409A valuation and your stock options: what it is and why it matters
Short answer: A 409A valuation is an appraisal of the fair market value of a private company’s common stock. Companies use it to set the exercise (strike) price of employee stock options at or above fair market value, which matters under the Internal Revenue Code section 409A rules on deferred compensation. Common stock is usually valued below the preferred stock investors buy, so a 409A price is often lower than the last round’s price.
Why companies get a 409A
- To grant options with a strike price at or above fair market value
- To support the valuation with an independent appraisal
- To have a current value when the board approves grants
Why a 409A can look high or low
A 409A values common stock. Investors usually buy preferred stock with extra rights, such as liquidation preferences, so the common value is often lower. A 409A can look high relative to what employees expect if revenue, a recent round or the market has moved the company’s value. If you think it is off, ask what inputs and methods the appraiser used.
When it is refreshed
Companies commonly refresh it at least annually and after material events such as a new financing round. Ask your finance team or valuation provider about your company’s schedule.
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What it means for employees
- Your strike price is usually set from the 409A in effect when options are granted.
- Exercising and selling options can have tax consequences that depend on the option type (ISO or NSO) and timing. Talk to a CPA or tax professional before you exercise.
Who helps with 409A work
Independent valuation firms prepare the appraisal. Your accounting or fractional CFO team supplies the financials, cap table and forecasts the appraiser needs, and keeps the records the board relies on.
Related: outsourced CFO services, outsourced accounting for startups, and advisors for equity compensation.
Frequently asked questions
What is a 409A valuation?
An appraisal of the fair market value of a private company's common stock, used to set stock option strike prices.
Why is my 409A lower than the last funding round price?
Investors usually buy preferred stock with extra rights; a 409A values common stock, which is often worth less.
How often is a 409A done?
Commonly at least once a year and after material events like a new funding round.
Who prepares a 409A?
Usually an independent valuation firm, using financials and forecasts supplied by the company's finance team.
Does a 409A affect my taxes?
It sets the strike price; the tax result of exercising or selling depends on option type and timing. Ask a CPA or tax professional.
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