The Qualified Small Business Stock (QSBS) federal tax exemption is foundational to the U.S. startup ecosystem. When complied with, it allows founders and early-stage investors to exclude up to $15 million (and in niche cases more) of capital gains from federal tax upon a sale of their shares.

For this reason, angel investors and VCs deeply scrutinize whether a startup maintains QSBS compliance, without which they may refuse to invest.

One under-appreciated QSBS compliance requirement is that companies not "redeem" more than 5% (of the company's aggregate value) in shares within any 2-year period. In many situations, this can create complications for founders seeking secondary liquidity in a funding round, like a Series B or C.

Most founders only hold common stock, but investors – for a number of reasons that we won't get into here – want to hold preferred stock. One way for founders to sell common stock but investors to receive preferred stock is for the company to serve as an intermediary: redeeming the common stock, canceling it, and then issuing new preferred stock to the investor. It works, except for when it hits the 5% QSBS redemption threshold.

Convertible Series FF stock, a unique form of founder stock that can be issued at formation, offers a fix for this problem. It allows founders to convert their Series FF shares into any other series of preferred stock as part of a sale to an investor. Because the company doesn't have to serve as an intermediary, there is no 5% redemption threshold issue. Founders get their liquidity without busting any QSBS requirements.

While most startups don’t issue their founders Series FF – it is not “standard” and not part of the conventional templates used for formations – we’re seeing it growing in popularity as founders consider more sophisticated tax-planning at the outset of their startup formation.

Long-term Series FF can help save founders millions of dollars in taxes or enable an early liquidity event that might not otherwise have been on the table. It will add some extra cost and complexity to a formation, but in many contexts founders see it as very high ROI.