What Is a 409A Valuation?
Direct answerA 409A valuation is an independent assessment of the fair market value of a private company's common stock. Startups use this valuation to help set the exercise price, also called the strike price, for stock options granted to employees and other service providers.
Section 409A is part of the U.S. tax code that governs certain forms of deferred compensation. For stock options, the rules generally require the exercise price to be at least the fair market value of the underlying stock on the date the option is granted if the option is to qualify for the relevant exclusion from Section 409A.
For founders, the important point is that a 409A valuation is about the value of the company's common stock for equity compensation. It is not the same thing as the valuation investors assign to the company when they invest in a fundraising round. Keeping those two valuations separate helps founders understand why a company's 409A value is often lower than the price investors paid for preferred stock.
One company, different stock values
Imagine your startup has raised money from investors and an investor paid $5 per share for preferred stock.
Later, you want to grant stock options to an employee.
The employee is not necessarily receiving the same type of stock that your investors purchased. Investors in a financing round typically receive preferred stock, while employee stock options generally relate to common stock.
That difference matters because the fair market value of the company's common stock can be different from the price investors paid for preferred stock.
A 409A valuation helps establish the fair market value of the company's common stock for purposes of granting stock options.
The valuation considers factors relevant to the company's value, such as its assets, expected future cash flows, comparable companies, recent transactions, and other facts available at the valuation date. The federal regulations require the fair market value of private-company stock to be determined using the reasonable application of a reasonable valuation method.
The result is often called the company's 409A valuation.
If the valuation determines that a share of common stock has a fair market value of $1, for example, an option grant would generally use an exercise price of at least $1 per share to satisfy the applicable Section 409A requirements for the stock option exclusion.
That does not mean the company is worth only $1 per share overall. It means that $1 is the determined fair market value of the particular stock being valued for the relevant purpose.
This is why founders should not automatically compare their 409A valuation with the valuation announced in their latest fundraising round. They are often measuring different things.
What the IRS says, and what founders are actually asking
The federal tax regulations provide that, for private-company stock that is not readily tradable on an established securities market, fair market value is determined through the reasonable application of a reasonable valuation method.
The regulations list factors that may be relevant, including the company's tangible and intangible assets, expected future cash flows, comparable companies, recent arm's-length transactions, and other relevant factors. The regulations also provide a presumption of reasonableness for certain valuation methods, including an independent appraisal that meets the specified requirements.
The important rule is not simply "get a 409A."
The underlying issue is how the fair market value of private-company stock is determined when a startup grants stock options. An option that is granted with an exercise price below the fair market value of the underlying stock can become subject to Section 409A rather than qualifying for the relevant stock-option exclusion.
An independent appraisal is one recognized method for establishing fair market value, and the regulations give certain independent appraisals a presumption of reasonableness when their requirements are satisfied.
This is why startups commonly obtain formal 409A valuations when they are preparing to grant stock options.
The confusion usually comes from treating both numbers as if they represent the same thing.
In a TechCrunch discussion of 409A valuations, founders and startup valuation experts explained that 409A valuations often come out below recent fundraising valuations because investors typically purchase preferred stock, while 409A valuations generally focus on the company's common stock. Different valuation methods and assumptions also contribute to the difference.
A lower 409A valuation does not automatically mean that investors think the company is worth less.
A fundraising valuation reflects the price investors agree to pay for the securities issued in a financing round. A 409A valuation is used to determine the fair market value of private-company stock for purposes such as setting the exercise price of stock options.
Those numbers therefore serve different purposes.
For founders, the practical lesson is to keep the 409A report, equity records, fundraising documents, and related company information organized separately while still keeping them connected to the same fundraising workflow.
A 409A valuation establishes the fair market value of a private company's common stock for purposes such as setting the exercise price of stock options.
It is different from the valuation investors assign to the company during a fundraising round because the two valuations serve different purposes and often relate to different types of stock.
For founders, the important thing is to understand when a 409A matters, keep the valuation current when appropriate, and preserve the report alongside the company's equity and fundraising records.
Cairnul organizes 409A reports alongside the documents, investor information, and fundraising records that make up the company's broader equity history.
From valuation documents to organized records
A 409A valuation is one document within a much larger company and fundraising record.
When a startup receives a 409A report, the report needs to stay accessible alongside the company's other important records. Founders also need to keep track of equity information, fundraising documents, investor records, and other materials that become part of the company's financing history.
Cairnul stores 409A reports in your Data Room without producing the valuation itself.
That means the valuation report has a clear place alongside the other documents founders organize during fundraising. As the company raises additional rounds, founders keep the relevant documents connected instead of searching through separate folders, spreadsheets, and email threads.
The goal is not to turn a 409A valuation into another administrative task to manage in isolation. It is to keep the document connected to the broader record of the company's fundraising activity.
Many founders assume that their 409A valuation should match the valuation from their most recent fundraising round.
It usually does not.
One reason is that the two valuations often relate to different types of stock. Investors typically purchase preferred stock during a financing round, while stock options generally relate to common stock. The rights and preferences attached to those shares can affect their respective values.
Another misconception is that a 409A valuation itself is the legal requirement for every stock option grant.
The more precise point is that Section 409A establishes rules that affect discounted stock options, including the requirement that the exercise price generally not be below the fair market value of the underlying stock at the time of grant for the option to qualify for the relevant exclusion. The regulations then provide rules for determining that fair market value, including recognized methods that can support a presumption of reasonableness.
Founders also sometimes assume that a 409A valuation is a permanent number.
It is not. The fair market value of a private company's stock can change as the company grows, raises money, reaches milestones, or experiences other material changes. The regulations specifically recognize that a previously calculated value may no longer be reasonable when material information has changed or when the valuation is more than 12 months old for the purpose at hand.
The practical takeaway is simple: treat the 409A as an important equity document that needs to stay current and organized as the company changes.
Get your equity records organized
Understand that a 409A valuation establishes the fair market value of private-company stock for relevant equity compensation purposes.
Know the difference between common stock and the preferred stock investors typically receive in a fundraising round.
Confirm how your stock option exercise price relates to the company's current fair market value.
Keep your current 409A valuation report with your company's important equity and corporate records.
Track material company changes that could affect when your existing valuation should be revisited.
Keep 409A reports, equity records, fundraising documents, and investor information connected in one organized workflow.
Frequently asked questions
Startups commonly obtain a 409A valuation when they are preparing to grant stock options. The underlying Section 409A rules require the exercise price of a qualifying stock option generally to be at least the fair market value of the underlying stock on the grant date. Federal regulations recognize several reasonable valuation methods, including certain independent appraisals.
A 409A valuation is primarily used to establish the fair market value of private-company stock for purposes such as setting the exercise price of stock options.
No. A fundraising valuation generally reflects the price investors pay for preferred stock in a financing round, while a 409A valuation generally focuses on the fair market value of common stock for equity compensation purposes.
The cost varies based on the valuation provider, company size, complexity, and stage of the business. There is no single federally prescribed fee for obtaining a 409A valuation.
A startup typically needs to revisit its valuation when it is preparing new equity grants or when material changes could affect the company's fair market value. The federal regulations also address circumstances where an older valuation may no longer be reasonable, including when material information has changed or the valuation date is more than 12 months old for the relevant transaction.
No. A 409A valuation and an investor-assigned fundraising valuation serve different purposes and may produce different values.
Keep every equity record organized
Cairnul helps founders organize investors, documents, and compliance in one place, so the whole raise stays clear from first sale to close. Join the waitlist to be among the first founders to run a cleaner, more organized round.
Join the waitlistDisclaimer. This content is provided for educational purposes only and does not constitute legal, tax, or investment advice. Fundraising rules, filing requirements, and fees may vary by jurisdiction and change over time. Always confirm current requirements with qualified counsel or the relevant regulator.