What is a 409A valuation and when do I need one?

What is a 409A valuation and why do I need one?

It is an independent determination of your common stock's fair market value that lets you grant options at a compliant strike price and claim a safe harbor under Section 409A.

Without a defensible valuation, the IRS can challenge your strike price and impose penalties on the employees who hold the options.

When does my startup need a 409A?

Generally before you grant your first stock options, again after any priced financing round, and at least every 12 months.

A material event — like a new round — can make an older valuation stale, so refresh it before the next grant.

What happens if I grant options below fair market value?

Options granted with a strike price below fair market value can be treated as deferred compensation that violates Section 409A, triggering immediate income tax plus a 20% additional tax — and interest — for the option holder.

The penalty falls on your employee, which is why founders take 409A compliance seriously.

What is the safe harbor?

If an independent, qualified appraiser determines the value (or you use another method the regulations bless), the IRS presumes your valuation is reasonable, and the burden shifts to the IRS to prove otherwise.

Most startups use an independent provider to get the clearest safe harbor, but the regulations recognize other qualifying methods if their conditions are met.

How does the 409A value relate to my priced-round valuation?

They are different numbers — your 409A sets common-stock value, which is normally well below the preferred-stock price investors pay in a round.

A high preferred price does not have to mean a high option strike price.

Talk to a startup attorney

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Frequently asked questions

What is a 409A valuation?

An independent appraisal of your company's common-stock fair market value, used to set a compliant exercise price for employee stock options and to claim a safe harbor under Section 409A. Startups usually get one before granting options.

When do I need one?

Generally before your first option grant, after each priced round, and at least every 12 months. A material event such as a new financing can make an older valuation stale, so refresh it before granting more options.

Can I do the valuation myself?

You can, but a self-made valuation generally does not qualify for the Section 409A safe harbor, which means the IRS does not have to presume it is reasonable. Most startups use a qualified independent provider to get the safe harbor.

How long is a 409A valuation valid?

Typically up to 12 months, or until a material event — like a new financing round — occurs, whichever comes first. After that you should obtain a new valuation before granting more options.

Does the option strike price have to equal the 409A value?

For options to avoid Section 409A problems (and for incentive stock options under Section 422), the exercise price generally must be at least the fair market value of the stock on the grant date — which the 409A valuation establishes.

Who pays the penalty if the valuation is wrong?

The option holder — your employee — bears the income tax, the 20% additional tax, and interest if a grant violates Section 409A. That is why founders treat getting the strike price right as protecting their team.

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