409A Valuation
Service description
A 409A valuation sets the fair market value of a private company's common stock. An independent appraiser analyzes the business, its finances and its recent funding, and issues a report. The company uses that value to set the exercise price of stock options, so the options are not treated as discounted.
Common industries
Applies to venture-backed startups and other private companies that grant stock options to employees.
ROI
Cheap safe-harbor protection that keeps option grants defensible; needs refreshing on financings and annually — recurring by nature.
Benefit
An independent valuation of a startup's common stock to set option strike prices and stay in safe-harbor under IRC 409A.
Why get it
Options granted below fair market value can create tax problems for the people who receive them. A valuation by an independent appraiser is presumed reasonable, and the IRS can overcome that presumption only by showing the valuation was grossly unreasonable.
When you benefit
Needed before a company grants options. The independent appraisal presumption covers grants made within 12 months, so a new valuation is needed sooner if something material changes.
What it costs
Typically a project fee.
When you pay
Usually a flat fee per valuation, set by the company's stage and the complexity of its capital structure. Updates are priced separately, and a company with complex equity may pay more than one with simple equity.
Other costs
Legal or tax advice on the option plan, staff time to assemble financial and ownership information, and board time to approve the value.
Risks to know
Options priced below fair market value can lead to income tax earlier than the holder expected, plus additional tax and interest, under Section 409A. A valuation that is stale or ignores a recent financing can lose its presumption of reasonableness. The cost lands on the employees holding the options, not only on the company.
When risks arise
Problems tend to surface when options are granted at an out-of-date price, in an IRS audit, or in diligence for a financing or sale. A grant made after a major event but before a refreshed valuation is a typical weak point.
The process
The provider reviews the company's financials, funding history and market. It values the business, then allocates value among the classes of stock, including common. The company reviews the draft, receives the signed report and uses the value to set option prices.
Your commitment
The company provides financial statements, projections, its capitalization table and the terms of its recent financings and equity plan. Management should be available to discuss the business, its outlook and any offers or deals in progress.
Documents to gather
- Financial statements and current projections
- Capitalization table and equity plan documents
- Terms of recent financings, including any term sheet
- Previous 409A reports and a list of recent option grants
Helpful reading
- Valuation of Privately Held Companies Equity Securities Issued as Compensation — AICPA & CIMA
- Federal Legislation on Employee Ownership — National Center for Employee Ownership
- 4.48.4 Business Valuation Guidelines — Internal Revenue Service
Further research
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