What Founders Need to Know About Stock for Stock Deals and QSBS
For many startup founders, a successful acquisition is the culmination of years of work. You’ve grown a business from idea to exit—and now it’s time to realize the upside. But if your equity qualifies as Qualified Small Business Stock (QSBS), how that exit is structured could determine whether you pay zero in federal capital gains tax or owe millions.
QSBS allows eligible shareholders in certain C corporations to exclude up to 100% of their capital gains on the sale of stock, up to the greater of $10 million or 10 times their cost basis. For founders, this can mean a once-in-a-lifetime tax break. But many miss out because of how their deal is structured—especially when it involves a stock-for-stock exchange.
The Role of Reorganizations in Startup M&A
Acquisitions often take the form of tax-free reorganizations. These are structured under Section 368 of the tax code and allow shareholders to exchange their shares for stock in the acquiring company without triggering immediate tax. The most common types for startups include:
Type A mergers (statutory mergers or consolidations)
Type B reorganizations (stock-for-stock exchanges)
Type C reorganizations (stock-for-assets deals, often followed by liquidation of the target)
These structures are attractive because they allow for tax deferral. But they also raise the question: What happens to QSBS-eligible stock if a shareholder receives public stock in return instead of cash? Does exchanging QSBS for acquirer stock preserve the original QSBS benefits?
Preserving QSBS in a Stock-for-Stock Deal
Fortunately, the answer is often yes. Section 1202(h)(4) provides that if QSBS is exchanged in a qualifying Section 368 reorganization, the stock received can also be treated as QSBS. In addition, your holding period carries over—so if you held the original stock for four years, the replacement stock only needs to be held for one more to hit the five-year requirement.
This continuity is critical for founders who are close to reaching that threshold or want to preserve optionality in a future liquidity event.
But there's a major caveat.
The $50 Million Limitation
Under Section 1202(h)(4)(B), if the acquiring company does not meet all QSBS requirements—most importantly, if its gross assets exceed $50 million immediately after the transaction—your ability to claim the full QSBS exclusion is capped. Specifically, you can only exclude the gain that was deferred at the time of the exchange.
Consider this example: You sell your startup in a stock-for-stock merger with a public company. Your shares were worth $10 million at the time of the deal and are now worth $30 million. Because the acquirer doesn’t meet QSBS eligibility (typically due to asset size), you can only exclude the original $10 million of deferred gain. The additional $20 million in appreciation is taxable.
This rule effectively draws a line in the sand: you can preserve the QSBS status of the original gain, but new value created post-acquisition is no longer shielded.
What If the Acquirer Does Qualify?
In the rare case that your company is acquired by another QSBS-eligible business—one that passes the $50 million test and meets all other criteria—the replacement shares can continue to qualify fully as QSBS. In that case, the exclusion cap doesn’t apply, and the original and replacement stock are treated as a continuation. The gain exclusion resets based on the full sale value, and the full QSBS benefit can be preserved.
This situation is most common in roll-up strategies among small businesses or when a startup is acquired early by a similarly sized firm.
Other Implications for Founders
There’s an added layer of complexity if there are multiple reorganizations before you reach the five-year holding period. Fortunately, Section 1202 provides that if QSBS is exchanged for new QSBS in a series of qualifying transactions, and each step meets the reorganization rules, your holding period can continue through each exchange. That means a founder could roll their equity through several QSBS-eligible entities and still retain access to the gain exclusion—though careful planning is critical at each step.
It’s also worth noting that even if the replacement shares are no longer considered QSBS, the basic shareholder-level requirements (e.g., five-year holding period, restrictions on transfers) still apply to the extent you’re relying on deferred gain from your original QSBS shares. That holding period remains meaningful, even if the stock is no longer QSBS under current law.
Why This Matters at the Term Sheet Stage
Founders tend to focus on deal value, earnouts, and vesting schedules—understandably so. But deal structure should be a core part of the negotiation. If your shares qualify as QSBS, the difference between a stock-for-stock deal and a cash buyout, or between a merger with a $49M acquirer versus a $500M one, can mean the difference between a tax-free windfall and a significant tax bill.
Even in many cases where QSBS requirements (like a “too short” hold period or surpassing the $10M exclusion cap) are unmet, QSBS rollovers can be a bridge to tax-free-land.
While most M&A advisors understand the tax-deferral mechanics of Section 368, fewer consider how those mechanics intersect with Section 1202 (QSBS). And even fewer negotiate to preserve QSBS status explicitly, or to carve out structures (such as partial cash-outs or rollovers) that optimize tax outcomes for founders.
Bottom Line
For startup founders, QSBS isn’t just a tax code curiosity—it can be a real, material part of the exit upside. Stock-for-stock acquisitions don’t necessarily wipe out that benefit, but they do require attention to detail, particularly around the acquirer’s eligibility and the terms of the exchange.
If you’re on the path to acquisition, don’t wait until the final stages to address this. Involve tax counsel early, model out the QSBS scenarios, and negotiate with an understanding of both value and structure. You only exit once—make sure it counts, not just before the close, but long after the IRS comes calling.
