You’ve been grinding at your startup for years. The IPO is finally on the horizon. Your stock options are sitting there, and you’re staring at a decision that could cost you hundreds of thousands of dollars if you get it wrong.
Should you exercise stock options before IPO?
Wait until after the IPO?
What about taxes?
We work with tech employees and founders navigating this exact situation every week. The truth is, there’s no universal answer. But there are frameworks that can help you make the right call for your situation.
The Tax Math You Need to Understand First
Let’s start with the biggest financial lever in this decision: taxes.
When you exercise stock options after an IPO and sell simultaneously (what’s called a cashless exercise), you pay ordinary income tax rates. We’re talking up to 37% federal, plus state taxes. Taxes can make up a significant portion of the total cost to exercise stock options, often the largest single expense.
But if you exercise before the IPO and hold those shares for at least 12 months, you qualify for long-term capital gains treatment. That’s roughly 20% federal (or less, depending on your income), potentially saving you 15-17% on every dollar of gain.
Here’s where it gets tactical. The popular move is the six-month pre-IPO exercise. You exercise six months before the company goes public, sit through the typical six-month lockup period, and boom. You’ve hit the one-year holding requirement for long-term capital gains treatment right when you can finally sell.
Sounds perfect, right?
Not so fast.
The Cash Flow Reality Check
Exercising stock options before an IPO requires real money. Not theoretical money. Actual cash sitting in your bank account.
Let’s look at an example. You have 100,000 options with a $1.50 strike price. The current fair market value is $3.25 per share. To exercise, you need $150,000 just for the purchase price. If these are non-qualified stock options (NSOs), you’ll also owe taxes on the spread between your strike price and the current valuation. That’s another $38,500 or more, depending on your tax bracket.
You’re writing a check for nearly $190,000 for shares you can’t sell yet.
And here’s the kicker: newly public companies are notoriously volatile. Pre-IPO valuations are typically at all-time highs. If the stock tanks after going public, you’re stuck holding illiquid shares that lost value while you still owe those taxes.
We’ve seen this happen. It’s brutal.
The Alternative Minimum Tax Trap for ISO Holders
If you hold incentive stock options (ISOs), you face an additional complexity: the Alternative Minimum Tax (AMT).
When you exercise ISOs and hold them through year-end without selling, the bargain element (the difference between your strike price and the fair market value) becomes taxable income for AMT purposes. The AMT rate is 26-28%, and you owe it even though you haven’t sold the shares or received any cash.
This is what we call phantom income. You pay real taxes on paper gains.
The good news? AMT payments often generate a dollar-for-dollar tax credit you can use in future years. It’s more of a timing issue than a permanent extra tax. But in the moment, it requires serious cash flow planning.
The Biggest Mistake We See Employees Make
Want to know the most common error? It’s not exercising at the wrong time.
It’s not making a decision at all.
Employees let options sit until they expire or until a forced timeline creates a bad decision under pressure. According to research from Carta, 46% of in-the-money options expired unexercised in 2022. That’s leaving money on the table because the decision felt too complicated or stressful.
The second biggest mistake? Exercising everything at once without understanding the tax consequences, especially AMT for ISO holders.
Both mistakes stem from the same root cause: not having a plan early enough.
How to Actually Think Through This Decision
Here’s the framework we use with clients:
Step 1: Assess Your Cash Position
Can you afford to exercise without touching your emergency fund or taking on debt? If not, the decision becomes much simpler. You probably shouldn’t exercise pre-IPO.
Step 2: Understand Your Risk Tolerance
You already have significant exposure to your company through your salary and existing equity. Adding more concentration by exercising early increases that risk. Even if the tax math says hold longer, your broader financial security might argue for selling earlier to diversify.
We’ve worked with employees who held too much company stock post-IPO and watched it drop 60% in a year. The tax savings didn’t matter anymore.
Step 3: Model the Tax Scenarios
Run the numbers for different exercise and sale timing combinations.
What do you owe if you exercise now versus after the IPO?
What if the stock goes up 50%?
What if it drops 30%?
This isn’t guessing. It’s scenario planning.
Step 4: Consider State-Specific Tax Changes
If you live in Washington state, pay attention. A new 9.9% state income tax on household income above $1 million begins in 2028. That creates a closing window in 2026-2027 where exercising large option grants before the tax takes effect could save nearly 10% on every dollar above the threshold.
State tax changes can materially shift the calculus.
Step 5: Understand the Lockup Period and Trading Windows
Lockup periods typically span six months post-IPO. Even after that, you can only sell during open trading windows (usually 4-6 weeks after quarterly earnings releases). Material non-public information provisions and insider trading restrictions may still prohibit transactions.
You may not have unrestricted ability to sell in the first open trading window. Plan accordingly.
When Exercising Early Makes Sense
Exercising before an IPO can be the right move if:
- You have the cash to cover both the exercise price and taxes without financial strain.
- You believe in the company’s long-term prospects and can stomach the volatility.
- The tax savings from long-term capital gains treatment justify the liquidity risk.
- You’ve modeled worst-case scenarios and can handle them.
- Your overall portfolio won’t become dangerously concentrated in one stock.
When Waiting Makes More Sense
Waiting until after the IPO might be smarter if:
- You don’t have the cash to exercise without taking on debt or depleting savings.
- You need liquidity more than you need tax optimization.
- The AMT hit would create a serious cash flow problem.
- You’re already heavily concentrated in company stock and need to diversify.
- The company’s post-IPO prospects feel uncertain.
The Real Answer: It Depends on Your Situation
We know that’s not the definitive answer you wanted. But here’s the truth: the right timing depends on your cash position, risk tolerance, tax situation, and financial goals.
What we can tell you is this: the employees who navigate IPOs successfully are the ones who plan early, model scenarios, and make intentional decisions rather than reactive ones.
If you’re facing this decision, start planning now. Not when the IPO is announced. Not when the lockup period ends. Now.
We help tech employees and founders navigate exactly these situations every day. We specialize in equity compensation strategies, tax planning for ISOs and NSOs, and QSBS optimization.
If you’re trying to figure out the right move for your stock options, let’s talk through your specific situation.
If you found this helpful, you might also want to read our post on QSBS planning strategies for founders and early employees. Understanding qualified small business stock treatment can add another layer of tax optimization to your equity strategy.
Until next time!
Common Questions
Should you exercise stock options before an IPO?
It depends on your strike price, current 409A valuation, AMT exposure, cash reserves, and probability of IPO. Exercising before an IPO can lock in a lower bargain element for AMT purposes, start the QSBS holding clock earlier (Section 1202 requires holding 5+ years), and start the long-term capital gains holding period. But it commits real cash now on shares that may never become liquid if the IPO is delayed or cancelled.
How does the Alternative Minimum Tax (AMT) affect ISO exercises before an IPO?
When you exercise Incentive Stock Options and hold the shares, the bargain element (fair market value minus strike price) is a preference item for AMT. If your AMT exceeds your regular tax, you owe the difference that year, even though you have no cash from selling shares. Pre-IPO this can create a major liquidity problem, especially for early employees with very low strike prices and high current 409A valuations.
What is the biggest mistake employees make with pre-IPO stock options?
Waiting until the IPO is imminent or already announced to exercise. By that point, the 409A valuation has typically climbed, the AMT bill is much larger, and you’ve lost the early-exercise window for QSBS qualification and long-term capital gains treatment. The decision needs to be planned years in advance, not weeks.
When does it make sense to wait instead of exercising pre-IPO options early?
Waiting can make more sense when the company’s IPO probability is low or uncertain, when exercise cost plus AMT would create unmanageable cash pressure, when you do not have a 5+ year holding window for QSBS, or when the strike price is high enough relative to current 409A that the upside from early exercise is small.
Can you afford to exercise pre-IPO stock options?
Before exercising, calculate three numbers: total exercise cost (number of shares times strike price), AMT liability triggered (typically 26-28% of the bargain element if you exceed AMT thresholds), and how long that capital might be locked up in illiquid private shares. A standard guideline: only exercise an amount where losing the entire investment would not derail your financial life.
Related reading: If you work at OpenAI or Anthropic, here’s what to think about before IPO.
