The Thursday sessions of the 2017 Annual Summit of the Angel Capital Association, this year in San Francisco, began with a presentation by Gary Kocher and Francisco Olmedo of K&L Gates on the little known tax benefit for startup founders and investors under Section 1202 of the Internal Revenue Code.

How this section will bear up under tax reform efforts in Congress this year remains to be seen. But if 1202 survives (let alone if tax reform can be leverage to improve 1202 for entrepreneurs and investors!), it should gain traction both in terms of awareness and active planning among startup founders and their early backers.

The basic value proposition of Section 1202 is this: start a qualifying small business as a C-corp, hold the stock for five years, don't permit the company to engage in certain redemptions, and the founders and investors can exclude up to $10M in capital gains from the sale of that stock. That's right: no tax on gains from startup investing, in the right company, at the right time, in the right way, up to the $10M cap. (The foregoing is a high level summary; additional terms and conditions apply!)

We'll update this post soon with links to other resources on the features of Section 1202:

  • A policy paper from the Legal Advisory Council to the Angel Capital Association on how Section 1202 might be improved (disclosure: I contributed to this paper authored by Gary and others who serve on this Legal Advisory Council, of which I am the current Chair);
  • A post from my colleague Alex Hecker on Section 1202, which he wrote for another blog platform; and
  • Gulp, the actual text of the law itself (for law geeks).

If you're founding a new company, you should know about Section 1202, and consider whether you can plan ahead to optimize the chances that Section 1202 might later apply to your exit. If you're investing in a new company, you should know about Section 1202, too, and consider whether your investment terms should include reps and covenants from the company about good faith efforts to qualify under Section 1202.