Case study: exercising pre-IPO ISOs
An early employee exercised before the IPO and made an AMT bet that paid off. The lesson is in why it worked, not that it did.
ISOs · Case studies
When does exercising private shares before an IPO actually make sense? When you can afford to lose the bet, and you size it so a loss would not hurt. Here is a composite of an early engineer who got it right, and the reason it worked was discipline, not luck.
Names and numbers here are a composite to protect the real people. The pattern is real.
The setup
Maya joined a startup early and held a chunk of ISOs at a low strike price. Years in, the company was clearly working, a funding round had pushed the 409A valuation up, and an IPO was a year or two out. Her options were deep in the money on paper. She wanted that gain taxed at the long-term capital gains rate, not as ordinary income, which meant starting the clock by exercising and holding.
The catch was the alternative minimum tax. Exercising would add the bargain element, the gap between the 409A value and her strike, to her AMT income. On a large exercise, that meant a cash bill on shares she could not yet sell.
The risk she was actually taking
Exercising pre-IPO shares means wiring cash into a single illiquid stock and owing AMT on top. If the company had stumbled, Maya would have been out the strike price, out the AMT, and holding paper she could not sell. That is the trap behind every pre-IPO exercise. See the AMT trap.
What she did right
She did not exercise the whole grant in one swing. She staged it.
She exercised early, while the spread was smaller
Each year the 409A price climbed, so the bargain element on a given block only grew. Exercising sooner meant a smaller spread per share and a smaller AMT hit.
She sized each year to her AMT room
She exercised up to the point where the AMT started to bite, then stopped, and picked it up again the next year. The bill each year was one she chose, not one that found her.
She only risked cash she could lose
The strike plus the AMT each year came from savings she had earmarked for the bet. If the company had failed, it would have stung. It would not have sunk her.
She tracked the AMT credit
The AMT she paid became a minimum tax credit she could recover later. She kept the records so it would not get lost.
How it played out
The IPO happened. Because Maya had cleared both holding periods on most of her shares, two years from grant and one year from exercise, that gain came through as long-term capital gains rather than ordinary income. The staged AMT she had paid along the way started flowing back as a credit in the lower-AMT years that followed.
Maya’s qualifying gain was taxed at the long-term capital gains rate. For 2026, that rate is 0% on taxable income up to $98,900 for married filing jointly and up to $49,450 for single filers, 15% up to $613,700 (married filing jointly) and $545,500 (single), and 20% above those 2026. Her AMT bet turned on the exemption, which for 2026 is $140,200 for married filing jointly and $90,100 for single filers 2026. That exemption begins to phase out at $1,000,000 of AMT income for married filing jointly and $500,000 for single filers, and is fully gone at $1,280,400 and $680,200 respectively 2026.
So pre-IPO exercise is a good idea?
Sometimes. It worked here because the bet was sized to survive a loss and staged to control the AMT. The same move with the whole grant exercised at once, on borrowed money, into a company that then stalls, is how people get hurt. The principle holds: I do not like betting money you cannot afford to lose on a stock you cannot sell.
What this means for you
The win was not the IPO. It was the discipline before it: exercise early while the spread is small, stage it to your AMT room, risk only cash you can lose, and keep the credit paperwork. Do the opposite and the same bet becomes a cautionary tale. For the framework, including the exercise-and-hold-vs-sell decision once shares are in hand, read planning your ISO exercise year.
A pre-IPO exercise is one of the highest-stakes calls an equity holder makes. If you are facing it, it is worth running the numbers with someone first. That is what a fit check is for.
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