Employees of startups can find the world of stock options and financing rounds to be overwhelming, which may lead to missed opportunities. Even though QSBS is still a new term to experienced investors, employees of small businesses, and startups. They should familiarize themselves with the tax benefits of section 1202 in order to make sure they do not miss out on time-sensitive investment windows.
While each company is unique, Series A funding is a common factor across growing, successful startups that can serve as a target milestone for employees and option holders to keep an eye out for.
What is Series A Funding?
Series A Funding occurs when a privately-owned start up seeks investors after it has proven its business model and needs increased capital in order to scale and generate more revenue.
Is Series A Funding the First Step in Financing?
No. Series A Funding only occurs after a company has seen enough success that they can arguably prove to large investors that they are worth investing in.
The first financing that happens in a startup is generally backed by the founders, investors who know the founders, or small angel investors. These funds usually amount in the tens of thousands where Series A usually brings in millions of dollars.
Takeaways for Employees of the Company
If you are an employee of a successful startup who has been given stock options, Series A Funding is an important milestone that you should pay attention to.
You may have been putting off exercising your options for many reasons; whether it be, a lack of liquidity to exercise or waiting to see if the market value increases enough to make it worth it. One way you can interpret the beginning of a Series A funding is the large venture capitalists and private equity firms seeing the company as one they are willing to take a risk on.
What are Venture Capitalist and Private Equity Looking For in Investments?
Most VCs and PEs are looking to make a 200%-300% return on their investment within a few years, and these institutions have the professionals and credentials to make such calculated predictions. If you are a startup employee who is new to the investment game and are unsure of your company’s potential, you can somewhat rely on the bet of Series A investors to help make that judgement.
More importantly, if you hold options in a startup company, and the company meets the requirements outlined in section 1202 defining qualified small business stock, it may be imperative that you exercise these options before or during Series A funding.
Qualifying for Small Business Stocks Tax Exemptions
Along with other criteria such as being a domestic C corporation and being involved in a qualified trade, a company must have less than $50 million in gross assets at the time of issuance of the stock for you to benefit from the associated tax relief that comes with QSBS. Options that are not exercised before this gross asset threshold is surpassed will no longer qualify for the potential $10 million tax-free.
Since Series A Funding has the potential to bring in millions of dollars in funds, this becomes an important time to make your decisions about exercising your options.
If you hold stock options and what to understand if they’re QSBS eligible, we can help. Contact us to learn more.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.