Private-Company Equity, Tender Offers, and Liquidity Events

Private-company equity often creates tax before it creates liquidity.

Then, when liquidity arrives, the transaction may not be what the employee thinks it is.

A tender might involve an actual stock sale.

Or an employee might surrender an unexercised option for cash.

Or the company might redeem existing shares.

Those transactions can produce very different tax results even when each feels like:

“I cashed out some equity.”

The first question is:

What legally happened to the equity?

Section 409A and private-company stock rights

A conventional stock option can generally avoid Section 409A deferred-compensation treatment when the applicable stock-right exemption requirements are satisfied.

Core conditions include an exercise price not below grant-date fair market value, a fixed number of shares, qualifying service-recipient stock, and no impermissible additional deferral feature.

A discounted option can create a Section 409A problem.

Financing price is not automatically common-stock FMV

Private companies can have preferred stock and common stock with different economic rights.

A preferred financing price does not automatically establish the fair market value of common stock for compensatory-option purposes.

Valuation must address the relevant security.

Delayed-settlement RSUs

Some private-company RSUs satisfy service conditions before shares are delivered.

That can create separate questions about:

• vesting;
• settlement;
• Section 409A;
• FICA timing;
• liquidity conditions.

Do not assume every private-company RSU follows a public-company vest-and-settle pattern.

Section 83(i)

Section 83(i) can permit certain eligible private-company employees to defer federal income inclusion for qualified stock received through qualifying option exercise or RSU settlement.

The potential deferral can extend up to five years subject to earlier statutory inclusion events.

But Section 83(i) is narrow.

It is not a universal deferral rule for private-company equity, and it does not broadly apply to ordinary restricted stock.

FICA timing is also a separate question.

Special withholding rules under Section 3402(t) can apply when deferred income becomes includible.

A tender offer is not one tax transaction

At least three transaction chains can appear:

unexercised option → cash cancellation

option → exercise → stock → sale

existing stock → issuer redemption or third-party sale

Identify the chain before calculating tax.

Track 1: cash cancellation of an unexercised option

Suppose an employee holds an unexercised NSO and, in a liquidity event, surrenders the option for cash.

If no stock is transferred to the employee, there is no intervening employee stock acquisition to turn into a capital transaction.

The cancellation payment is compensation under the applicable Section 83 framework.

There is:

• no employee stock basis from an exercise;
• no employee stock holding period;
• no employee stock sale;
• no employee Form 1099-B stock transaction merely because the option was cashed out.

The chain is:

option right → cancellation → compensation

Track 2: actual exercise followed by stock sale

Now suppose the employee actually exercises the NSO.

Assume:

• exercise cost = $20,000;
• stock acquired is worth $100,000.

Exercise compensation can be:

$80,000

Stock basis generally becomes:

$100,000

If the employee then sells those actual shares for approximately $100,000:

$100,000 proceeds − $100,000 basis ≈ $0 capital gain/loss

This chain is:

exercise → compensation → stock acquisition → stock sale

It is fundamentally different from option cancellation.

Existing shares and issuer repurchases

A shareholder may already own stock before the liquidity event.

A third-party sale generally begins with the normal sale/exchange framework.

If the issuing corporation repurchases the shares, Section 302 becomes important.

A redemption can receive exchange treatment when the statutory requirements are met.

If they are not, Section 301 distribution treatment can apply.

Section 318 attribution can affect the analysis.

Therefore:

issuer repurchase ≠ automatically capital gain

ISO liquidity events

If an ISO is exercised and the resulting shares are immediately sold in a tender, the statutory ISO holding periods generally will not have been satisfied.

That can create a disqualifying disposition.

An employer-organized tender does not itself preserve ISO qualifying treatment.

Withholding and liquidity

A private-company liquidity event can combine compensation, payroll taxes, AMT, capital gain, and state tax.

The amount withheld during the transaction does not establish final liability.

Common private-company mistakes

Watch for:

• treating financing price as automatic common-stock FMV;
• assuming private-company options are outside Section 409A;
• treating delayed RSUs like immediate-settlement RSUs;
• assuming Section 83(i) applies to all private equity;
• calling every tender a stock sale;
• treating option cancellation as exercise plus sale;
• inventing stock basis where no stock was transferred;
• assuming issuer repurchase automatically creates capital gain;
• ignoring Section 318 attribution;
• assuming a tender preserves ISO treatment.

Related pages

• RSUs: When They Are Taxed and What Happens When You Sell the Shares — analyze delayed or liquidity-conditioned RSUs.
• NSOs/NQSOs: Tax at Exercise and Tax at Sale — distinguish actual option exercise from cancellation.
• ISOs: Exercise, Qualifying Dispositions, and Disqualifying Dispositions — determine whether a tender creates a disqualifying disposition.
• Equity Compensation Withholding: Why the Amount Withheld May Not Equal Your Tax — evaluate payment gaps created by a liquidity event.
• Multi-State Equity Compensation: Which State Taxes RSUs, Options, and Stock Sales? — analyze service compensation when the employee moved.