409A Valuations Explained: What Founders Need to Know

What is a 409A Valuation?

A 409A valuation is an independent appraisal of your company's common stock fair market value (FMV). It's named after Section 409A of the Internal Revenue Code, which governs the taxation of deferred compensation, including stock options.

Why it matters: If you grant stock options at below fair market value, employees face significant tax penalties. A proper 409A valuation creates "safe harbor" protection, meaning the IRS will presume your valuation is reasonable.

When Do You Need One?

You need a 409A valuation:

• Before granting your first stock options
• After a new funding round (material event that changes value)
• After 12 months since your last valuation
• After a material event (major contract, acquisition, significant pivot)

The Safe Harbor Requirements

To qualify for safe harbor protection, your 409A valuation must:

1. Be performed by a qualified independent appraiser with relevant education and 5+ years of business valuation experience
2. Consider all available information material to the company's value
3. Be no more than 12 months old at the time of grant
4. Apply generally accepted valuation methods

Common Methods Used

Option Pricing Method (OPM)

Treats each class of stock as a call option on the company's equity value. Best for early-stage companies with complex capital structures.

Probability-Weighted Expected Return Method (PWERM)

Models various future scenarios (IPO, acquisition, stay private) and weights them by probability. Good when exit is foreseeable.

Current Value Method

Simply allocates current value across share classes. Used mainly for very early-stage companies.

What Affects Your 409A Value?

Several factors influence where your common stock value lands:

• Recent financing terms (post-money valuation, preferences)
• Discount for lack of marketability (DLOM)
• Company stage and risk profile
• Time to potential liquidity event
• Comparable company data

The Process

1. Engagement: We scope the work and send a data request
2. Data collection: You provide financials, cap table, and business context
3. Analysis: We apply appropriate methods and document assumptions
4. Report delivery: You receive a 409A-compliant report
5. Board approval: Your board accepts the valuation

Timeline: Typically 5-7 business days once we have all data.

Common Misconceptions

Myth: "Our last round valuation is our 409A value."

Reality: Common stock is worth less than preferred stock due to liquidation preferences and other rights. The FMV of common is typically 20-40% of the preferred price in early stages.

Myth: "We can just pick a low number."

Reality: Without proper documentation, you lose safe harbor protection. The IRS can challenge artificially low values.

Next Steps

Need a 409A valuation? Book a call to discuss your timeline and requirements. We deliver 409A-compliant reports in 5-7 business days.