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When you join a private, venture-backed startup, your offer letter probably included a grant of stock options at a specific “strike price.” That number isn’t arbitrary — it’s anchored to the fair market value (FMV) of the company’s common stock at the moment your grant was approved. For employees at private companies, the fair market value stock options startup boards rely on comes from a third-party valuation known as a 409A. Unlike publicly traded shares whose price updates every second the market is open, FMV for a private company is reassessed periodically and snapshot-locked into your grant.
The reason this matters: every cent between the FMV at exercise and the strike price you were granted at can become taxable income, and in some cases that gap drives an Alternative Minimum Tax (AMT) liability that catches employees off guard. Understanding FMV stock options mechanics is the difference between a windfall and a painful, surprise tax bill — and this guide walks through everything an employee navigating a private-company grant should know.
Fair market value, in plain terms, is the price at which the company’s common stock would change hands between an informed, willing buyer and seller. For a public company, that’s the live ticker price. For a private startup, FMV is a regulatory construct — established under IRS Section 409A — that anchors how option grants and exercises are priced and taxed.
The fair market value employee options grants reference is almost never the same as the company’s headline valuation. A unicorn priced at $1B post-money on its Series D doesn’t have $1B worth of common stock floating around — the bulk of that value sits in preferred shares with senior liquidation preferences. Common stock, which is what employees typically receive, is worth materially less per share, and that gap is what creates both the opportunity and the tax complexity.
The IRS requires startups to obtain an independent appraisal of their common stock under Section 409A of the Internal Revenue Code (see the IRS overview of Section 409A). Most startups commission a 409A valuation every 12 months, or sooner if a material event occurs — a new priced round, a tender offer, an acquisition signal, or a sharp shift in financial performance.
A 409A report typically uses a blend of three valuation approaches: an income approach grounded in discounted cash flow projections, a market approach using comparable public companies and recent M&A multiples, and occasionally a cost approach for the very earliest-stage companies. Most growth-stage startups rely on a hybrid market and option-pricing model that allocates value across the cap table, then discounts the common stock to reflect illiquidity and the priority of preferred liquidation preferences.
What does this mean for the fair market value stock options startup employees actually receive? Common stock FMV is almost always materially lower than preferred share price — frequently 30 to 60 percent lower at early stages, narrowing as the company approaches a liquidity event. That common-stock discount is the reason a Series B priced at $20 per preferred share can still produce option grants at a $5 to $8 strike, and it’s the reason your offer letter math may feel suspiciously generous compared to coverage of the company’s last round.
The fair market value stock options startup boards approve serves three concrete functions every employee should internalize:
Sets the strike (exercise) price. Section 409A requires that stock options be priced at or above FMV on the date of grant. Pricing below FMV triggers immediate income tax plus a 20 percent penalty for the employee — a fact pattern startups go to extreme lengths to avoid, which is exactly why companies are careful about the timing and methodology of their 409A reports.
Anchors the bargain element at exercise. When you exercise, the difference between the current FMV and your strike price is the “spread.” For nonqualified stock options (NSOs), that spread is ordinary income on the day of exercise. For incentive stock options (ISOs), the spread is an AMT preference item — meaning you might owe Alternative Minimum Tax even though you haven’t sold a single share.
Establishes your tax basis going forward. Your cost basis after exercise equals your strike price plus any spread already taxed. That number determines whether your eventual sale is taxed as ordinary income, short-term capital gains, or long-term capital gains — a difference that can be tens of percentage points on the same dollar of gain.
In my experience writing about equity compensation, the single most expensive mistake I see is exercising ISOs without modeling AMT first. The AMT calculation can trigger a five- or six-figure cash tax bill in a year when the employee has literally received no liquidity — they just bought paper shares of a private company. That’s not theoretical; it’s a recurring story that landed hundreds of dot-com-era employees in tax trouble after the 2000 crash, and the wave of post-2022 down rounds has produced fresh casualties. The Harvard Business Review has written extensively on how to think through high-stakes career and equity decisions, and the throughline is consistent: model the downside before you commit cash.
If you’re weighing whether to exercise, the Should I Buy My Equity? guide walks through the framework most advisors use with clients. And if you want to model the after-tax outcome under different FMV trajectories, the Equity Simulator handles the math without forcing you to build a spreadsheet from scratch.
Here’s where the fair market value employee options story gets uncomfortable. FMV is not a friendly, monotonically rising number. It moves with company performance, market conditions, and the mechanics of subsequent funding rounds.
Up rounds raise FMV. A new preferred round at a higher price typically pulls common-stock FMV up at the next 409A. Your new grants will be issued at the higher strike, but options you already hold are locked at the original strike — unambiguously good for you.
Down rounds compress FMV. In the post-2022 valuation reset, many late-stage companies saw their 409A drop 30 to 50 percent. Employees who exercised at the peak ended up holding shares with a tax basis higher than the current FMV — meaning they had paid AMT on phantom gains that subsequently evaporated.
Tender offers reset the floor. When a company runs a secondary tender, the price paid by the buyer becomes hard market data that boards typically incorporate into the next 409A. A tender at $15 effectively rules out a common-stock FMV below $15 for some defined window afterward, regardless of how the underlying business is performing.
Bloomberg has covered the wave of unicorn down rounds in the post-ZIRP environment, and the pattern is consistent: employees who exercised on the way up and didn’t diversify ended up holding concentrated, illiquid positions worth less than their tax basis. That’s the worst outcome on the FMV stock options decision tree, and it’s avoidable with disciplined planning.
Talking to tech employees about equity, I keep encountering the same misunderstandings about FMV stock options. They’re worth walking through one at a time, because each of them costs real money when left uncorrected.
Misconception 1: My options are worth (FMV minus strike) times shares. No — that number is the theoretical spread at this moment, before tax, before any discount for illiquidity, transfer restrictions, vesting risk, and the very real possibility that FMV declines before you can sell. Treating that line item as cash on hand is how employees end up with mortgaged exercise costs and no liquidity to show for them.
Misconception 2: If the 409A says FMV is $X, that’s what I can sell for. Also no. The 409A is a regulatory floor for option pricing, not a market quote. Actual secondary buyers may pay above or below the 409A FMV depending on demand, with significant spread, friction, and company-imposed transfer restrictions in between.
Misconception 3: I should exercise the moment I’m vested to start the long-term capital gains clock. Sometimes — but for ISOs, this is precisely the situation where AMT can wipe out the planned tax benefit. The math depends on your strike, the current FMV, your overall income, and your liquidity to pay the AMT. Don’t assume; model it. Our breakdown of how to pay for stock options covers the financing trade-offs employees actually face.
Misconception 4: My grant is ‘safe’ at the strike price forever. Options expire. Most plans give you only 90 days post-termination to exercise vested options, after which they’re gone. If FMV has run up but you don’t have the cash to exercise within that window, you can lose the entire upside in a matter of weeks.
There’s no universal answer to “should I exercise?” — but there is a disciplined process for getting to a defensible answer. Here’s the framework most advisors I respect use when sitting down with a startup employee:
Step 1 — Map your liquidity and tax baseline. What’s your cash reserve outside the company? What’s your marginal tax rate? Can you absorb a worst-case AMT bill without liquidating other assets? If the answer to any of those is shaky, the case for aggressive exercise gets much weaker.
Step 2 — Model the spread under three FMV scenarios. Use the current 409A FMV, a 30 percent haircut scenario, and the last tender or secondary print if one exists. If your decision changes dramatically across those three scenarios, you’re highly sensitive to FMV — be cautious about treating today’s number as gospel.
Step 3 — Quantify concentration risk. Even if the math says exercise, ask: how much of my net worth will be locked in a single startup’s equity afterward? Modern portfolio theory has plenty to say about single-stock concentration, and most of what it says isn’t flattering.
Step 4 — Consider partial exercise and partial pooling. Rather than exercise everything and bet the household on one outcome, more employees are exercising a portion, selling a portion via tender when available, and pooling a portion across a diversified basket of similar-stage startups. The fair market value stock options startup employees hold is just one input into a portfolio decision, not the whole decision.
Step 5 — Time multi-year exercises around AMT. If you can split exercises across tax years to stay below AMT crossover points, you may capture long-term capital gains treatment on ISOs without triggering the cash tax bill in a single year. This requires careful modeling and ideally a CPA familiar with equity compensation, not your general-purpose tax preparer.
Here’s the uncomfortable truth at the core of any honest conversation about the fair market value employee options actually carry: that number is a piece of paper until there’s a liquidity event. The 409A doesn’t pay your mortgage. A high FMV without a path to liquidity is, in practical terms, just a high tax basis on an illiquid asset — and a single, undiversified one at that.
Equity pooling — the model Aption is built around — addresses this by giving employees a way to convert a portion of their concentrated, illiquid position into diversified exposure across a basket of comparable startups. You don’t sell outright; you pool. Your shares contribute to a portfolio, and you receive proportional exposure to that basket’s eventual outcomes rather than a single binary.
For employees navigating fair market value stock options startup decisions, pooling isn’t a silver bullet — there are real considerations around tax characterization, control, timing, and the structure of the pool itself. But as part of a broader strategy, it can help break the “all eggs in one basket” trap that high-FMV-but-illiquid stock creates. The Introduction to Equity Pooling walks through the mechanics, the trade-offs, and how a pooled position behaves differently than a concentrated one.
Fair market value sits at the center of every stock option decision an employee makes at a private startup. It sets your strike price. It drives your taxes. It informs — though it doesn’t dictate — whether to exercise, hold, sell, or pool. The biggest mistakes I see come from treating FMV as either irrelevant (it isn’t — it’s load-bearing for your tax picture) or as a guaranteed cash value (it isn’t that either — it’s a regulatory snapshot, not a market quote).
Build the model. Run the scenarios. Pay attention to both your tax exposure and your concentration risk. The fair market value stock options startup employees rely on is too important to manage by gut feel. And if you want to explore whether your equity makes sense to pool rather than exercise outright, you can request an offer from Aption and walk through your specific situation against a diversified alternative.
Disclaimer: The author name used in this article may be a pen name or pseudonym and is used for illustrative and editorial purposes only. This article is for informational purposes only and does not constitute investment, tax, or legal advice. Consult qualified professionals before making financial decisions.
Rachel is a private wealth blogger focused on equity compensation, tax planning, and portfolio diversification strategies for tech professionals.