The recent tax law[i] has numerous implications for regional economic development strategies, which we will dig into in this blog. First up: Qualified Small Business Stock.
Many regional tech-based economic development strategies address capital access for startups at least partly by encouraging high net worth individuals, or angels, to invest in local startups. The U.S. Economic Development Administration’s Build to Scale awards speak to the prevalence of this approach, as it has funded many projects designed to educate wealthy individuals about investing or to facilitate angel investment through funds or networks.
Converting local wealth into startup investment capital is attractive to economic developers because of the opportunity to retain high-growth companies, strengthen the regional entrepreneurship ecosystem, and realize tax revenue. The pitch to potential angel investors is typically along the lines of: investing in local entrepreneurs (instead of those in other regions or in bonds, stocks, and other assets) will do good for the region by expanding employment and innovation while doing well for the angel by earning an attractive return on investment.
The new tax law brings a host of changes that may affect the ROI calculation for angel investors and, therefore, change the implications for economic development.
Expanded QSBS incentive
The most direct, and perhaps most significant, change in the law affecting angel investing is to the qualified small business stock (QSBS) incentive. This incentive is now even more rewarding, and it was already a significant financial consideration for many investors.
Research by the U.S. Department of the Treasury shows that QSBS claims, first authorized in 1993, took off after legislation in 2010 changed the deduction from 75% to 100%. Specifically, the country saw claims rise from a total of about $3 billion in 2014 (the last year before the full deduction could be realized) to a peak of $51 billion in 2021 (a high point for venture capital activity) and still about $20 billion in 2022.
The new QSBS incentive will make more companies eligible, offer greater deductions, and reduce the tax impact of early sales.
Each of these factors should make angels more interested in investing, but they may nudge investors toward different companies than in the past.
Gross assets increased to $75 million
Previously, for a company to be eligible for a QSBS investment, its gross assets had to be under $50 million including any capital invested at the time of stock issuance. That limit has increased by 50% to $75 million, making larger companies eligible.[ii]
The practical implications of this size change could be substantial. In 2024, only the estimated post-investment valuations of pre-seed ($7.6 million) and seed ($16.8 million) stage investment could be expected to be eligible under the previous QSBS gross asset test of $50 million, as measured by adding the median pre-money valuation and median deal size data from PitchBook-NVCA Venture Monitor Q1 2025. However, the asset values suggested by 2024’s median early-stage venture capital ($50.5 million) and late-stage venture capital ($70.6 million) deals would also pass the new QSBS size standard.
In short: the change to the gross asset test appears to open many downstream investment opportunities to QSBS tax benefits, and investors may follow.
The long-term industry trend toward larger investment deals already has put pressure on the earliest stages of startup capital access in many regions of the country. Even relatively sophisticated markets have expressed concerns about an expanding gulf between the first money into promising startups and the point at which private investors are willing to step in with capital. Other things being equal, this QSBS change may exacerbate such challenges.
Tax benefits for earlier sales
QSBS rules continue to provide 100% deductibility only for gains realized after five years, but the law now offers a 50% deduction for gains realized after three years and 75% after four years.
Investors with flexibility already have better options than to exercise this rule change. QSBS investments held for more than six months can be rolled into another eligible investment while keeping the original investment’s holding period. Therefore, allowing a partial deduction for holdings after three years seems more likely to offer tax savings to investors that need to sell stakes early for cashflow purposes than to alter deliberate investor behavior.
The change could be beneficial to founders who are leveraging QSBS benefits and need additional income (or any income) before an exit. A sale of personal shares to secondary markets after three years could now have reduced taxes, potentially yielding more cash for the seller. There may be other risks involved with such a move, however, as any quick review of venture capital blogs will demonstrate that perspectives vary on when and how it is considered reasonable for a founder to sell their shares.
Gain exclusion cap increased to $15 million and indexed to inflation
Particularly successful investments will now offer an even greater ROI, as the maximum amount of gain that can be excluded from federal tax has increased from $10 million to $15 million, which will also now be indexed to inflation (a second cap of 10x the tax basis is unchanged).
This change could influence investors in two opposing directions:
Increasing investment relative to other assets. To the extent that investors believe a deal is likely to return more than $10 million, an increase in the QSBS exclusion cap will improve projected ROI. This seems unlikely to matter in evaluations of one startup versus another—most investors already are looking for companies that will generate the highest possible gain, but it may strengthen the appeal of investing in any startup versus investing in another asset class. This could become an important consideration not only relative to existing investment options but also as investors are encouraged to look at the tax law’s changes to the treatment of Opportunity Zones and agricultural property.
Decreasing investment in subsequent QSBS deals. Existing law already softens the QSBS exclusion cap by allowing investors to roll excess gains into another QSBS-eligible investment with deferred taxes (via Section 1045). Therefore, increasing the cap means that particularly successful investors will have less money that is strongly incentivized to be reinvested immediately in another eligible deal. Without the lure of deferral, many investors will either invest more patiently or use the gain for other purposes. The Treasury research cited earlier found that, from 2012-2022, more than 75% of individual investors claimed a QSBS exclusion only once.
Other new tax implications for angel investors
The tax law changed many provisions affecting wealthy individuals, and the full ramifications may take months or years to be fully reflected as the Internal Revenue Service, accountants, advisers, and individuals sort through the legislation, regulations, and personal decisions.
A partial list of provisions that could affect how much and where individuals want to invest includes the following:
- Increase in the estate tax exemption
- New floor on charitable giving eligibility
- Expanded business deductions
- Revised and permanent Opportunity Zones
How regions can respond
Perhaps the most important action that regions executing a tech- and innovation-based economic development strategy can take is continuing to talk with local entrepreneurs and investors about capital needs and availability. These conversations are crucial to calibrating strategies and programs to be effective without being wasteful.
The most concerning potential impact of the new QSBS rules is that it could encourage investment to move toward larger startups. Regions that are already seeing companies struggle to find private financing for small and early-stage capital needs may feel the effects of any further shifts soonest and should begin to consider the most appropriate response. In some areas, the right approach will be to raise a public or nonprofit follow-on investment fund that can bridge companies to private investors. In other areas, the best fit will be to create an alternative capital program (such as revenue-based financing or forgivable loans) that will serve a similar purpose. Yet other areas may be best suited by not solving for capital access issues, even if it means seeing startups move out of the region, and instead prioritizing support for other stages of the innovation lifecycle. This is a difficult strategic choice to make, and talking with local entrepreneurs and investors will, again, be critical.
[i] The legislation’s official title was the “One Big Beautiful Bill Act” until its final days in the Senate, when the title was stripped from the bill.
[ii] The effective size increase for QSBS-eligible companies is even greater than the $25 million increase in the gross assets test. Frost Brown Todd points out that other changes in the tax law (including the return of full research expense deductions) reduce a company’s gross assets, effectively allowing an even more valuable company relative to prior rules.