Every startup that grants stock options needs a number: the fair market value of its common stock. A 409A valuation is how you get that number in a way the IRS will respect.
This guide covers what a 409A is, when you need one, how long it lasts, and what it costs to get wrong.
A 409A sets the price your options must not go below
A 409A valuation is an appraisal of the fair market value (FMV) of your company's common stock. The name comes from Section 409A of the Internal Revenue Code, which governs deferred compensation.
A stock option with an exercise price below FMV on the grant date is treated as deferred compensation. That brings the option under Section 409A's rules, which most startup options cannot meet.
Skipping a 409A shifts real tax risk onto your employees
If an option is found to be priced below FMV and fails Section 409A, the consequences land mostly on the option holder:
- Income tax on the vested spread, in the year it vests, even before exercise.
- An additional 20% federal tax on that amount.
- Interest calculated back to when the tax should have been paid.
Some states add their own penalty. The company can also face withholding and reporting failures.
These rules come from Section 409A and the Treasury regulations under it.
An independent appraisal gets a "presumption of reasonableness"
The Treasury regulations list methods that are presumed reasonable. The one most startups use is a valuation by a qualified independent appraiser.
With that presumption, the IRS must show the valuation was grossly unreasonable to challenge it. Without it, the company must prove its own number was reasonable.
A second route exists for illiquid startups: a valuation by a qualified individual inside the company, if the company meets conditions on age and on not expecting an acquisition or IPO soon. Most venture-backed companies use an outside appraiser anyway.
A 409A lasts up to 12 months, or until something material changes
The presumption covers a valuation that is no more than 12 months old. It ends earlier if a material event changes the company's value.
Common material events include:
- A priced equity round, such as a Series Seed or Series A.
- A significant secondary sale of common stock at a set price.
- An acquisition offer or a letter of intent.
- A major change in the business, such as losing a key customer or a large jump in revenue.
Appraisers value common stock below the preferred price, for good reasons
Investors buy preferred stock. Employees get options on common stock. The 409A values the common.
Common is usually worth less than preferred because preferred has a liquidation preference and other rights. The appraiser also applies a discount for lack of marketability, since private shares cannot be sold easily.
Typical approaches include:
- The backsolve method, which starts from the price of the latest round and allocates value across share classes.
- The income approach, based on projected cash flows.
- The asset approach, used for very early companies with little revenue.
A 409A takes one to three weeks and costs from under $1,000 upward
Plan for two to three weeks from kickoff to final report, though many firms offer faster turnaround for a fee. Price depends on stage and complexity.
As published examples, Eqvista lists 409A plans starting at $990 a year, and Cake Equity lists a standalone 409A at $1,500.
The appraiser will ask for:
- Your current cap table, with every share class and its rights.
- Recent financing documents: SAFEs, notes, and priced-round terms.
- Financial statements and projections.
- A short description of the business, market and competitors.
A clean cap table export cuts days off the process.
Capable tracks the 409A so you never grant on a stale one
Capable records each 409A with its fair market value, valuation date, effective period and report. It warns you before a valuation expires.
When you draft an option grant, Capable uses the current fair market value as the exercise price. Your cap table exports in the format appraisers ask for.
If you are moving from Pulley, your existing 409A stays valid. Record it in Capable with its original dates; the 12-month window keeps running from the valuation date.
Related guides
This guide is general information, not tax or legal advice. Ask your appraiser, accountant or counsel about your company.