We are building the technology infrastructure that enables investors to graduate from expensive direct indexing accounts into low-cost ETFs without triggering taxes.
The problem: Direct indexing strategies charge 40-60 basis points annually for tax-loss harvesting benefits that largely disappear after 3-5 years of appreciation. Once most positions are underwater, investors are stuck—they can't exit without triggering massive capital gains taxes, yet they're still paying premium fees for diminishing value.
The solution: Section 351 conversions. By contributing appreciated securities to a newly-formed ETF in a tax-free exchange, investors can transition to a low-cost ETF structure (typically 5-20 bps) while preserving their cost basis and deferring taxes indefinitely.
Section 351 of the Internal Revenue Code allows for non-recognition transactions when transferring property to a corporation in exchange for stock. Here's how it applies to ETFs:
The Exchange:
• New ETFs can be seeded with a basket of securities that meet specific diversification criteria
• This contribution is a non-recognition transaction under Section 351—no taxable event occurs
• Investors receive newly minted ETF shares in exchange for their contributed securities
• Capital gains taxes only occur upon selling the ETF shares (typically years later)
Tax Treatment:
• Contributors receive equivalent value in ETF shares to the market value of contributed holdings
• Total cost basis of received ETF shares equals total basis of original contributions
• If contributions were held long-term, ETF shares are considered long-term from day one
• ETFs typically have minimal distributions, giving investors better control over when taxable events occur
Diversification Requirements (25/50 Test per §368(a)(2)(F)):
• No single holding can exceed 25% of the total portfolio value
• The top 5 positions cannot exceed 50% of the portfolio's net asset value
• Portfolios of 10+ securities are more likely to qualify
Control Requirement:
• Investors must collectively control at least 80% of the ETF's value upon launch
• Both direct and indirect ownership counts toward this threshold
Eligible Assets (must be exchange-traded):
• US and foreign ETFs (US-traded)
• US equities, ADRs, foreign equities, GDRs
• Fixed income ETFs
• Commodity ETFs and spot crypto within an ETF
• MLPs and public partnerships
• Cash and government bonds (not counted for diversification purposes)
Ineligible Assets:
• Mutual funds
• Private stocks, REITs, or RSUs
• Spot crypto held directly (must be within an ETF wrapper)
Grey Area:
• Closed-end funds (if publicly traded and redeemable in-kind)
• Hedge funds without derivatives exposure
Understanding how ETFs maintain their peg to NAV is critical to understanding why 351 conversions work:
Key Players:
• Authorized Participants (APs): Broker-dealers legally permitted to transact directly with the ETF in large blocks called creation units (typically 25k-100k shares)
• Custodian: Financial institution holding the ETF's assets (e.g., BNY Mellon, State Street, JPMorgan, Citi, Northern Trust)
Creation Process (increasing ETF share supply):
1. AP checks ETF's daily basket (list + weights of required securities)
2. AP acquires the basket in the market
3. AP delivers basket to the ETF's custodian
4. ETF issues a creation unit of new shares to the AP
5. AP sells those shares on the exchange (share supply increases, price moves toward NAV)
Redemption Process (decreasing ETF share supply):
1. AP buys ETF shares on the exchange until it holds a full creation unit
2. AP delivers these shares to the fund
3. ETF redeems (cancels) the shares and returns the underlying basket or cash to the AP
4. AP may sell or keep those securities (share supply decreases, price moves toward NAV)
Why This Matters for Tax Efficiency:
In-kind redemptions allow the ETF to flush out low-cost-basis lots without triggering capital gains for remaining shareholders. This is the tax "magic" of ETFs—and 351 conversions let investors seed an ETF with their appreciated positions, inheriting this tax-efficient structure.
In 2024, approximately 700 new ETFs launched. The ETF market is growing rapidly, but 351-seeded launches remain a boutique corner dominated by manual processes. Our opportunity is to industrialize this workflow and make tax-efficient transitions accessible at scale.
1. Contributor Intake & Eligibility Engine
Secure portal where clients upload holdings data. The system runs real-time diversification and control tests (both per-contributor and in aggregate), flags ineligible securities, and proposes minimal edits to pass regulatory thresholds. Maintains drift buffers to prevent market movements from breaking compliance before seed day.
2. Custodian Adapters & Data Normalization
Direct API integrations with major custodians (Schwab, Fidelity, Pershing) to ingest tax-lot data automatically—quantity, cost basis, acquisition dates. Eliminates manual CSV wrangling and reduces errors.
3. Basis-Override Generator
When contributors exchange securities for ETF shares via 351, their cost basis carries over—it doesn't reset. Custodians, unaware this was a tax-free exchange, default to using the issue-day NAV as basis. This tool auto-generates "Cost Basis Adjustment Forms" (CSV files) and submits them to each custodian, instructing them to override the default basis with the correct carried-over values. Saves hours of manual coordination and prevents future tax headaches.
4. Seed-Night Orchestration Console
Single dashboard for the critical T-1 tasks: reconcile delivered shares vs. acceptance list, run final diversification checks at market close, compute initial NAV and share count, split creation units. Creates an error-free, repeatable runbook for launch day.
5. Rule 6c-11 Website Automation
ETFs must publish daily holdings, NAV vs. market price, 30-day median bid/ask spread, and premium/discount history. This module auto-publishes from administrator data feeds, supports multiple tickers, and eliminates ongoing vendor overhead.
6. Document Automation
Auto-generate templated docs: Plan of Exchange, contributor representation letters, custodian LOAs (Letters of Authorization), KYC packages. Reduces legal back-and-forth.
7. Compliance "Linting" for Marketing & Filings
Static checks on factsheets, website copy, and creation basket policies—compare against prospectus language. Flags potential compliance issues before distributor review, cutting approval iterations.
8. AP/Market Maker Capital-Markets Kit
Auto-produce market-maker briefs (basket liquidity, ADV, top holdings turnover), creation/redemption files, and a day-one monitoring dashboard (spreads, depth, volume). Ensures tight spreads from launch and reduces handholding.
9. Launch Calendar & Task Tracker
T-45/T-21/T-14/T-7/T-2/T-1 milestone tracker with task owners (Legal, Ops, Custody, Capital Markets), SLA timers, and "freeze window" enforcement (alerts if trading occurs in a contributing account). Enables running multiple launches in parallel without missing dependencies.
Certain roles require regulatory licensing, independence, or specialized expertise that can't (or shouldn't) be brought in-house:
• Series trust, board, and governance structures
• Fund administrator / accountant (daily NAV, books, records)
• Custodian and transfer agent (hold assets, issue shares)
• Distributor / principal underwriter (FINRA broker-dealer)
• Auditor & tax counsel (formal 351 opinion, year-end audit)
• Exchange listing, Authorized Participants, and lead market maker
• Fund counsel and independent trustee counsel
The business model is to orchestrate these vendors, not replace them—acting as the system integrator and process automation layer.
Phase 0: Strategic Framing
Select legal wrapper (series trust vs. standalone), confirm Rule 6c-11 eligibility, define investment philosophy, and set commercial rails (target $25-50M AUM via in-kind contributions).
Phase 1: Provider Stack
Acquire legal counsel, administrator, custodian, distributor, auditor, and onboard Authorized Participants.
Phase 2: Design 351 Exchange
Verify tax-free eligibility under Section 351 (control test, diversification test). Draft the Plan of Exchange documenting the business purpose, contributing parties, and assets.
Phase 3: Data & Documentation
Collect client consent (351 representation letters, KYC/AML), gather tax-lot data from custodians, and impose trading freeze 1-2 weeks before seed day to prevent drift.
Phase 4: Regulatory & Listing
File Form N-1A (prospectus/registration statement), await SEC effectiveness, schedule exchange listing, and publish Rule 6c-11 disclosures on fund website.
Phase 5: Seed Night (T-1)
Contributors' securities transfer in-kind to ETF custodian. Administrator prices all securities at market close, confirms diversification and 80% control, strikes initial NAV, and issues creation units to contributors.
Phase 6: Launch Day (T-0)
ETF begins trading publicly. Contributors' accounts now show ETF shares. Custodians import basis-override files. Tax counsel issues written 351 opinion (T+5).
Phase 7: Ongoing Operations
Maintain tax posture (gradually flush low-basis lots via in-kind redemptions with APs), support capital markets (tight spreads, healthy primary market activity), and handle compliance calendar (monthly N-PORT filings, annual audits).
The direct indexing industry has sold investors on a compelling value prop: harvest losses, defer gains, customize holdings. But after a few years of appreciation, the benefits erode while the 40-60 bps fees persist. Investors become trapped—unable to exit without triggering taxes, yet paying premium fees for minimal ongoing value.
351 conversions offer a tax-advantaged exit. By systematizing the process, we can make this transition accessible to thousands of investors currently stuck in expensive accounts. This is an infrastructure play in a corner of fintech still dominated by spreadsheets, email threads, and manual coordination.
The business scales horizontally: each new ETF launch reuses the same infrastructure. Over time, the marginal cost of launching drops significantly. We're not just building software—we're building the rails for a new category of tax-efficient wealth management.