409A Valuation FAQ: Your Questions Answered
Everything you need to know about 409A valuations, from basic requirements to compliance best practices. Get clear answers to the most common questions about startup stock option valuations.
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Basics & Requirements
What is a 409A valuation?
A 409A valuation is an independent appraisal that determines the fair market value (FMV) of a private company's common stock, as required by IRS Section 409A. It is primarily used to set the exercise (strike) price of employee stock options.
Why do startups need a 409A valuation?
Startups need a 409A valuation to issue stock options compliantly. Without a valid 409A, employees may face severe tax penalties, and the company risks IRS scrutiny.
When should a company get its first 409A valuation?
A company should obtain its first 409A valuation before issuing stock options for the first time, typically after incorporation or shortly after raising a seed round.
How long is a 409A valuation valid?
A 409A valuation is generally valid for 12 months, unless a material event occurs that impacts the company's value.
Timing & Updates
What is considered a material event for 409A purposes?
Fundraising rounds
- M&A activity
- Significant revenue changes
- New major customers or contracts
- Changes in business model or financial outlook
- Any of these may require a new 409A valuation.
What is "safe harbor" under Section 409A?
Safe harbor means the IRS will presume your valuation is reasonable if it is prepared by an independent, qualified valuation provider, significantly reducing audit risk.
How often should a 409A valuation be updated?
At minimum:
- Once every 12 months
- Immediately after a material event
Methodology & Calculations
How is a 409A valuation calculated?
A 409A valuation typically uses one or more of the following approaches:
- Market approach
- Income approach (DCF)
- Asset-based approach
- The final value reflects company stage, risk profile, and capital structure.
What valuation methods are used in a 409A report?
Common methods include:
- Comparable company analysis
- Discounted cash flow (DCF)
- Option Pricing Model (OPM)
- Probability-Weighted Expected Return Method (PWERM)
What is the difference between a 409A valuation and a fundraising valuation?
A fundraising valuation reflects the price investors pay for preferred shares, while a 409A valuation determines the FMV of common stock, which is typically lower due to liquidation preferences and risk.
What information is required for a 409A valuation?
Common inputs include:
- Cap table
- Financial statements and forecasts
- Fundraising history
- Business overview
- Comparable companies
- Key contracts and risks
Costs & Providers
How much does a 409A valuation cost?
409A valuation costs range from $399 to $15,000+ depending on provider type. Online platforms charge $399–$1,500, boutique firms $2,000–$5,000, and Big 4 accounting firms $5,000–$15,000+. Key factors include company stage, cap table complexity, and turnaround time.
How long does a 409A valuation take?
Most 409A valuations take 1–3 weeks. Automated or AI-assisted platforms can reduce this to days instead of weeks.
How do I choose a 409A valuation provider?
Look for:
- IRS-compliant methodology
- Independence
- Experience with startups
- Speed and transparency
- Audit support and documentation
Compliance & Penalties
Can a founder do their own 409A valuation?
No. To qualify for safe harbor protection, the valuation must be independent. Self-prepared valuations do not meet IRS standards.
What happens if a 409A valuation is too high?
If too high, employees may be discouraged from exercising options, reducing the incentive value of equity compensation.
What happens if a 409A valuation is too low?
An unreasonably low valuation increases IRS audit risk and may invalidate safe harbor protections.
What are the penalties for not having a valid 409A valuation?
Penalties can include:
- Immediate income taxation
- 20% federal penalty tax
- State penalties and interest
- Employee dissatisfaction and legal exposure
Special Cases
Do non-U.S. companies need a 409A valuation?
Yes. Any company issuing U.S. tax-subject equity compensation must comply with Section 409A, regardless of where the company is incorporated.
Is a 409A valuation required for founders?
Founders generally need a 409A valuation if they receive or exercise stock options or issue equity compensation post-incorporation.
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