It depends on the specific investments. Each portfolio company must independently meet the QSBS requirements under Section 1202 of the Internal Revenue Code. The fund itself does not "qualify" for QSBS; individual investments within the fund do or do not.
The Requirements
Each portfolio company must meet all of the following criteria for the investment to qualify:
- Domestic C-corporation: The company must be a U.S. C-corp (not an LLC or S-corp).
- Gross assets of $50 million or less: Measured at the time the stock was issued to the fund.
- Active qualified trade or business: At least 80% of assets must be used in a qualifying business.
- Original issuance: The fund must have acquired the stock directly from the company, not purchased it secondarily.
- Five-year holding period: The fund must hold the stock for at least five years.
Common Disqualifiers
- Certain service businesses are excluded: health, law, engineering, accounting, financial services, and others.
- Companies that exceed the $50 million asset threshold before the fund invests do not qualify.
- Stock acquired in secondary transactions (purchased from another investor) does not qualify.
- Holding for less than five years disqualifies the gain exclusion.
The Benefit
If the requirements are met and the fund holds the stock for at least five years, LPs can exclude up to 100% of their share of the gain from federal income tax. This is one of the most significant tax benefits available to venture capital investors and can materially improve after-tax returns on qualifying exits.
This content is for informational purposes only and does not constitute legal, tax, or compliance advice. Consult qualified counsel for guidance specific to your situation.