Brian Nichols is the co-founder of Angel Squad, a community where you’ll learn how to angel invest and get a chance to invest as little as $1k into Hustle Fund's top performing early-stage startups

Writing the check feels like the hard part. Then tax season arrives and you realize record keeping matters more than you thought. Angel investors face specific legal and tax requirements that can make or break your returns. Get it right and you keep more money. Get it wrong and you either overpay or face problems with the IRS.

Why Delaware C-Corps Matter

Start with the structure. Most startups you'll invest in should be Delaware C-Corps. Elizabeth Yin, co-founder and General Partner at Hustle Fund who previously ran the 500 Startups accelerator, is adamant about this. 

VCs won't touch LLCs because of tax treatment. LLCs are pass-through entities. If your portfolio company makes money or loses money, that flows through to every investor's personal taxes. Imagine if you're a VC with 99 investors in your fund. None of them want to deal with extra tax paperwork for one startup. The ops burden becomes massive.

For angels, the tax complexity of LLCs is annoying but manageable since you're only dealing with your own returns. Still, if a founder wants to raise VC money eventually, they need to be a C-Corp from the start. Converting later costs money and time.

Eric Bahn, co-founder and General Partner at Hustle Fund, made this mistake with his first company. He formed a California LLC instead of a Delaware C-Corp. When he sold the business, his tax accountant told him he would have saved significant money on taxes if he'd structured it correctly from the beginning.

Now let's talk about what you need to keep. First, all investment documents. The SAFE or convertible note or stock purchase agreement. Whatever you signed to put money in. Keep copies somewhere you can find them. A Dropbox folder works. A Google Drive works. Just make sure you have them.

Essential Documents to Track

Second, track every company you invest in with basic details. Company name, date of investment, amount invested, valuation or cap, type of security. You need this for your own portfolio tracking. You also need it when companies ask you to fill out forms for later rounds or when they exit.

Third, save all company updates and communications. Quarterly updates from founders. Annual reports. Cap table updates. Dissolution notices. These create a paper trail that can matter for tax purposes later.

Claiming Losses and Write-Offs

The tax side gets interesting around write-offs. You can claim losses on investments that go to zero. But you need documentation. The cleanest case is when a founder formally dissolves the company and sends you dissolution documents. That's your proof the investment is worthless.

What about when a company just ghosts you? Elizabeth mentioned this happens in her angel portfolio. She can't get ahold of them. The website disappears. The founder moved on to a new job. Her accountant has been able to take those as write-offs using circumstantial evidence. The website is gone. The founder's LinkedIn shows they're doing something else. There's no business activity. That combination can be enough.

But different accountants interpret the rules differently. Some want more proof. This is why keeping detailed records matters. Screenshots of the dead website. LinkedIn profiles showing the founder at a new company. Emails showing they stopped responding. Build your case.

QSBS: The Best Tax Break in Investing

The bigger opportunity is Qualified Small Business Stock. QSBS rules came out of the 2009 financial crisis to incentivize people to invest in small businesses. The deal: if you invest in a company worth under $50 million, hold the stock for five years, and it's a US C-Corp, you pay zero federal taxes on gains when you exit. Not reduced taxes. Zero.

Say you're an early employee at a seed-stage startup valued at $15 million. You exercise your options today. Seven years later, the company sells and you make $2 million on your shares. Under QSBS, you pay zero federal taxes on that gain. You still pay state taxes if your state has them. But federal is zero.

This applies to angel investors too. Invest $25k in a seed round. Company exits five years later at a billion-dollar valuation. Your shares are worth $5 million. Zero federal taxes. That's a meaningful incentive to invest early and hold long term.

The fine print matters though. QSBS has specific requirements around when you bought the stock, how much you make on the deal, and the company's structure. Some debate exists around whether investing via SAFE starts your five-year clock immediately or only when the SAFE converts. Different lawyers argue both sides. You need your own counsel on specifics.

But the principle is powerful. If you're investing in early-stage startups, QSBS significantly beats normal capital gains treatment. This is one reason angels should strongly prefer Delaware C-Corps. International companies don't qualify. Late-stage investments often don't qualify. The benefits accrue to people who take early risk.

Tracking Portfolio Performance

What about tracking portfolio performance? You need to know how your investments are doing. Not just for returns, but to understand your own judgment. Which kinds of companies worked? Which didn't? You can't learn without data.

Simple spreadsheet works fine. Company name, investment date, amount, current status, current value if known. Update it quarterly or whenever you get company updates. Over time, patterns emerge. You start seeing what kinds of founders or markets or problems you're good at evaluating.

Elizabeth talks about this in the context of learning angel investing. Most companies will return zero. Some will return small multiples. A few might return 10x or more. You need a portfolio approach because you can't predict which will be which. But tracking lets you see if your hit rate improves over time.

Things That Can Go Wrong

One area that surprises people: embezzlement happens. Elizabeth has seen it four times across nearly 400 investments. That's a low percentage but not zero. In all cases, the founders passed background checks. No criminal records. Upstanding citizens. Due diligence didn't catch it. The money just disappeared.

Her friends in those companies didn't sue or call the police. The money was gone and it felt pointless to pursue. This is why diversification matters. You cannot eliminate all risk in angel investing. You can only manage it through portfolio construction.

Another weird edge case: co-founders break up while running the company together. Elizabeth helped one founder work out a deal with her ex-husband to get him off the cap table. Family situations. Health crises. Visa issues. All kinds of personal complications can derail startups. Your job as an investor is to be supportive where you can but recognize you can't fix everything.

Working With Professionals

What do you actually need from a lawyer? Setup costs if you're organizing your investing through an entity. Document review for larger investments. Maybe help with a fund if you go that route. Most angels don't need extensive legal help once they understand the basics.

The templated services like Clerky work fine for simple situations. Boutique lawyers make sense if you're doing anything complex. Big firm lawyers cost a lot but sometimes offer deferred payment arrangements. Those aren't free though. You're just paying higher rates later.

Work with a tax professional who understands startup investing. Not every accountant does. QSBS alone requires specific expertise. You want someone who can help you maximize the tax benefits while staying compliant.

The system isn't designed to make this easy. But proper record keeping protects you. It lets you claim write-offs when companies fail. It ensures you get QSBS benefits when companies succeed. It helps you learn from experience. And it keeps you organized when companies need updated investor information for future rounds.

Angel Squad members benefit from shared knowledge here. Tax questions come up constantly. People share their accountants. War stories about documentation needs. Learning from others' mistakes is cheaper than making all your own. That community knowledge compounds over time and makes everyone better at the operational side of angel investing.