Imagine a family member transferring a large family asset to the next generation by treating the asset as a corporation which keeps issuing new shares. If shares are transferred as-is, the recipient would have to treat their value as income, so instead the corporation issues a bunch of ISOs and allows the recipient to exercise those.

If the shares are never sold, the recipient avoids income tax and estate tax on a fairly large wealth transfer.

> if investors are buying preferred shares and not common stock which the employees own, how is the fair market value of the ISO's determined?

IRS code section 409a. Companies typically hire 409a evaluators who have data on companies with similar metrics. But from employee's standpoint it's basically the strike price of ISOs issued to someone who'd join today.