What is a 409A Valuation? Startup Equity, Pricing & Compliance

If you're a startup founder planning to offer employee stock options — or if you're raising funding — you’ve probably heard investors, lawyers, or CFOs mention a 409A valuation.

But what is a 409A valuation? Why is it such a big deal for startups? And how often do you need one?

In this blog, we’ll break down what 409A means, why it matters, how it’s calculated, and how to avoid expensive mistakes (like triggering IRS penalties).

What is a 409A Valuation?

A 409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common stock. It’s required by the IRS under Section 409A of the Internal Revenue Code, which governs non-cash compensation like stock options.

In simple terms:
It tells you the price per share you can legally offer to employees when you grant stock options.

Why Do Startups Need a 409A Valuation?

Startups need a 409A valuation primarily to issue stock options to employees without triggering tax problems.

If you grant options below fair market value (FMV) — and don’t have a valid 409A — the IRS may consider it deferred compensation, resulting in:

• Immediate income tax for the employee

• A 20% penalty + interest

• Potential audits or legal risks

A valid 409A valuation protects both the company and employees from these consequences.

When Do You Need a 409A Valuation for a Startup?

Here’s when you absolutely need to get a 409A valuation for a startup:

• Before the first employee stock option grant

• Every 12 months (or sooner if there’s a material event)

• After a new funding round

• After a significant change in business (M&A, product launch, large revenue shift)

Failing to update a 409A after a major milestone could invalidate your current FMV.

Who Performs a 409A Valuation?

Typically, a third-party valuation firm performs your 409A to ensure independence and compliance.

Common providers include:

• Carta

• Pulley

• Morgan Stanley Shareworks

• Aranca

• Scalar

They use multiple valuation methods (like the income or market approach) and provide a report that includes:

• FMV per common share

• Supporting analysis

• Validity period (usually 12 months unless something material changes)

How is 409A Valuation Calculated?

409A valuation firms often use a combination of these three methods:

1. Market Approach: Looks at comparables — what similar private/public companies are worth

2. Income Approach: Projects future earnings or cash flow, then discounts them to present value

3. Asset Approach: Based on company assets (rarely used for startups)

They also factor in:

• Preferred stock pricing (from recent funding rounds)

• Option pool size

• Company revenue, roadmap, projections

• Capital structure (common vs preferred stock)

409A vs Preferred Share Price: Why the Discount?

Let’s say your startup just raised a round where preferred shares were priced at $10 each.
Your 409A valuation might still value common stock at $2 per share. Why?

Because preferred shares have rights — liquidation preferences, anti-dilution, board seats.
Common stock doesn’t.

409A valuations reflect this difference — so employees don’t get overtaxed for holding lower-rights stock.

How Much Does a 409A Valuation Cost?

• Early-stage startups: $1,000 to $5,000 per report

• Growth-stage or complex cap tables: $5,000 to $15,000+

• Providers like Carta may bundle it with cap table services or offer it free under certain plans

What Happens If You Don’t Get a 409A Valuation?

• You risk IRS penalties if stock options are priced below FMV

• Your employees may owe back taxes + penalties

• Future investors or acquirers may raise red flags during due diligence

• Option grants can be challenged or invalidated

409A Valuation Template Example (Simplified)

Note: This is a simplified structure for illustrative purposes only.

Tips to Simplify Your 409A Process

• Keep your cap table clean and updated

• Prepare a solid financial model (3-year projection)

• Document recent milestones and traction

• Work with a cap table tool like Carta or Pulley

• Budget for a new valuation after major events

Conclusion

A 409A valuation isn’t just a tax compliance checkbox — it’s a foundational step in managing startup equity.

Done right, it helps you grant options, attract talent, and stay IRS-compliant.
Done wrong, it can lead to tax nightmares and investor headaches.

If you're offering equity or raising funding, you need a 409A. Start early, get it done professionally, and revisit it often.

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