Its not that trivial. ISO's have a $100k limit.
[1] http://www.naspp.com/blog/2009/08/iso-100000-limitation.html
That's... not rare at all. For a company with a $5 million valuation, you only have to be offered 2% of the company in order to hit that cap. An early employee could easily hit that. And of course, as the company grows, it becomes easier and easier to hit that cap, because it's based on an absolute dollar value (the valuation of a company will always grow faster than the percentage offered will shrink - or to look at it another way, if it doesn't, you probably don't want to exercise those options anyway, so the conversation is moot).
It's not a linear limit - it's a fixed (constant) cap, but yes.
This doesn't mean you can't receive more than $100,000 in options, but it does mean you'll be taxed on those as NSOs, which is much higher.
Also, note that because of the cliff, you receive your full first year on a single day, which means that your second year's worth of options are much more likely to exceed the ISO cap and auto-convert to NSOs.
Later, when a company is close to going public, normal packages will often have less growth in valuation assumed and so it becomes easier to hit the cap as a regular employee. That is not coincidentally the same time companies switch to RSUs.
(Someone made the point elsewhere in this discussion that inflation will render the cap more of an issue as time goes on. They have a real point, I think. Combined with inflated A rounds this may start to be more common than it has been in the last 20 years.)
Yes, I said in my original comment that it becomes easier to hit the cap as the company grows. However:
> It’s very rare to be offered more than 1% of a company that is already worth $5M. The people who get offers like this are, it turns out, the ones complaining about this tax law most loudly. They are not run of the mill employees.
This is not true. It's not really that rare for a first hire to get 1% or more[0], and it's also not that rare to have a company that makes that first hire after raising enough money to be valued at $5M. I say this as someone who has been both a founder and an early-stage investor.
But more broadly: most of the people who are complaining about this cap (and complaining the loudest) aren't the early employees. They're the ones who joined later - late enough that they're likely "only" to double or triple the value of their equity by the time an IPO happens (unlike early employees), but still early enough that there's no IPO or acquisition on the horizon[1].
[0] http://avc.com/2010/11/employee-equity-how-much/
[1] Which, given the increasing tendency of large startups to delay IPOs "indefinitely", basically means "any employee of a privately-held company".
>“Similarly, awards with vesting triggers based on exit events such as an initial public offering or change-in-control would be taxable on grant unless they require the recipient to be employed through the liquidity date.“
From Fenwick’s analysis.