A 409A valuation is used to determine the fair market value of a private company's common stock, often for the purpose of setting the strike price for employee stock option grants. A proper 409A valuation by a professional (individual practitioner or firm) provides safe harbor for the company under IRS tax code section 409A, which regulates the taxation of non-qualified deferred compensation plans.
409A valuations are important because they ensure that the strike price for stock options is not set below their fair market value. If the strike price is deemed below fair market value, employees and companies may face negative tax consequences, including penalties.
Valuation methodologies and inputs
The valuation process takes into account a variety of factors, including the company’s financial performance, industry trends, comparable transactions, and the rights and preferences of different classes stock.
The third-party, independent, valuation team often derive an overall company value based on market and company-specific inputs, then allocate that total value to a common per share value conclusion. For early stage, pre-revenue companies, the latest round of financing is often considered the best indication of value.
Note that employee options are generally for a company’s common shares. Since VC investors typically receive preferred stock, which comes with additional rights and preferences compared to common stock, price paid per preferred share is often much higher than a common per share (after discount for lack of marketability) for 409A purposes.
Valuation cadence
409A valuations need to be refreshed at least once a year or when there are significant changes that impact the value of the business. For early stage companies, receiving new term terms / closing a new financing round would trigger a 409A update.
As of January 2024, OCV companies will have a board determined FMV at 2x par value as of the company launch date. Absent of a new funding or other material event in the first 12 months, the company will perform a 409A valuation as of its first anniversary date.
Valuation provider
OCV companies’ CapTable management platform also provides 409A valuation services as part of their annual subscription.
To request a new 409A valuation report
- Log into the company’s CapTable Management System
- Find “Compliance & Tax” in the navigation bar and select “409A valuations”
- Find the appropriate launch button to get started and follow input screens instructions to provide requested data
- The Company’s Finance & Accounting Team is available to help with this process at their standard billable rate
- Typical turnaround time for a draft valuation report is 1-2 weeks. Once draft is available, Management team will review (OCV, Company’s Finance or Team, is available to support a quick reasonableness check), accept as final or request changes. Prior to a meaningful revenue base and before receiving any external indication of value (i.e. a term sheet), 409A value (or common price per share) is expected to be negligible as the business faces significant uncertainty and funding risk.
- Management should send a copy of the final 409A report to the company’s Legal Team. 409A value sign off is part of the routine board consent process for new option grants.
It’s worthwhile noting that the 409A valuation has a specific use case. Generally speaking, the overall company value estimate from 409As would differ from pre-money valuations used in the context of startup financing.
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