409A Valuation

A 409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common stock, required by the IRS whenever a company issues stock options.

How It Works

• Purpose: Set the FMV per share of common stock so the company can legally set the strike price on new option grants.
• Who does it: Independent valuation firms (e.g., Carta, Scalar, EquityZen).
• Inputs they analyze:
  • Company financials and projections
  • Comparable public companies and market data
  • Recent financing rounds and other transaction data
• Adjustments: They apply discounts for:
  • Lack of marketability (private shares are hard to sell)
  • Differences between preferred and common stock rights
• Output: A report with a per-share FMV for common stock. This number becomes the minimum strike price for new options.
• Timing:
  • Before the first option grant
  • Refreshed at least every 12 months, or sooner after:
    • A new priced equity round
    • An acquisition offer or major term sheet
    • A major business pivot or material change

Why It Matters to You

• High 409A → high strike price:
  • You pay more to exercise your options.
  • You need a larger exit to make meaningful money.
• Low 409A → low strike price:
  • Cheaper to exercise; more upside per share.
  • But if it’s too low and not defensible, the IRS can argue you received options at a discount and tax you on that difference.
• Typical practice: Competent founders aim for a conservative but defensible 409A, often 20–40% of the last preferred share price at early stages.

Example

• Company just raised a seed round at a $12M valuation.
• Preferred shares: priced at $1.20 per share.
• 409A result: common stock FMV = $0.40 per share (a 3× discount, standard at seed).
• You receive options for 0.5% of the company with a $0.40 strike price.

If the company exits at $50M (assuming simple conversion and ignoring dilution for simplicity):

• Rough gross value per share ≈ $1.20
• Gain per share ≈ $1.20 − $0.40 = $0.80

If the company exits at $200M:

• Rough gross value per share might be ≈ $4.00+
• Gain per share ≈ $4.00 − $0.40 = $3.60+

The 409A at grant date sets the floor (your strike). The exit price and how big the company gets determine your actual upside.

What to Watch Out For

• 409A more than 12 months old
  • Indicates a stale valuation.
  • The company may be delaying a refresh to avoid showing a higher strike price to new hires.
• 409A equal to preferred price
  • At early stage, this is almost always wrong.
  • Common stock should trade at a meaningful discount to preferred because it has fewer rights and protections.
• No 409A at all
  • If you’re getting options and the company can’t produce a 409A report, the grant may not be legally compliant.
  • This can create tax risk for you and the company.

Related Terms

• Strike Price — The fixed price you pay to exercise your options, usually set at or above the 409A FMV on the grant date.
• Common Stock — The class of shares employees typically receive; valued lower than preferred in a 409A because it has fewer rights (e.g., no liquidation preference).
• Preferred Shares — Investor shares with special rights (liquidation preference, anti-dilution, etc.) that usually price 2–5× higher than common in early-stage 409As.