Qualified Small Business Stock Exclusion

November 12, 2023

by a searcher from Wake Forest University in Philadelphia, PA, USA

Hi all,

I am in the early stages of determining the structure for my self funded search. (have a deal under exclusivity). I am learning about the QSBS structure and curious why this structure isn't used more frequently. It seems that the structure makes a ton of sense if you have a 5-7 year hold period and do not plan to take distributions ahead of exit (e.g. use max leverage for the initial purchase and paydown debt during 5 year hold or use cash for growth),

Are there any considerations that folks are concerned about? I'm aware of (i) the stroke of pen risk and that some members of congress are trying to eliminate this exclusion (though I think fairly easy to switch to S Corp if the exclusion is eliminated from tax code), (ii) double taxation given you need to structure as C-Corp (though non-issue if you don't take distributions), and (iii) some business are excluded from this exclusion (financial, tax, etc.).

Thanks all in advance for the help!

Reply by a searcher
from Harvard University in New York, NY, USA

I am acquiring a company via a new C Corp for the reasons you suggest. One additional benefit is reducing cash leaving the business due to paying taxes. If the owners are taxed at the highest bracket rate personally, they will owe high 30% to 40+% whereas a C Corp is currently taxed in low to mid 20%. One consideration for not going this route is future buyers will prefer asset deals over equity deals, so it's possible you may have to take a lower exit price but if you are saving long-term capital gains tax, there is enough room to end up making up for that if needed. The size of the company at exit may also play a role on how much asset vs stock matters.

Reply by a searcher
from Babson College in New York, NY, USA

It's a very interesting exclusion, I haven't dug into the details of it in a year or two... but would you still be able to do a dividend recap? That way you could focus on debt pay down for the first several years and then do a larger recap (hopefully at lower rates than current) thus avoiding the double taxation issue.

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