409A Valuation
An independent appraisal of a private company's common stock fair market value, used to legally set employee option strike prices.
A 409A valuation is an independent third-party appraisal, required under IRS Section 409A, that determines the fair market value of a private company's common stock. Companies use this value as the strike price for employee stock options, since pricing options below fair market value creates significant tax penalties for employees under the same tax code section.
409A values are typically well below the price investors pay for preferred stock in the same company, because preferred stock carries extra rights (liquidation preference, anti-dilution, board seats) that common stock lacks. Companies must refresh their 409A roughly every 12 months, or sooner after a material event like a new financing round, acquisition offer, or major change in the business.
Getting the 409A wrong hurts employees, not just the company. Under Section 409A, compensation that fails its rules is included in income early and the tax is increased by an amount equal to 20 percent of that compensation, plus interest — which is why option grants priced below fair market value are a real problem rather than a paperwork issue.
The Treasury regulations give companies a presumption of reasonableness for a value set by a qualified independent appraisal dated no more than 12 months before the grant, unless the IRS shows the method or its application was grossly unreasonable. That's the 'safe harbor' founders hear about, and it's why most venture-backed companies pay an outside firm rather than setting the price themselves. The regulations also say an earlier valuation stops being reasonable if it fails to reflect later information that may materially affect the company's value — their own examples are resolving material litigation or issuing a patent, and a new priced round deserves the same treatment.
The 409A isn't the company's 'real' valuation. It values common stock for tax compliance and says nothing about what the company would sell for.
A company raises a Series B at $8.00 per preferred share. Its 409A valuation, reflecting the lower rights of common stock, comes back at $2.50 per share — meaning new employee option grants are priced at a $2.50 strike, not $8.00, making the options meaningfully cheaper to exercise.
Refresh your 409A immediately after any priced financing round, not just on the annual clock — using a stale, pre-round 409A to price new option grants is a common compliance mistake that can trigger IRS penalties for employees.
Why is the 409A price so much lower than the price investors paid?
Because preferred stock carries extra economic and control rights (liquidation preference, anti-dilution, board representation) that common stock doesn't have, so a fair appraisal of common stock alone comes in lower.
How often does a company need a new 409A valuation?
The independent-appraisal safe harbor covers a valuation dated no more than 12 months before the grant, so most companies refresh at least annually — and sooner after a material event like a priced round, a large SAFE raise on different terms, a serious acquisition offer, or a major change in the business.
Can a founder do their own 409A valuation?
Technically a company can set the value by other reasonable methods, but it gives up the independent-appraisal presumption, so if the IRS challenges the value the company carries the burden of defending it. For most venture-backed startups, a qualified outside appraisal is the straightforward choice.
What's the penalty for granting options below the 409A price?
Discounted options can fail Section 409A, which pulls the income into tax early and adds an extra tax equal to 20 percent of the amount plus interest — a cost that lands on the employee.
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Run the numbers yourself: dilution, SAFE conversion, and fund-returner calculators.