Early exercise sounds empowering. You buy your options now, start the tax clock, and (hopefully) lock in a low strike price. It seems simple on paper, but it can be messy in real life. Cash goes out, taxes may come due, and liquidity is still a big question. Here’s how to decide if exercising before vesting or before a liquidity event actually helps you, or just hands the IRS a tip.
1. Know what “early” really means
Early exercise means you are exercising before the company’s value jumps or before your options vest. This lets the long-term capital gains clock start sooner. It can also cut or eliminate the spread between strike price and fair market value, which lowers immediate tax. However, once you exercise, you own restricted stock. If you leave, unvested shares are repurchased.
2. Get the basics down before you move
It’s vital to learn how options, vesting, and taxation work. Online resources like this stock option basics for startups guide can keep you from guessing. Once you grasp ISOs vs NSOs, 409A valuations, and the Alternative Minimum Tax (AMT), you can model real numbers. Blindly exercising because “everyone in growth mode does it” is risky.
3. File the 83(b) election on time, or don’t bother
If you exercise unvested shares early and want favorable tax treatment, you must file an 83(b) election within 30 days of exercise. If you miss this window, the IRS treats each vesting tranche as new income. This means ordinary income rates, not capital gains. Be sure to calendar the deadline the moment you sign the exercise paperwork. You should send it via certified mail and keep the receipt.
4. Model best, base, and worst cases
Run three scenarios: company skyrockets, company grows slowly, company flatlines or dies. In the big win case, early exercise plus an on-time 83(b) means most upside is taxed at long-term capital gains, AMT stays manageable, and you keep more of the win. In a steady but slow climb, your cash is locked up for years while tax savings stay modest. In a flop, you lose exercised cash and can’t always claim a full capital loss. Be sure to put real numbers on strike cost, FMV, tax, and timelines.
5. Consider your cash flow and tax budget
Exercising takes cash, and paying AMT or state tax might take more. Will that money hurt your emergency fund? Will you need to borrow? Early exercise should not torpedo your financial stability. Build a simple spreadsheet. Add strike price cost, estimated AMT, and filing fees. Compare that to savings, debt, and big life expenses ahead.
6. Ask about company policies and future plans
Some startups do not allow early exercise. Others do but have complex repurchase rights. Ask HR or legal departments about secondary windows, tender offers, or planned liquidity programs. A promised tender in 12 months can change the math, and so does a down round that could reset valuations. Corporate policies matter as much as the tax code here.
Endnote
Early exercise is not a default move; it is a lever you pull with intent. Pause, price the risk, and see if the tax benefit is worth the cash you lock away. Confirm the 83(b) clock, company policies, and your own runway. Be sure to also talk to a startup-savvy CPA, not a generic tax preparer. When you mix clear basics, disciplined math, and honest risk tolerance, you can choose confidently, not fearfully.