Fundraising & Equity
Definition
A 409A valuation is an independent appraisal of the fair market value (FMV) of a private company's common stock. It is required by the IRS before a company can issue stock options, establishing the exercise price to avoid significant tax penalties.
Section 409A of the Internal Revenue Code requires that stock options be granted with an exercise price at or above the fair market value of the underlying shares at the time of grant. For private companies, this requires a formal, independent 409A valuation from a qualified appraiser. The valuation is typically performed by a third-party valuation firm and uses methods such as the Black-Scholes model, discounted cash flow analysis, or the Option Pricing Model (OPM). A 409A valuation is valid for 12 months (or until a material event like a funding round). Failing to obtain a 409A — or setting option prices below FMV — can result in options being taxed as ordinary income at vesting rather than exercise, plus a 20% penalty tax under IRS 409A. After a priced funding round, the 409A almost always increases, so timing option grants before a round can benefit employees.
Every startup that grants stock options needs a current 409A valuation. Getting it wrong exposes employees to unexpected and severe tax consequences. A finance advisor or startup attorney can help you understand when to obtain a new valuation, how to find a qualified appraiser, and how the 409A affects your cap table management and option grant timing.