IPO Within 12 Months: Urgent Pre-IPO Exercise and AMT Planning

With an IPO in the next year, you have a narrow window to exercise ISOs at the lower pre-IPO valuation before the trading price—and your AMT exposure—potentially skyrocket. Understand the lockup period risk and how pre-IPO exercises start your long-term capital gains clock sooner.

Exercise ISOs now while the AMT spread is lower. The AMT preference item on ISO exercises is the spread between exercise price and fair market value at the time of exercise. Pre-IPO FMV (typically set by a 409A valuation) is almost always lower than the post-IPO trading price. Exercising before the IPO means a smaller AMT hit. Waiting until after the IPO often makes the AMT cost prohibitive.

Plan for the lockup period. Most IPOs include a 90-to-180-day lockup during which insiders cannot sell shares. If you exercise ISOs now and the stock price drops during lockup, you still owe AMT based on the FMV at exercise -- not the lower trading price. This is the scenario that bankrupted early employees during the dot-com bust.

Pre-IPO exercise starts the LTCG clock sooner. Long-term capital gains treatment requires holding shares for at least one year after exercise (and two years after grant for ISOs). Exercising now means you may qualify for long-term rates shortly after the lockup expires, rather than waiting an additional year post-IPO.

The tradeoff: Exercising pre-IPO is almost always the right move for ISOs, but it requires cash upfront to cover the exercise price and the AMT liability -- with no guarantee the stock price will hold after the IPO. A CPA can quantify the AMT exposure so you know the exact cost before committing.