The Secret Returns Rocket Fuel

The best reason to invest in early stage venture capital is the fantastic returns that traditionally come from high-performing funds. That’s well known.  What is less well known, however, is the second best reason to invest in early stage venture: the Qualified Small Business Stock (QSBS) federal tax exemption – also known as a 1202 exemption.

Here’s a quick summary of the QSBS exemption: Any capital used to purchase stock in specific types of companies (like tech companies) at a valuation of less than $50M that remains in the company for at least 5 years accrues gains completely tax free – up to the greater of $10M or 10x the amount invested.

You read that right, all gains are completely tax free if the hold period is at least 5 years on an early stage tech company.

With the Biden Administration pondering tax increases and the elimination of capital gains taxes, the 1202 exemption would appear to be the only way to avoid paying 37-39.8% taxes on investment gains. This makes a massive difference to the net returns of investing in early stage venture capital versus any other possible strategy.

SaaS Ventures is specifically engineered to maximize QSBS exemptions.  While traditional venture capital funds investing in this valuation range operate concentrated portfolios with returns coming from their one or two best investments, SaaS Ventures’ diversified approach ensures that, with the same gross return, the gain is spread across more companies and therefore more of the gain is QSBS tax exempt.

Here’s how it looks in practice:

Example #1: Investing $1,000,000 into an asset that increases 30% per year (if that exists) and is treated as a dividend/short term capital gains is worth $2.39M in 5 years after tax.  Note that if the capital gains tax exemption goes away, example #2 would follow these same economics.

Example #2:  Investing $1,000,000 into a traditional venture capital or private equity fund with a 30% IRR that is taxed at the long term capital gains rate produces the overwhelming majority of its returns from a small number of investments is worth $2.82M in 5 years after tax.

Investing $1,000,000 into SaaS Ventures, if we produce a 30% IRR, would likely be worth $3.71M in 5 years after tax.

So these funds which produce the same gross returns will perform dramatically differently after tax, with the SaaS Ventures model producing almost 2x the after tax gains of a similar model taxed as ordinary income!