409A Valuation vs Fair Market Value: Why They Are Not Two Numbers

How this page fits with our other guides: This article is about terminology: what fair market value means and how a 409A valuation relates to it. How the 409A sets the exercise price, including grant-date mechanics and the consequences of pricing below FMV, is covered in our guide to how a 409A valuation sets strike price. Why common stock is worth less than what investors pay is explained in 409A price vs preferred price. We link to those pages rather than repeat them.

Is a 409A valuation the same as fair market value?

Not quite, but they describe one number. Fair market value is the standard: the price a willing buyer and willing seller would agree on. A 409A valuation is the independent appraisal that applies that standard to a private company's common stock and concludes its fair market value per share as of a valuation date. The 409A is the process; FMV is its answer.

The confusion is understandable. In everyday startup language, “our 409A” is shorthand for the per-share figure the report concludes, so people say “the 409A is $0.63” when they mean “the fair market value of our common stock is $0.63.” That shorthand is fine in a board meeting. It becomes a problem when a founder starts treating the 409A and FMV as two different benchmarks, for example by asking whether a grant should be priced “at the 409A or at FMV.” For a private company relying on a current, valid appraisal, the answer is that those are the same thing.

A more precise way to state the 409A valuation vs fair market value relationship is this: fair market value is a legal concept that exists whether or not anyone has measured it. A 409A valuation is the evidence a company uses to show what that value was on a given date. When the evidence is current and qualifies for a regulatory presumption, the IRS generally has to accept it. When it is stale or unsupported, the company is left arguing about what FMV “really” was.

What “Fair Market Value” Means Under Section 409A

Section 409A of the Internal Revenue Code governs nonqualified deferred compensation. Stock options are not automatically deferred compensation, but they can be. Treasury Regulations Section 1.409A-1(b)(5)(i) excludes a stock option from Section 409A only if, among other conditions, its exercise price can never be less than the fair market value of the underlying stock on the date the option is granted. That single condition is why every private company issuing options needs a defensible FMV.

The 409A regulations do not restate a one-line definition of fair market value for private stock. Instead, valuation practice draws on the long-standing federal tax definition found in Treasury Regulations Section 20.2031-1(b) and Revenue Ruling 59-60: the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts. Three features of that definition matter for startups:

• It is a hypothetical transaction. FMV does not require that anyone actually bought common stock at that price. It asks what a hypothetical, informed buyer would pay.
• It values the specific security. The buyer is purchasing a share of common stock, with common stock's rights, not preferred stock with liquidation preferences, and not the whole company.
• It is measured on a date. FMV is a point-in-time concept. The question is what the stock was worth on the grant date, using what was known or reasonably knowable then.

For stock that is readily tradable on an established securities market, the regulations at Section 1.409A-1(b)(5)(iv)(A) let a company determine FMV from actual trading, such as the closing price on the grant date or the trading day before. Private companies have no such market, so Section 1.409A-1(b)(5)(iv)(B) applies instead, and that is where a 409A valuation comes in.

How is fair market value determined in a 409A valuation?

An appraiser estimates the company's total equity value using income, market and asset approaches, allocates that value across preferred and common stock according to each class's rights, and then applies a discount for lack of marketability. The result is the fair market value of one share of common stock on the valuation date, which the board adopts.

The regulations require the reasonable application of a reasonable valuation method and list the factors a reasonable method considers: the value of tangible and intangible assets, the present value of anticipated future cash flows, the market value of stock in comparable companies, recent arm's-length transactions in the company's own stock, control premiums or discounts for lack of marketability, and whether the method is used consistently for other purposes. In practice, a 409A works through four layers:

1. Enterprise and equity value. The appraiser applies one or more of the income, market and cost approaches. For a company that recently raised a priced round, the market approach often calibrates to that round through a backsolve.
2. Allocation across share classes. Total equity value is split among preferred stock, common stock, options and warrants, using an option pricing model, a probability-weighted scenario model, or a hybrid. This step respects liquidation preferences, participation and conversion rights.
3. Marketable value per common share. The allocation produces a value for common stock as if it could be freely sold.
4. Discount for lack of marketability. Because private common stock cannot be readily sold, the appraiser applies a DLOM, estimated with models compared in our DLOM models guide. What remains is the fair market value of common stock.

Here is an illustrative example of how far the starting headline number and the ending FMV can sit from each other. A company has just closed a Series A at $2.00 per preferred share, on 20 million fully diluted shares.

Every figure in that table is a legitimate number. Only the last one is the 409A FMV. The others are inputs, intermediate results, or entirely different securities.

Why the 409A and FMV Get Confused With Other Numbers

Most mix-ups in the 409A vs FMV debate are really confusion between FMV and a different number entirely. Four come up again and again:

• The preferred price. Investors pay for preferred stock, which comes with liquidation preferences, often anti-dilution protection, and governance rights. Common stock has none of those, so it is worth less. The gap is explained in detail in our preferred price guide.
• The post-money valuation. A headline post-money valuation is the preferred price multiplied by the fully diluted share count. It assumes every share is worth what the newest investor paid, which is not true for common.
• Enterprise value. Enterprise value describes the whole business, before debt and cash and before any split among share classes. It is an input to the 409A, not its conclusion.
• A secondary or tender price. When employees sell shares to investors, the price paid is evidence of value, and a 409A appraiser must consider it. But it may reflect special terms, a strategic buyer, or limited volume, so it is not automatically fair market value. Our guide to 409A valuations and secondary sales covers how appraisers weigh these trades.

There is also a vocabulary problem. Accountants use “fair value,” tax advisers use “fair market value,” and both are routinely abbreviated or swapped in conversation. The next two sections separate them.

FMV, Fair Value and the 409A: Terms Compared

The table below lists the value terms a startup is most likely to meet, what each one measures, and whether it is the same figure as the 409A fair market value of common stock.

Note the gift and estate row. Those transfers use the same willing-buyer, willing-seller definition, but the interest being valued and the purpose differ. A gift of a large block of founder stock to a trust is usually supported by its own appraisal rather than by borrowing the per-share figure from the latest 409A.

What is the difference between fair market value and fair value?

Fair market value is a tax standard: the price between a hypothetical willing buyer and seller, used under Section 409A to price options. Fair value is an accounting standard under U.S. GAAP. For stock options, ASC 718 fair value is the value of the option itself, typically from Black-Scholes, which takes the 409A FMV of the share as an input.

The FMV vs fair value distinction matters because both numbers appear in the same board pack. Suppose the board grants options with a $0.63 exercise price, equal to the 409A FMV. For tax purposes, the option is priced at fair market value and is exempt from Section 409A. For financial reporting, the company must still record compensation expense equal to the option's grant-date fair value under ASC 718, which might be $0.35 per option after inputs for volatility, expected term, and the risk-free rate. The $0.63 and the $0.35 are not in conflict. One is the value of a share; the other is the value of a right to buy that share at $0.63.

Private companies usually rely on a single appraisal of common stock for both purposes, and the AICPA's valuation guide for privately held company equity securities is written with that dual use in mind. Auditors review the common stock value as part of the stock compensation audit, so a 409A that is weak for tax purposes tends to draw questions on the accounting side as well.

How 409A FMV Feeds Your Strike Price

The practical reason any of this matters is the exercise price. The 409A fair market value per share is the floor: an option granted with a strike price at or above FMV on the grant date can be exempt from Section 409A, while an option granted below FMV is generally treated as deferred compensation. Unless it was designed to comply with Section 409A's timing rules, which typical startup options are not, a discounted option fails the statute, and the holder faces income inclusion as the option vests, an additional 20% federal tax, and premium interest. State taxes may also apply.

Boards therefore usually set the exercise price exactly at the most recent 409A FMV. Our strike price guide covers the mechanics we deliberately leave out here: which date counts as the grant date, how to handle offers signed before board approval, and how to correct a grant that was priced too low.

How much protection that FMV gives depends on how it was determined. Treasury Regulations Section 1.409A-1(b)(5)(iv)(B)(2) gives a presumption of reasonableness to three methods: an independent appraisal as of a date no more than 12 months before the grant, a binding formula price that qualifies as a nonlapse restriction and is used consistently for transfers of the stock, and a qualifying written valuation for an illiquid startup prepared by someone with significant knowledge and experience. With a presumption, the IRS can overturn the value only by showing it was grossly unreasonable. Our 409A safe harbor guide walks through each method.

Where Else 409A FMV Shows Up: ISOs, 83(b) and AMT

Once a company has a credible 409A fair market value, it tends to become the reference point for several other tax calculations involving common stock:

• Incentive stock options. Section 422 independently requires an ISO's exercise price to be at least the stock's fair market value on the grant date. The same 409A typically supports both requirements.
• 83(b) elections. When a founder or early employee receives restricted stock and files an 83(b) election, the taxable amount is the stock's fair market value at transfer, determined without regard to vesting restrictions that will lapse, minus any amount paid. A current 409A is the usual support for that figure.
• Exercise of ISOs and the AMT. The spread between FMV at exercise and the exercise price is an adjustment for alternative minimum tax purposes. For a private company, FMV at exercise is generally taken from the 409A in effect on the exercise date, which is why a large jump in the 409A can raise employees' AMT exposure.
• Exercise of NSOs. On exercise of a nonqualified option, the spread between FMV and the exercise price is ordinary compensation income, subject to withholding. The company needs an FMV on the exercise date to compute it.

In each case, the underlying question is the same: what was a share of common stock worth on that date? The 409A answers it once, and several tax calculations use the answer.

When a 409A Value Stops Representing Fair Market Value

Because FMV is measured on the grant date, the 409A conclusion is only as good as its currency. Section 1.409A-1(b)(5)(iv)(B)(1) states that using a previously calculated value is not reasonable if it fails to reflect information available after the calculation date that may materially affect the company's value, or if the value was calculated as of a date more than 12 months before it is used. That creates three situations where the 409A figure and FMV can drift apart:

• A material event. A new priced round, an acquisition offer, a large customer win, or a significant setback can change value overnight. Our list of material events that trigger a new 409A covers the common ones.
• The 12-month limit. Even with no material events, a valuation older than 12 months cannot support new grants.
• The stock becomes readily tradable. After an IPO, FMV comes from the public market under Section 1.409A-1(b)(5)(iv)(A), and an appraisal is no longer the basis for new grants.

In each case, the old 409A still says what common stock was worth on its own valuation date. It simply no longer tells you what the fair market value of common stock is today.

The Bottom Line on 409A Valuation vs Fair Market Value

The 409A valuation vs fair market value question has a short answer: fair market value is the standard, and a 409A valuation is how a private company measures it. The output of a current, independent 409A is the fair market value of common stock, and that figure is the minimum exercise price for compliant option grants. Framed that way, 409A vs FMV is a distinction between a process and its result, not between two prices.

For founders and CFOs, three habits keep the terminology from causing real problems. Price grants from the 409A FMV, not from the preferred price or a post-money calculation. Keep FMV and ASC 718 fair value separate in board materials, since they measure different things. And refresh the 409A whenever a material event occurs or the valuation approaches 12 months old, so the number you rely on is still FMV on the day you grant.

The figures in this article are illustrative and are not a valuation of any company. This article is general information about Section 409A, valuation practice and the taxation of equity compensation, not legal, tax or accounting advice. Whether a valuation qualifies for a presumption of reasonableness under Treasury Regulations Section 1.409A-1(b)(5)(iv)(B), and how a specific grant, election or exercise is taxed, depends on the facts; consult your own counsel and tax advisor.