Stock in a private company is an ownership stake in a business whose shares don’t trade on any public exchange, which means the price is set by periodic appraisal rather than a market, the shares come with contractual restrictions on who you can sell to, and turning them into cash usually requires waiting for the company to be acquired or go public. Everything else — how the shares are taxed, what you keep if you leave, how much of the company you actually own after several funding rounds — flows from those three facts.
What You Actually Own: Common vs. Preferred
A private company’s charter typically creates at least two classes of stock, and which one you hold determines both your voting power and where you sit in line when money is paid out.1U.S. Securities and Exchange Commission. Description of Capital Stock
Common stock is what founders and employees usually hold. It carries voting rights on major corporate decisions, but it sits at the bottom of the payout hierarchy. If the company is sold or dissolved, common shareholders get paid only after all debts and preferred stock obligations are satisfied.1U.S. Securities and Exchange Commission. Description of Capital Stock
Preferred stock is what venture capital firms and institutional investors receive when they fund the company. Preferred shares come with a liquidation preference, which is the right to get paid before common shareholders in any sale or wind-down. A standard “1x non-participating” preference means the investor gets their original investment back first. If an acquisition price isn’t large enough to cover those preferences and still leave something meaningful for common holders, the people holding common stock can walk away with little or nothing, even if the company sold for millions. Preferred stock also frequently includes anti-dilution protections that adjust the investor’s ownership if the company later raises money at a lower valuation.
The company tracks every share, option, and warrant it has issued on a document called the capitalization table. The cap table is the master record for figuring out who owns what percentage on a fully diluted basis, meaning it accounts for all shares that could exist if every option and warrant were exercised.
How the Shares Get a Price
Public stock has a market price every second the exchange is open. Private stock doesn’t, so the company must hire an independent appraiser to determine the fair market value of its common stock. This process is called a 409A valuation, named after the section of the tax code that requires it.
The purpose is straightforward. The IRS wants to make sure companies don’t hand employees stock options priced below what the stock is actually worth. If options are priced too low, the employee faces a 20% penalty tax on top of regular income tax, plus interest that accrues back to the year the compensation was first deferred.2Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation That penalty falls on the employee, not the company.
The 409A produces a per-share price for common stock, and that price becomes the floor for any options the company grants. Companies generally refresh the valuation at least every 12 months to stay within the IRS safe harbor, and a major event like a new funding round triggers an immediate update. The resulting price is almost always significantly lower than what investors pay for preferred stock in the same round, because common stock lacks the liquidation preferences and other protections that make preferred shares more valuable. That gap between the preferred price and the common price is exactly what makes employee options potentially valuable.
The Three Ways You Get Shares
Employees and service providers receive private equity through three main grant types, each with different ownership rights and tax consequences.
Stock Options
A stock option gives you the right to buy shares at a locked-in price, called the strike price, which equals the 409A valuation on the date of your grant. If the company’s value grows, you can later buy shares at that older, lower price and keep the difference. Options come in two flavors.
Incentive stock options (ISOs) are available only to employees. If you meet certain holding requirements, the profit when you eventually sell is taxed at the lower long-term capital gains rate. To qualify, you must hold the shares for at least two years after the grant date and at least one year after you exercise. ISOs also have a $100,000 annual cap: if the total value of ISO shares first becoming exercisable in any calendar year exceeds $100,000 measured at grant-date value, the excess is automatically treated as non-qualified options.3Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options4eCFR. 26 CFR 1.422-4 – $100,000 Limitation for Incentive Stock Options
Non-qualified stock options (NSOs) can go to employees, contractors, and advisors. When you exercise NSOs, the spread between your strike price and the current fair market value counts as ordinary income, subject to income tax withholding that year. There is no special holding period that unlocks a lower rate on the spread itself.
Restricted Stock Awards
A restricted stock award (RSA) gives you actual shares on day one, but those shares are subject to forfeiture until they vest. Because you technically own the stock immediately, you have an option that can save significant money: filing a Section 83(b) election with the IRS within 30 days of receiving the grant.5Internal Revenue Service. Form 15620 – Section 83(b) Election Instructions This election lets you pay ordinary income tax on the stock’s value right now, when it is presumably low. Any future appreciation is then taxed at capital gains rates when you sell, rather than as ordinary income as each tranche vests.6Justia Law. 26 USC 83 – Property Transferred in Connection With Performance of Services
The catch: if you file the 83(b) election and then leave before vesting, you forfeit the unvested shares and get no tax deduction for the income you already reported. The 30-day deadline is rigid and cannot be extended.
Restricted Stock Units
A restricted stock unit (RSU) is a promise to deliver shares at a future date, not an immediate transfer of ownership. You don’t own anything until the RSU vests, which means the 83(b) election does not apply. Tax hits when shares are delivered, and the value at that point counts as ordinary income.
Private companies increasingly use RSUs with double-trigger vesting. The first trigger is the standard time-based vesting schedule. The second trigger is a liquidity event such as an IPO or acquisition. Both conditions must be satisfied before shares are actually delivered. Without the second trigger, employees would owe income tax on shares they can’t sell, because private stock has no ready market.
Vesting
Nearly all private company equity comes with a vesting schedule that ties your right to keep the shares to continued employment. The most common arrangement is a four-year schedule with a one-year cliff: you earn nothing for the first 12 months, then 25% of your grant vests at the one-year mark, with the remainder vesting in equal monthly or quarterly installments over the next three years.
If you leave before the cliff, you walk away with zero equity regardless of how close you were to the 12-month mark. After the cliff, departing employees keep whatever has vested but forfeit the rest.
The Tax Bills You Need to See Coming
Three tax situations matter more than any others for private company shareholders.
AMT on ISO Exercises
ISOs get favorable capital gains treatment when you sell, but exercising them while holding the shares creates a tax problem in the same year that catches people off guard. The spread between your strike price and the stock’s fair market value at exercise doesn’t count as regular income, but it does count as income for purposes of the Alternative Minimum Tax. If you exercise a large block of ISOs at a company whose 409A valuation has climbed substantially since your grant, the AMT adjustment can be enormous.
Take a simplified example. You exercise 10,000 shares at a $2 strike price when the current fair market value is $12. The $100,000 spread gets added to your income for AMT purposes. You then calculate your tax liability under both the regular system and the AMT system, and you owe whichever amount is higher. If the ISO spread pushes you above the AMT exemption threshold, you owe tax on income for which you received no cash, because you’re holding illiquid private stock you probably can’t sell yet.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Spreading exercises across multiple tax years in smaller batches keeps the annual AMT adjustment lower. One safety valve: if you exercise ISOs and sell the shares in the same calendar year, the spread is taxed as ordinary income instead of triggering an AMT adjustment. That eliminates the AMT risk but also eliminates the capital gains benefit, so it is a tradeoff.
Ordinary Income on NSOs and RSUs
NSO exercises and RSU vesting both generate ordinary income tax at the time of the event. For RSUs, the value of the shares on the delivery date is taxable; for NSOs, the spread between strike price and fair market value at exercise is taxable. Double-trigger RSUs defer that tax bill until there is a realistic path to cash.
The QSBS Exclusion
Section 1202 of the tax code offers what may be the single most powerful tax break available to private company shareholders. If your stock qualifies as Qualified Small Business Stock, you can exclude some or all of the capital gains from federal income tax when you sell.
Several conditions must be met:8Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock
- The company must be a domestic C corporation.
- For stock issued after July 4, 2025, the company’s total gross assets must not exceed $75 million at issuance. Stock issued before that date uses the older $50 million threshold.
- You must acquire the stock directly from the company in exchange for money, property, or services. Buying shares on a secondary market doesn’t count.
- The company must use at least 80% of its assets in an active qualified trade or business throughout substantially all of your holding period.
- Only individuals, certain trusts, and estates can claim the exclusion.
For shares acquired after July 4, 2025, the exclusion follows a tiered holding schedule: 50% of the gain is excluded after three years, 75% after four years, and 100% after five years or more. The per-issuer cap on excludable gain is the greater of $15 million or ten times your adjusted basis in the stock, with inflation indexing beginning in 2027. Unexcluded gain on shares held less than five years is taxed at the 28% collectibles rate rather than the standard long-term capital gains rate.
Certain industries are excluded entirely, including health services, law, engineering, architecture, accounting, financial services, consulting, performing arts, and athletics. The common thread is businesses whose principal asset is the reputation or skill of specific employees. Most technology and product companies qualify; most professional services firms do not.
Filing an 83(b) election on restricted stock at a low value maximizes this benefit by starting the holding period clock immediately and keeping your basis low.
What Happens When You Leave
More private-company equity gets destroyed at this moment than anywhere else. When you leave the company, whether you quit or are laid off, the clock starts ticking on your vested stock options. Most option agreements give you just 90 days after your last day of employment to exercise your vested options by paying the strike price in cash. If you don’t exercise within that window, your options expire worthless.
The 90-day window creates a brutal squeeze. Exercising requires paying cash out of pocket for shares you can’t immediately sell. For employees who joined early and accumulated large grants, the exercise cost alone can run into tens of thousands of dollars, with an additional tax bill on top. NSO holders owe ordinary income tax on the spread at exercise. ISO holders face the AMT exposure described above.
There is an additional sting for ISO holders. Federal tax law requires that you exercise ISOs within three months of leaving employment to preserve the favorable ISO tax treatment.3Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options If you exercise after that window, assuming the company even allows it, your ISOs automatically convert to NSOs, and the entire spread becomes ordinary income.
Any equity that hasn’t vested by your departure date is forfeited. For stock options and RSUs, unvested portions simply disappear. For restricted stock awards where you actually own the shares, the company typically has a contractual right to repurchase unvested shares at the original purchase price, which can be a fraction of a penny per share.
Why You Can’t Just Sell
Even after your shares vest, you can’t freely sell or transfer private company stock. Two layers of restrictions apply.
Contractual Restrictions
Private company shareholder agreements almost universally include a right of first refusal, which gives the company or its major investors the right to buy your shares on the same terms any outside buyer has offered. You can’t simply find a willing buyer and complete the sale; the company gets to step in and match the deal. Many agreements also include co-sale rights, which let minority shareholders tag along proportionally when a major shareholder sells, and drag-along rights, which force minority shareholders to participate in a sale approved by a supermajority of the shareholder base.
Federal Securities Restrictions
Shares acquired through option exercises, restricted stock awards, and other private issuances are classified as restricted securities under SEC rules. If the company is a non-reporting issuer, which most private companies are, you must hold the shares for at least one year before reselling them under Rule 144, and the company must make certain basic information publicly available. Even after the holding period expires, you need the company’s cooperation to remove the restrictive legend from your share certificate before any transfer can proceed.9U.S. Securities and Exchange Commission. Rule 144 – Selling Restricted and Control Securities
How Dilution Shrinks Your Ownership
Every time a private company raises a new round of funding, it issues new shares to the incoming investors, which increases the total number of shares outstanding and shrinks the percentage ownership of everyone who already holds stock.
A concrete example makes this easier to see. Suppose you own 50,000 shares out of 1,000,000 total, giving you 5% ownership. The company then raises a Series B round by issuing 500,000 new shares to investors. You still own 50,000 shares, but now out of 1,500,000 total, your ownership drops to about 3.3%. Nothing changed about your shares; the pie got bigger and your slice got proportionally smaller.
Dilution compounds with each successive funding round. A founder who starts with 50% can end up in the low teens after several rounds. Employee option pools also contribute, since companies typically set aside 10% to 15% of total shares for employee grants, and that pool gets topped up before new rounds. Preferred shareholders often have anti-dilution provisions that cushion the blow, but common stockholders and option holders rarely have the same protection. The percentage you were told at hire may look very different by the time the company sells.
Turning Shares Into Cash
Converting private equity to cash requires a specific corporate event, and most shareholders wait years.
Acquisition
The most common exit is a sale of the company. When an acquisition closes, the purchase price flows through the capital structure in order: debts first, then preferred stock liquidation preferences, then whatever remains to common shareholders. If the preferred investors have a 1x liquidation preference and the sale price barely covers their invested capital, common shareholders can receive little or nothing. The math is worth running before you celebrate a headline acquisition price.
IPO
An initial public offering converts private stock into publicly tradable securities, but shareholders face a lock-up period after the IPO date during which they cannot sell. Most lock-up agreements restrict sales for 180 days, though terms vary by company.10Investor.gov. Initial Public Offerings – Lockup Agreements The stock price can move significantly during the lock-up, so the value on the day you can finally sell may be very different from the IPO price.
Secondary Sales and Tender Offers
Before an IPO or acquisition, some liquidity opportunities exist but they are controlled and limited. A company may run a formal tender offer, setting a price and inviting shareholders to sell some or all of their vested shares back to the company or to new institutional buyers. The company controls who participates, how many shares can be sold, and the price. A handful of third-party platforms also facilitate secondary transactions in late-stage private companies. These transactions always require the company’s approval, and the company’s right of first refusal typically gives it the power to block any sale it doesn’t like.
For most employees at most private companies, realistic liquidity is years away and not guaranteed. Roughly three-quarters of venture-backed startups never reach an IPO or acquisition at a price that returns meaningful cash to common shareholders. Private stock can still be a valuable component of your compensation, but it is not something to plan your finances around on a specific timeline.