409A valuation

What is a 409A Valuation?

Definition: A 409A valuation is a mandatory independent assessment that determines the fair market value (FMV) of a private company's common stock, primarily for the purpose of pricing employee stock options.

Key points:

• Established by IRS tax code Section 409A in 2005 to prevent companies from underpricing stock options
• Creates a "safe harbor" that protects companies and employees from tax penalties when options are granted
• Must be conducted by qualified independent appraisers using accepted valuation methodologies
• Needs refreshing at least annually or after significant business events (funding rounds, major revenue changes)

Think of a 409A valuation as a financial physical exam for your company's equity. Without this regular check-up, both your business and employees could face severe tax consequences, including immediate taxation and a 20% federal penalty on option holders.