The Looming Concern
With Biden’s Build Back Better Amendment (BBBA) looming as a threat to the current way small businesses are operating today, those who invest in these businesses are equally concerned. Among them are angel investors who fund a large percentage of small businesses as collective entities. Angel investors are now at risk of having their QSBS tax exemptions cut in half, and if the proposed amendments are passed, they might not pursue investing the way they have in the past.
The proposed amendment, if adopted, would affect American taxpayers with an adjusted gross income (AGI) over $400k, cutting the previously allowable 100% QSBS tax exclusion down to only 50%. This severely drives down the incentive for Angel Investors to pour capital into high-risk startups. These economy-driving investors are not only concerned about how their current QSBS investments will play out, but are also considering if they would make such moves in the future.
Angel Investors and the Risk-Reward Ratio
In a story shared by members of our coalition, we learned that Angel Investors are often serial investors who are embedded in the world of startup economy and have often invested much more than just capital.
One investor had poured capital into no less than 60 early stage tech companies over the past 8 years and considered QSBS eligibility in each and every investment. After the successful sale of his own marketing technology company, he invested his returns in 15 more small businesses within a year. The joy of helping young tech companies thrive coupled with the incentives laid out by Section 1202 provoked him to stay in the game and, according to him, he’d continue to play for the next 20 years.
Angel Investors like this one understand the risk-reward ratio associated with technology startups. These startups create jobs and drive innovation that will soon become commonplace in the fast-paced technology-driven world we live in today. Only 20-30% of early-state tech startups succeed and most who are willing to invest in these companies lose their invested money for the potential to collect on such a valued tax incentive. It is Section 1202 which motivates investors and provides small business owners with the access to capital they need to create jobs and push prior limits.
Naturally, when the ratio is disrupted, investors start to question whether it is worth it to continue with high-risk investments. In reality, investing in private equities would have a much more promising return. So the question is: in an area as nuanced and exceptional as QSBS, when these investors bow out, will anyone come to fill their place.
Without capital, innovative companies and entrepreneurs will not have the resources to launch their businesses and see them succeed. The risk-reward ratio would deter many investors, and many innovative businesses that need outside equity would no longer have the necessary means to operate. With the collections from this amendment totalling less than 1% of the cost of the BBBA, the potential risk far outweighs the benefit.
We Want to Hear From You
If you are concerned about how the BBBA may impact your company’s eligibility for the 100% QSBS exclusion or you are an angel investor with your own story, we want to hear from you. Join us as we unite our voices to speak out against these proposed amendments.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.