A 409A valuation is an important (and legally required) step in a startup’s life. This is a basic lesson plan for founders on valuations.
409A valuations are used to determine the fair market value (FMV) of your common stock. In other words, they determine the price employees, contractors, and anyone else who gets common stock pay to purchase their stock options.
If you get a 409A valuation by an objective third-party at least once a year (or sooner, in response to a material event like another financing round), you can take advantage of IRS 409A safe harbor. When you are in the 409A safe harbor, the IRS will likely accept the FMV that was determined in the 409A unless they determine that the FMV is “grossly unreasonable.”
How to select a 409A provider
Before you select a 409A provider, here’s what you should look for:
- Service. Do they keep the valuation in-house or outsource it? Do they get to know your company before valuing it? Are they clear about the process and willing to answer any questions you have?
- Experience. How many other valuations have they done? How many years of experience do they have?
- Audit-readiness. Are they willing to stand by their valuation and support you during an audit?
- Technology. Do they connect to your cap table and use technology to speed up the process and reduce errors?
- Complete reports. Do they spell out how they came to your valuation?
Not all companies that offer 409A valuations provide the same level of service or detail in their 409A reports. Download our sample 409A report to see what a complete 409A report looks like and help guide your evaluation of 409A providers.
How to understand your 409A report
When you receive your 409A report, be sure to look for:
A reasonable fair market value
The key part of any valuation is the FMV (or strike price). In our report, we include it in the introduction, and then we explain how we got to that number.
When evaluating this number, keep in mind that third-party appraisers have an obligation to come up with a number that is, in fact, fair. While you and your shareholders may see certain benefits from a lower FMV, you risk the IRS determining the valuation is “grossly unreasonable,” rejecting the valuation, and revising the tax treatment of options issued under that valuation. If this happens, any employees who received incorrectly priced options could be taxed on those options immediately and may have to pay penalties.
That said, if you have reason to think the valuation you received isn’t fair, you should check the appraiser’s valuation methodology—and the provider should provide insight and an opportunity for your approval.
A methodology that makes sense
Your appraiser should be able to explain how they came up with your valuation and why they chose the method. Confirm with them that the numbers they’re basing the valuation on (revenue, growth rate, etc.) are accurate.
To get a general idea of what you could find in a 409A report, we’ve prepared a sample for informational purposes only. Our actual reports may vary in the language and methodology outlined in this report. Reach out to our team today if you have any questions or need a 409A valuation.
Download sample 409A report
DISCLOSURE: This communication is on behalf of eShares Inc., d/b/a Carta Inc. (“Carta”). This communication is for informational purposes only, and contains general information only. Carta is not, by means of this communication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.
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