Equity compensation
Everything you need to know about your private company equity compensation
Equity in a private company is harder to reason about than public stock for one reason: you cannot sell it when you want to. Every tax rule still applies, but the escape hatch of selling shares to pay the tax is often closed. This guide covers the instruments, how the strike is set, the elections and deadlines that matter, how liquidity arrives, who gets paid ahead of you, the Section 1202 exclusion, and whether to exercise before the IPO.
- The three instruments: ISOs, NSOs and double-trigger RSUs
- 409A valuations and your strike price
- Early exercise and the 83(b) election
- Post-termination exercise windows
- Tender offers and secondaries
- Liquidation preferences and dilution
- QSBS: the Section 1202 exclusion
- Should you exercise before the IPO?
- Common mistakes
The three instruments: ISOs, NSOs and double-trigger RSUs
Early-stage companies mostly grant options; late-stage companies increasingly grant RSUs. Our stock options explainer covers the mechanics; here is what changes when the company is private.
| Feature | Incentive stock option (ISO) | Non-qualified option (NSO) | Double-trigger RSU |
|---|---|---|---|
| What you get | Right to buy shares at a fixed strike | Right to buy shares at a fixed strike | Promise of shares once two conditions are met |
| Tax at exercise or settlement | None for regular tax; spread is an AMT adjustment | Spread is wages (W-2 box 12 code V), 22% federal withholding | Full share value is wages when both triggers are met |
| Tax at sale | All gain long-term if held 2 years from grant and 1 year from exercise | Gain above exercise-date value is capital gain | Gain above settlement-date value is capital gain |
| Private-company wrinkle | Statutory 3-month post-termination window; $100,000 per year cap | Tax due in cash at exercise with no market to sell into | No tax until a liquidity event, so no phantom income |
A "double-trigger" RSU vests only when both a time condition (your schedule) and a liquidity condition (an IPO or acquisition) are met, so you are not taxed on shares you cannot sell. The cost: when the trigger fires, several years of units become wages in one tax year, often at the 35% or 37% bracket, while the default 22% supplemental withholding (IRS Publication 15) falls far short. Everything in our RSU tax guide about the withholding gap applies, multiplied.
409A valuations and your strike price
Your strike is set by a 409A valuation, an appraisal of the common stock's fair market value. The name comes from Internal Revenue Code section 409A, which treats an option granted with a strike below fair market value as deferred compensation (Treas. Reg. 1.409A-1(b)(5)(i)(C)). The penalty lands on you, not the company: immediate income inclusion plus an additional 20% tax and interest under section 409A(a)(1)(B). ISOs separately require a strike at or above grant-date value under section 422(b)(4).
The regulations presume a valuation reasonable if an independent appraiser prepared it no more than 12 months before the grant and nothing has since materially affected value, such as a new funding round. That is why companies refresh the 409A at least annually and after each priced round.
The 409A price is for common stock and is usually well below the preferred price investors paid, because common sits behind the liquidation preferences described below; a $2 strike against a $10 preferred price does not mean you are up $8. And the 409A value on your exercise date drives the AMT adjustment on an ISO or the wage income on an NSO, so exercising just before a 409A step-up is cheaper than just after.
Early exercise and the 83(b) election
Some plans let you exercise before vesting: you pay the strike now and receive restricted shares the company can repurchase at cost if you leave early. On its own this is a trap, because under section 83(a) restricted shares are taxed as they vest at their then-current value. The fix is the section 83(b) election, a statement filed with the IRS no later than 30 days after the shares are transferred to you, electing to be taxed now on the spread between fair market value and what you paid. Exercise at a strike equal to the current 409A value and that spread is zero, so the election costs nothing and starts your capital gains and QSBS clocks immediately. It is made on shares, not options; Publication 525 says you cannot make it for an option itself.
Two warnings: the 30-day deadline is absolute, and if you later forfeit the shares, section 83(b)(1) allows no deduction for tax paid on the election (nothing to lose when the spread was zero).
| Scenario: 20,000 options, $0.25 strike = 409A value at grant, 4-year vest | Taxable event during vesting | Sale at $12 after IPO |
|---|---|---|
| Early exercise at grant, 83(b) filed (cost $5,000) | $0 income | $235,000 long-term gain; QSBS may exclude some or all |
| Early exercise, no 83(b), 5,000 shares vest yearly at $1, $2, $3, $4 | $45,000 of wages spread over four years | Gain above each vest-date value is capital gain |
| Wait, exercise NSOs after vesting at $4 409A value | $75,000 of wages at exercise, cash tax due | $160,000 capital gain |
| Wait, exercise ISOs after vesting at $4 | $75,000 AMT adjustment at exercise | $235,000 long-term gain if holding periods met |
State tax is ignored. Whether the AMT adjustment in the last row produces an actual bill depends on your other income and the 2026 exemption of $90,100 single or $140,200 joint (Rev. Proc. 2025-32); the ISO AMT calculator runs the numbers.
Post-termination exercise windows
When you leave, unvested options are forfeited and vested options must be exercised within a plan-set window, commonly 90 days. ISOs also face a statutory limit: section 422(a)(2) requires employment until no more than three months before exercise, so an ISO exercised later is taxed as an NSO even if the plan allows it.
The private-company problem is that exercising means paying the strike, plus any NSO withholding, in cash for shares you cannot sell. People with large grants at high 409A values regularly choose between a six-figure check and walking away. Know your window and your exercise cost before you resign.
Tender offers and secondaries
Pre-IPO liquidity usually arrives in two forms. A tender offer is a company-organized event in which the company or an investor offers to buy employee shares at a set price, often with per-person caps; under SEC Rule 14e-1 it must stay open at least 20 business days. A secondary sale is a private transaction with a buyer, which almost always requires company consent and is subject to its right of first refusal.
Tax follows the instrument: shares from an NSO exercise or an 83(b)-elected early exercise produce capital gain measured from your basis, while ISO shares sold inside the holding periods are a disqualifying disposition taxed as wages, as in our ISO cashless exercise guide. Tender offers that let you exercise and sell in one step forfeit ISO treatment on the sold shares.
Liquidation preferences and dilution
Investors buy preferred stock; you hold common. Preferred typically carries a liquidation preference, most often "1x non-participating": in a sale, preferred holders receive their money back first, or convert to common and share pro rata, whichever is worth more. Common gets what is left, so the headline valuation overstates what your shares are worth unless the exit is well above the preference stack.
| Exit price (investors hold 40M of 100M shares with $40M of 1x preference) | Preferred receives | Common pool (60M shares) | Per common share | Naive 60% share would imply |
|---|---|---|---|---|
| $60 million | $40M (takes preference; conversion worth $24M) | $20M | $0.33 | $0.60 |
| $100 million | $40M (indifferent) | $60M | $1.00 | $1.00 |
| $200 million | $80M (converts) | $120M | $2.00 | $2.00 |
Ask for the total preference stack and the fully diluted share count when you join. Your grant is a number of shares, not a percentage, and each new round issues more shares, so your percentage falls even as the company grows. Participating preferred, multiple preferences and ratchets make the common position worse than the table shows.
QSBS: the Section 1202 exclusion
Section 1202 lets you exclude gain on "qualified small business stock" from federal tax. In plain terms: the company must be a domestic C corporation; you must have acquired the stock at original issuance (exercising options and receiving stock as compensation count); gross assets must not have exceeded the threshold when the stock was issued; and at least 80% of assets must be used in an active business outside excluded fields such as health, law, consulting, financial services and brokerage. Most software companies pass this test, but confirm.
The 2025 tax law changed the figures for stock acquired after July 4, 2025. For that stock the gross-asset ceiling is $75 million (previously $50 million), the exclusion is 50% after three years, 75% after four and 100% after five, and the per-issuer cap is the greater of $15 million (indexed after 2026) or 10 times your basis. For stock acquired after September 27, 2010 and on or before July 4, 2025, the exclusion is 100% but only after a five-year hold, with a $10 million cap. The clock runs from when you own stock, which is why an 83(b)-elected early exercise can start it years before an exercise at IPO.
Should you exercise before the IPO?
No general answer exists, but the questions repeat.
| Question | Leans toward exercising now | Leans toward waiting |
|---|---|---|
| What is the spread between 409A value and strike? | Small or zero: little AMT or NSO income | Large: a cash tax bill on shares you cannot sell |
| Can you afford to lose the exercise cost entirely? | Yes, without changing your life | No, or it would come from emergency savings |
| Are the options ISOs with AMT room left this year? | Yes: exercise up to the AMT-free amount | No: the AMT bill arrives before any liquidity |
| Is QSBS plausibly available? | Yes: starting the holding period early is worth a lot | Company is an LLC, too large, or in an excluded field |
| Are you planning to leave soon? | Exercise what you want to keep before the window closes | If staying, options cost nothing to hold |
| How concentrated are you already? | Equity is a small part of net worth | Most of your wealth is already in this company |
A common middle course is to exercise each year only the ISOs that fit under your AMT threshold, and NSOs only when the spread is small. Waiting until after the IPO is not free: the value at exercise will be far higher, lock-ups delay sales, and the ISO and QSBS clocks start late. When equity has become most of your net worth, concentration dominates everything on this page; see our guide to planning for high earners.
Common mistakes
- Missing the 30-day 83(b) deadline after an early exercise. There is no extension.
- Treating the preferred price as your share value. Common sits behind the preference stack.
- Exercising NSOs with a large spread without cash set aside for the tax.
- Letting ISOs convert to NSOs by exercising more than three months after leaving.
- Exercising a large ISO block in one year and triggering AMT that cannot be funded until liquidity arrives.
- Ignoring the double-trigger pile-up. Several years of RSUs settling at once will not be covered by 22% withholding.
Bottom line. Private company equity is governed by the same tax rules as public stock plus a liquidity constraint that turns every tax bill into a cash problem. The highest-value moves are cheap and early: an 83(b) election when the spread is zero, ISO exercises sized to your AMT room, and knowing your post-termination window and preference stack before you need them. The expensive mistakes come from treating a paper valuation as money.
Thresholds and the QSBS rules depend on the tax year and on when your stock was issued. Verify the current figures against the Code sections linked above, the IRS revenue procedure for the year, and your own plan documents before acting.