Chapter 9: Private company equity: paper money
Jordan's equity portal says his 40,000 options are worth $504,000. His company's last press release implies they are worth more. The IRS says the shares behind them are worth $9.00 each. His bank says the whole position is worth nothing, because nobody will lend against it and nobody is offering to buy it. Every one of those statements is correct, which is the entire problem with private company equity: it is a number wearing the costume of money. This chapter is about the three prices, the cash it takes to turn options into shares, and the handful of days when paper gets a chance to become real.
Three prices for the same share
Private companies carry three different valuations at once, and confusing them is the most expensive vocabulary mistake in tech.
The 409A valuation is an independent appraisal of the common stock, the kind employees get. Jordan's is $9.00. It is deliberately conservative, it sets the strike price of new option grants, and it is the number the IRS uses to measure the bargain element from chapter 7. For tax purposes, it is the only price that exists.
The preferred price is what investors paid in the last funding round, $15.00 in Jordan's case. Preferred shares come with protections common shares lack, above all a liquidation preference: if the company sells low, preferred holders get their money back before common holders get anything. Investors pay $15.00 for a different, safer instrument. Your shares are not that instrument.
The headline valuation is the preferred price multiplied by every share outstanding. Jordan's company has 80,000,000 shares, so the press release says $1.2 billion. It is a marketing number built on the price of the safest share applied to all of them.
The exercise-cost trap
Now the cash. Suppose Jordan, instead of the careful slices from chapter 7, exercised all 40,000 options in one year. The strike alone is 40,000 times $2.40, or $96,000, wired to the company. The bargain element is 40,000 times $6.60, or $264,000, and running it through the exact chapter 7 machinery (income $160,000, single, 2026) gives an AMTI of $424,000, still under the $500,000 phaseout, an AMT base of $333,900, and a tentative minimum tax of $88,602, which is $63,570 at 26% plus $25,032 at 28% on the slice above $244,500. Subtract his $27,134 regular tax and the AMT is $61,468.
| The real cost of exercising all 40,000 options | Amount |
|---|---|
| Strike price, 40,000 shares at $2.40 | $96,000 |
| Federal AMT on the $264,000 bargain element | $61,468 |
| Total cash required | $157,468 |
State tax comes on top in most states, and California runs its own alternative minimum tax. Call it roughly $160,000 of real cash, before state, for 40,000 shares that cannot be sold, in a company that has not yet proven it will ever be sold. That framing produces the only question that matters, and it deserves to be asked exactly this way: if I had $157,000 of cash in my brokerage account today, would I invest all of it in this one private company? Investors call a version of this the kill question, because an honest answer kills most full exercises. Run your own numbers in the calculator below before any exercise conversation gets serious.
Price any private exercise as a cash investment: strike plus the full tax bill, in dollars you could otherwise put anywhere. If you would not invest that cash in the company today, do not exercise that many options. Partial exercises sized to chapter 7's AMT room let you answer yes to a smaller question.
Early exercise and the 30-day form
Some companies allow early exercise: buying option shares before they vest, with the company keeping the right to repurchase unvested shares at your strike if you leave. Early exercise shines when the strike is pennies and the 409A has barely moved above it, because the bargain element rounds to nothing, the tax rounds to nothing, and both the capital gains clock and the chapter 8 QSBS clock start immediately. The whole strategy hangs on one piece of paper.
The 83(b) election
An 83(b) election tells the IRS to tax your unvested shares now, at today's value, instead of taxing each chunk later as it vests at whatever the value has grown to. For an early exercise at a strike equal to the 409A, "tax me now" means tax on a spread of zero. The election must be postmarked within 30 days of the exercise, and day 31 is too late. There is no extension, no relief, no do-over, and missing it can convert a near-free exercise into ordinary income on every vesting date for four years. File by certified mail with a return receipt, keep a stamped copy, confirm your company received its copy, and calendar the deadline the day you exercise. Few forms in the entire tax code carry this much value per page.
The 90-day gauntlet
A recruiter calls Jordan with a strong offer, and his option agreement turns into a countdown. Like most plans, his gives departing employees 90 days to exercise vested options or lose them. The law requires the 90-day cap for ISOs to keep their status; some companies grant longer windows, which quietly converts the options to NSOs after day 90. Four doors exist, each with a price tag.
The extension ask deserves emphasis because it is free. More companies now offer multi-year windows to departing employees, and others grant them when asked, especially to people leaving on good terms. Losing ISO status stings less than it sounds: a wage-taxed spread on a real gain beats a forfeited option on any gain. Ask before resigning, in writing, and read the answer before setting a last day.
Tender offers: when paper blinks
Occasionally a private company opens a tender offer, a window where employees may sell some shares, usually to investors, at a set price. Nadia, a data scientist at a late-stage company in this guide's cast, gets one: $12.00 per share, while the preferred price is $15.00 and the 409A is $9.00. She owns 50,000 shares from options she exercised two years ago, and the tender caps employee participation at 20% of holdings.
10,000 shares sold at $12.00. Cash, settled in two weeks, hers.
The same shares at the $15.00 preferred price. The discount is the cost of certainty.
Nadia sells the full 20% allowed and does not agonize. Her reasoning: the $12.00 price is below preferred because buyers of common stock without protections should pay less, so the discount is honest, and $120,000 of real money diversifies a net worth that is otherwise one private ticker plus a salary from the same ticker. The sale is a long-term capital gain measured from her exercise-day basis, and she reads the tender documents' tax section before signing because tender terms vary. Her test for the rest: the kill question in reverse. She would not buy 40,000 more shares at $12.00 today, so selling some at $12.00 is consistent. The IPO may price higher someday. Certainty, this decade, is also worth something.
Tender offers and secondaries (private sales to outside buyers, where the company permits them) are the rare exits before an exit. The default instinct, holding everything for the bigger number later, deserves suspicion: chapter 10's concentration math applies double when the position cannot be sold on a bad day. Selling a meaningful slice at a fair discount is usually the adult move.
Borrowing against paper
One more door appears once headlines get big: lenders offering cash against private shares. Decline.
The loan is real even when the stock stops being
Loans against private stock combine the worst features of every instrument in this guide: the debt is fixed, the collateral is unsellable, and the valuation that justified the loan can be cut in half by one funding round. If the company stumbles, you cannot sell to repay, the lender can pursue your other assets on recourse terms, and the interest ran the whole time. People who borrowed against 2021 valuations spent 2023 paying real interest on imaginary wealth. If you need cash from your equity, the answers are a tender, an approved secondary, or patience.
Where people go wrong
- Believing the portal. Options times preferred price is a marketing number. Your tax price is the 409A, and your cash price is zero until a buyer exists.
- Exercising everything in one year. The full bill was $157,468 for Jordan. Chapter 7's AMT-room slices buy the same shares over a few years at a fraction of the tax.
- Filing the 83(b) on day 32. The 30-day deadline forgives nobody. Certified mail, the day of exercise, every time.
- Discovering the 90-day window after resigning. The extension ask costs nothing and must happen before the last day is set.
- Skipping a tender to wait for the IPO. Companies stay private for a decade, and some never make it. A fair price today for part of the position beats a perfect price never.
- Borrowing against the headline. The loan survives the down round. You might not.
Key takeaways
- Private equity carries three prices: the 409A ($9.00, the tax price), the preferred price ($15.00, a safer instrument's price), and the headline (every share at the safest price). None is cash until someone buys your shares.
- Exercising Jordan's full 40,000 options costs $96,000 of strike plus $61,468 of AMT, $157,468 of real cash for paper. Ask the kill question before wiring anything.
- Early exercise plus a timely 83(b) can make exercise nearly free and start every clock, but the election dies 30 days after exercise with no extensions.
- Leaving starts a 90-day clock with four doors: exercise all, exercise a slice, negotiate an extension (free to ask, converts ISOs to NSOs), or walk away.
- Tenders and secondaries are the rare chances to turn paper real. Selling a slice at a discount, as Nadia does, is diversification, not disloyalty. Never borrow against shares you cannot sell.
Sources: IRS: Topic 427, Stock Options · IRS: Publication 525, Taxable and Nontaxable Income · SEC Investor.gov: Employee Stock Plans · Finvest Personal Finance Guide