Many founders are, and should be, meticulous about their equity. The tax on eventually selling that equity, which is likely the greatest expense they will ever face, usually receives no planning at all until the issue is forced upon them.
This dynamic is somewhat understandable. For many years the equity was essentially worth nothing, and planning around a hypothetical fortune can feel premature. But equity tax planning has a property many decisions do not. Some of the most effective tools require years of lead time, so by the time the problem feels (or is) concrete, most of the options are less impactful.
Two common outcomes
The first is the fast exit. An acquisition closes quickly, and the proceeds arrive within months or a year of the initial discussions. A founder selling $20M of low-basis stock in a high-tax state pays roughly 37% of the gain, about $7.4M, in combined federal and state tax.1
The second is slower and potentially more damaging. The company goes public, the lockup expires, but the founder does not sell (partly out of loyalty and optics, partly because selling means a large tax bill). It could also be because up until now, they've only ever experienced their equity increase in value. Newly public stocks decline often and sometimes sharply. A founder, or early employee, holding through a 50%+ drawdown in the asset that represents nearly all of their net worth learns that the tax they were avoiding was the cheaper of the two costs.
Both outcomes share a cause. No tax capacity was in place when liquidity arrived, so every path led to either paying the full tax immediately or not selling at all.
What lead time buys
Founders do have one dedicated provision, qualified small business stock (QSBS), and for startups that qualify it is the first thing to understand. QSBS can exclude $10 million or more of gain per issuer outright.2 But QSBS is capped and not every company qualifies for it. For founders whose equity has grown in value significantly, it can cover part of the tax bill, but typically not all of it. For the remainder, one of the most effective tools is proper planning well in advance of a liquidity event. One tool that may be powerful in these situations is a tax-aware long/short investment strategy.
The strategy is built as an investment first. It seeks pre-tax returns from a diversified long/short equity portfolio, and it gives the founder liquid holdings independent of the company's fortunes. The loss harvesting comes on top of that investment case.
The strategy pairs long and short positions, which gives it tax loss harvesting ability in both up and down markets. Rising markets create losses on the short side, falling markets on the long side, with the strategy systematically harvesting while staying fully invested.3 Those losses accumulate year after year into a loss base that does not expire. In our simulations, run from 2016 through the middle of this year, the losses come to 20% to 30% of portfolio value in a typical year. The cumulative loss total passes 100% of invested capital around the third year, reaches ~1.7x the capital by the fifth year, and ~3x by the tenth.4
Those loss figures are the argument for starting early. A program started five years before liquidity, funded with even a fraction of the eventual proceeds, may deliver accumulated losses of ~1.7x the amount invested. A three-year head start accumulates losses on the order of the investment itself. Every dollar of losses absorbs a dollar of gain at the sale, deferring tax that would otherwise be paid immediately. Investing in the strategy after the liquidity event still works, but it builds the loss base after the gains are already being realized, and the first years of selling get less benefit.
Where the capital comes from
The usual objection is that founders have little liquid capital before an exit. However, these days secondary sales and tenders have become routine at growth-stage companies. Proceeds from a Series C or D secondary are well suited to funding a tax-aware long/short strategy. So are accumulated savings, prior exits, or the first tranche sold after an IPO. The strategy needs to match the size of what the founder realistically intends to sell in the first few years, rather than the size of their entire stake.
And selling some of their equity, regardless of taxes, is generally the right decision. The venture business is built on power laws, but in our view a founder's personal net worth should not be built the same way. Selling just enough to secure a family's finances changes nothing about a founder's commitment to the business. The founders who come to regret their equity decisions are typically the ones who sold nothing, or who paid taxes they had years of warning to plan for, rather than the ones who sold a sensible slice.
The window
A founder's window opens long before the tax does. That window is when the problem is cheapest to address. It is also when diversifying away from a single concentrated position matters most. The strategy compounds with time, so beginning to build a loss base when a liquidity event starts looking probable, rather than when the proceeds are scheduled, can be a smart decision. One that few founders are aware of today.
For the mechanics and the research in full, see our full research primer.