I almost redeemed a departing co-founder's shares eighteen months after our seed round closed. My attorney stopped the wire two days before it went out, because that single buyback would have disqualified the QSBS exclusion for every shareholder who bought stock in the two years around it, not just his.
Most founders think QSBS risk lives entirely in the eligibility requirements: gross assets under $75 million, a five-year hold, the 80 percent active-business test. Those are the rules everyone Googles before they issue stock. The redemption rules are the ones nobody checks until a lawyer flags them mid-transaction, and by then the buyback is often already agreed to.
How one buyback disqualifies stock that was never involved
Section 1202(c)(3) has two separate redemption tests, and either one can quietly kill an exclusion that has nothing to do with the person being bought out.
- The four-year rule: any significant redemption from a shareholder, or someone related to them, happening anywhere from two years before to two years after a share issuance can disqualify that specific issuance from QSBS treatment.
- The two-year rule: if the company redeems more than 5 percent of its total stock value, measured at the start of the two-year window, during the year before to the year after an issuance, that issuance loses QSBS eligibility, regardless of who got bought out.
The two-year rule is the one that catches founders off guard, because it doesn't care who was redeemed. Buy back a departing engineer's early-exercised shares, and you can disqualify QSBS for an investor who bought stock in a completely unrelated round eighteen months later, if the redemption crossed the 5 percent threshold.
What actually counts as a redemption
A de minimis exception exists: a redemption is ignored only if it is both under $10,000 and under 2 percent of the company's outstanding stock value on that date. Most real transactions clear that bar instantly, a departing employee's early-exercised shares, a co-founder buyout, a small secondary for an early angel. "Small" from your perspective is not the same as small to the IRS.
The email to send your attorney before you redeem anything
Send this before you agree to terms with the person being bought out, not after. Getting the QSBS math on the table before a number is agreed keeps you from having to unwind a handshake deal.
A version that works:
Subject: QSBS check before [name]'s buyback closes
We're planning to redeem [X]% of [name]'s shares for [$ amount] around [date]. Before I sign anything: does this trigger the Section 1202(c)(3) four-year or two-year redemption rule for shares issued in that window, including [most recent financing round]? If it does, I want three options costed out before we close: restructuring the buyback as a smaller de minimis tranche, delaying it outside the window, or accepting the QSBS impact with a written list of exactly which shareholders it affects.
If you're already past the point of asking
If the buyback already closed, the fix is documentation, not panic. Ask counsel to run the exact redemption math against your issuance dates, list which shares are impacted and which aren't, and put that analysis in writing now, while records and context still exist, instead of leaving it to be reconstructed at exit. Acquirer's counsel in a future deal will ask for exactly this.
The 30-day move
Before your next buyback, cap table cleanup, or advisor equity repurchase, list every redemption planned for the next 12 months on one page: who, how much, and what date. Send that list to your attorney with the email above attached, before any of them close, not after the first one does.
This is the same conversation to have alongside cap table cleanup before your next round and buying back advisor equity before your Series A. Redemptions, pool sizing, and cap table hygiene all get negotiated in the same pass. QSBS exposure should be checked in that same pass, not separately, and well before you've already listed the other
ways founders quietly lose QSBS disqualification and the five exclusion requirements that have to hold up at exit.
Frequently asked questions
What is a QSBS redemption?
A redemption is any repurchase of stock by the company from a shareholder. Under Section 1202(c)(3), certain redemptions occurring near a stock issuance can disqualify that issuance from the QSBS capital gains exclusion, even if the redeemed shareholder isn't the one holding the QSBS.
Does buying back a departing employee's stock affect QSBS?
It can. If the redemption exceeds the de minimis exception and falls within the four-year related-party window or pushes total redemptions over 5 percent of stock value in the two-year window, it can disqualify QSBS issued in that period, for anyone, not just the employee being bought out.
What is the de minimis exception to the QSBS redemption rules?
A redemption is disregarded only if it is both under $10,000 and under 2 percent of the company's outstanding stock value, measured on the date of the redemption. A redemption has to clear both thresholds to be ignored.
Can a redemption disqualify QSBS for shareholders who weren't bought out?
Yes. Under the two-year significant redemption rule, the disqualification attaches to the stock issuance itself, not to the specific person redeemed. Every shareholder who received stock in that same issuance window can be affected.
When should I loop in my attorney on a stock buyback?
Before you agree to a price or a timeline with the person being redeemed, not after. Once terms are set, unwinding a deal to protect other shareholders' QSBS is a much harder conversation than checking the math first.
Most QSBS damage doesn't come from missing a filing deadline. It comes from a buyback that looked routine at the time, cleared internally in a Slack thread, and never touched the person whose exclusion it quietly broke. The fix costs one email and a two-day delay. The alternative costs someone their exclusion at exit, with no way to undo it.