The Current Value Method (CVM) and When It's Used in a 409A

How this page fits with our method guides: The CVM is one of four allocation methods described in the AICPA guide. Our option pricing model guide covers the method most 409A reports use, our PWERM guide covers scenario-based allocation, and our hybrid method guide covers the late-stage blend of the two. This page covers only the current value method: what it does, when it fits, and where it breaks.

What is the current value method in a 409A valuation?

The current value method is an allocation method that divides a company's equity value among its share classes as if the company were sold or liquidated today. Each preferred class takes the greater of its liquidation preference or its as-converted value, and common stock receives whatever is left.

A 409A valuation has two steps. The appraiser first estimates the total equity value of the company, using the income, market or asset approach. The appraiser then allocates that value among preferred stock, common stock, options and warrants. The CVM allocation method is a tool for the second step only. It does not tell you what the company is worth; it tells you how a known value would be divided on a single date.

That single date is the important part. The CVM looks only at the present. It does not consider what the company might be worth when it actually exits, how uncertain that future value is, or how long common holders will wait. Every other allocation method builds the future into the allocation in some way. The current value method deliberately leaves it out.

How the CVM Allocation Method Works

A current value method 409A allocation follows the company's charter, the same way a buyer's payout schedule would in a sale closing today:

1. Start with today's equity value. This comes from the valuation approach the appraiser selected, or, when a sale is about to close, from the deal consideration payable to equity holders after debt, transaction costs and any amounts held back.
2. Test each preferred class for conversion. A non-participating preferred holder can either take its liquidation preference or convert to common and share pro rata. The CVM assumes each holder picks whichever pays more at today's value.
3. Pay the preferences in order of seniority. Classes that do not convert take their preference first, senior series before junior ones. Participating preferred takes its preference and then shares in the remainder, subject to any cap.
4. Distribute the residual. What remains goes to common stock and to any preferred that converted, pro rata on an as-converted basis. In-the-money options and warrants are typically treated as exercised, with their exercise proceeds added to the value being distributed.
5. Apply a DLOM to common. The resulting marketable value per common share is discounted for lack of marketability, reflecting how long common holders will wait for cash.

If you have read a sale waterfall, this will look familiar. The current value method is essentially that waterfall, applied to the value on the valuation date. Our guide to common stock vs preferred stock in a 409A covers the preference terms that drive it.

A Worked Current Value Method Example

Take a company with a simple capital structure. Options are left out to keep the example readable:

• 6,000,000 shares of common stock
• 4,000,000 shares of Series A preferred, issued at $2.00, 1x non-participating, converts 1:1
• Total liquidation preference: $8.0 million

The Series A holds 40% of the shares on an as-converted basis, so it converts only when 40% of equity value exceeds its $8.0 million preference. That happens above $20.0 million of equity value. The table shows the CVM result at three equity values, alongside an option pricing model at the same values, using a three-year term, 60% volatility and a 3.8% risk-free rate:

Three things stand out:

• Below the preference, the CVM gives common nothing. At $6.0 million, a sale today would pay common zero. The OPM still gives common about $0.30 per share, because the company might grow past its preference before it exits.
• Between the preference and the conversion point, the CVM understates common. At $12.0 million, common gets about $0.67 under the CVM and about $0.88 under the OPM. The difference is the option value the CVM leaves out.
• Above the conversion point, the CVM can overstate common. At $30.0 million, the CVM treats preferred as plain common and gives every share $3.00. The OPM recognizes that preferred keeps its downside protection if value falls later, so common gets less, about $2.79.

The CVM does not always produce a lower common value. It produces the value that would apply if the company were sold today, and the gap with an OPM can run in either direction.

When is the current value method appropriate?

The current value method is appropriate in two situations under the AICPA guide: when an acquisition or dissolution is imminent, so the company's future as a going concern hardly matters, or when a company is so early that it has made no material progress on its business plan and has no reasonable basis to estimate future value above the preferences.

1. An imminent liquidity event

When a sale or wind-down is about to happen, the “sold today” assumption is close to the truth. If a definitive merger agreement has been signed and closing is expected within weeks, the deal consideration will flow through the charter's waterfall on a known date at a known price. Modeling a range of future outcomes, as an OPM does, would describe a future that is unlikely to happen.

The same reasoning applies to an orderly dissolution where the board has approved a wind-down and the remaining assets will be distributed under the preference stack. In both cases, the appraiser should still deal with escrows, holdbacks and earn-outs, which are paid later and are not certain. Those amounts are often valued separately and discounted for time and risk.

The key word is imminent. A letter of intent that has not been signed into a definitive agreement, or a sale process with several interested buyers, is not imminent. Those situations call for a PWERM or hybrid model that weights the sale against the company continuing on its own. Our 409A exit planning guide covers how valuations change as a sale process moves forward.

2. A very early company with no material progress

The second situation is a company at such an early stage that all three of these conditions hold:

• No material progress has been made on its business plan.
• No significant common equity value has been created above the preferred stock's liquidation preference.
• There is no reasonable basis for estimating the amount or timing of any common equity value above that preference that might be created in the future.

In practice, this describes a company that has just formed, perhaps raised a small amount of preferred, and has not yet built a product or found customers. In that setting, an OPM's volatility and term assumptions have little to anchor them, and the CVM gives a defensible, simple answer.

These conditions stop holding quickly. A working product, early revenue, a signed pilot or a priced round from outside investors are all signs of progress and of value above the preference. Our guide to 409A valuation methods for pre-revenue startups covers how appraisers value companies at this stage more broadly.

Why is the current value method rarely used in 409A valuations?

The current value method is rarely used because it ignores the option value of common stock. Most companies granting options are going concerns that will not exit for years, and their common stock is worth something because value may grow past the preferences. The CVM assigns no value to that possibility, so it misstates common for most companies.

Three further problems push appraisers toward other methods:

• It cannot be calibrated to a recent round. When a company has sold preferred recently in an arm's-length round, the AICPA guide expects the valuation to be calibrated to that price. Under the CVM, the example's Series A is worth exactly its $2.00 preference at any equity value from $8.0 million to $20.0 million, so the round price says almost nothing about what equity is worth. An OPM backsolve, by contrast, solves for a single equity value; our backsolve method guide explains how.
• It treats preferred as worth no more than its preference. Investors who just paid $2.00 per share did so expecting the company to grow. Under the CVM, their shares are worth no more than $2.00 unless equity value is already above the conversion point. That is inconsistent with why they invested.
• It is sensitive to small changes in value. Near the preference amount, a modest change in equity value can move the common stock value from zero to a meaningful number. That makes the conclusion unstable from one report to the next.

For these reasons, the option pricing model is the default allocation method for most early and growth-stage 409A reports, and PWERM or the hybrid method take over as an exit comes into view. The current value method 409A use cases are the edges: the very beginning and the very end of a company's private life.

CVM vs OPM vs PWERM vs Hybrid at a Glance

The AICPA guide describes four allocation methods. This table compares the CVM allocation method with the other three on the points that matter for a 409A:

The method should follow from the facts. A change from an OPM to the CVM between two reports should be tied to a specific event, such as a signed merger agreement or a board-approved dissolution, and a change in the other direction should be explained just as clearly.

The Current Value Method and the 409A Safe Harbor

Section 409A does not name an allocation method. Treasury Regulations Section 1.409A-1(b)(5)(iv)(B) requires that fair market value be determined by the reasonable application of a reasonable valuation method, considering all available information material to the value of the company. A valuation is presumed reasonable if it meets one of three presumptions: an independent appraisal with a valuation date no more than 12 months before the grant, a qualifying formula used consistently, or a written valuation of an illiquid startup prepared by a qualified person.

Two points matter for the CVM:

• The illiquid startup presumption is not available near an exit. It does not apply if the company reasonably anticipates a change in control within 90 days or an IPO within 180 days. That is often exactly when the CVM is used for an imminent sale, so those valuations usually rely on the independent appraisal presumption.
• A presumption does not protect an unreasonable method. The IRS can rebut a presumption by showing that the valuation or method was grossly unreasonable. Applying the CVM to a growing company with a product, customers and a recent priced round, to produce a low common value, is the kind of choice a reviewer could challenge. Our 409A safe harbor guide covers the presumptions in detail.

The stakes are real. If an option is granted with an exercise price below fair market value, and no exemption applies, the option can become deferred compensation subject to Section 409A. If it then fails to comply, the holder may owe income tax on the vested amount, an additional 20% tax and interest. A valuation is also only as current as the facts behind it. If a signed deal is terminated after a CVM report, that is a material event for the 409A, and the company should get a new valuation before granting again.

What Reviewers Check in a CVM Allocation

Auditors and buyers' diligence teams reviewing a current value method 409A typically look for:

• Support for the trigger. For an imminent sale, the signed agreement, expected closing date and board approval. For the early-stage case, evidence that the three AICPA conditions actually hold.
• Correct net proceeds. Debt payoff, transaction expenses, escrows, holdbacks and earn-outs should be handled explicitly, not assumed away.
• Charter terms applied correctly. Seniority, participation rights, caps, conversion ratios and any anti-dilution adjustments should match the current certificate of incorporation.
• A supported DLOM. Close to a closing, the discount for lack of marketability is often small. For the early-stage case, common may wait years and the discount can be substantial. Our Finnerty DLOM model guide covers one common way to estimate it.
• A reason not to use an OPM. The report should explain why a method that captures option value was not chosen, especially if the company has raised a priced round. Our guide to audit-defensible 409A valuations covers the documentation that holds up under review.

The Bottom Line on the Current Value Method

The current value method answers one question: how would value be divided if the company were sold today? When a sale or wind-down is about to happen, or when a company is too new to have a future anyone can estimate, that is the right question. For most companies granting options, it is not, because their common stock is worth something precisely because the company has not been sold yet.

If your appraiser proposes a current value method 409A allocation, ask which of the two situations applies and what evidence supports it. If neither fits, expect an option pricing model, a PWERM or a hybrid method instead.

The worked example in this article is illustrative, with simplified inputs, and is not a valuation of any company. This article is general information about Section 409A and valuation practice, 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) depends on the specific facts; consult your own counsel and tax advisor.