The Case for Early NSO Exercise: Why Planning Now Could Save You Big Later
“When should I start planning around my stock options?” It’s a question I get all the time from startup employees. And my answer is usually simple: Right now. Waiting for liquidity often means missing your best shot at tax savings. In this article, we will focus on Non-Qualified Stock Options (NSOs). If you have Non-Qualified Stock Options (NSOs), one move to consider is exercising them before a liquidity event, usually when your "spread" is tighter.
Why exercise before a liquidity event?
When you exercise NSOs, you’ll owe ordinary income taxes on the “spread” between the strike price and the fair market value (409A) at the time of exercise. If you wait until the company IPOs or offers a tender, and the FMV has grown significantly, when you purchase those shares you're locking in much higher income taxes. But if you exercise when the valuation is still low, you can pay tax on a smaller spread, start the clock on long-term capital gains, and potentially cut your tax bill by tens of thousands.
Case Study
Assume you work at a growing startup, and the rumor mill is swirling about a potential IPO in the next 2 years. You've currently vested 20,000 NSOs at a strike price of $3, and the company's current 409A valuation is $5 per share.
For the first time, it hits you…these options might actually turn into real wealth.
The first question on your mind? What will my after-tax proceeds look like if I exercise today versus waiting until the IPO?
*For the sake of this example, let's assume you've maxed out Social Security taxes for the year. Also, assume that in the "Exercise Early" scenario, you hold the shares longer than a year and a day to qualify for long-term capital gains treatment.
Thats a $34,265 difference of in your pocket proceeds!
Think Net, Not Gross
Too often, people focus on the potential upside of their stock options and ignore the actual after-tax value. What matters most is what ends up in your pocket, not the headline number on paper. By exercising early, you may unlock access to long-term capital gains treatment instead of ordinary income tax. That difference, which is often 12–15%, can mean thousands more in net proceeds when you eventually sell.
This strategy isn’t for everyone
I’ve walked this road with many clients. More often than not, those “life-changing equity grants” end up as a nothing-burger. Most people won’t see an IPO or even a meaningful tender offer. And that’s why this decision should always be made through the lens of your bigger financial plan. You have to be honest with yourself when it comes to purchasing your private stock. You’re buying an illiquid asset.
Okay, Brett, now that you've crushed my dreams why would i consider exercising shares earlier?
I'm glad you asked! As I mentioned before, these purchase decisions need to be based on your financial situation and also include non-quantifiable items like:
If you believe in your company’s trajectory upward
If IPO or liquidity rumors are swirling
If your company occasionally offers tender events(never guranteed)
Or you’re planning to leave and want to own what you helped build
Then it may be worth considering.
Here’s what you potentially gain by purchasing shares earlier:
Tax planning control—pay tax on a smaller spread
Long-term capital gains—the tax benefit hero
Equity ownership—even if you leave the company
If you want to understand how this might work in your specific situation, Book an Intro to get started.
This article is for informational purposes only and does not constitute tax advice. Please consult with a qualified tax professional for advice specific to your situation.
