For purposes of this article, we are referring to General Partners of venture capital (VC) firms or similar private equity investment funds. General Partners can accumulate capital gains from two main sources, i.e. (i) direct investments or (ii) carried interest. Generally, General Partners of VC firms will make investments alongside their fund, which would be treated the same as an angel or accredited investor for QSBS purposes. The direct investments would need to meet all the Section 1202 QSBS checklist items.
Industry-standard is that General Partners do not start receiving carried interest until the total fund has been returned and in some cases, there will also be a hurdle rate. If not all of the funds’ investments qualify for QSBS it can create perplexities with the allocation and timing of carried interest to each individual investment. Also, it is nearly impossible to forecast what the returns will be regarding carried interest. Even though it is a complex process to report carried interest as a Section 1202 QSBS carried interest gain it is still possible. General Partners will have to submit comprehensive documentation and make descriptive disclosures on why the carried interest qualifies for QSBS.