- A founder’s guide to the 409A valuation
- What is a 409A valuation?
- Why your startup needs a 409A valuation
- When to get a 409A valuation
- What qualifies as a 409A material event?
- How long is a 409A valuation valid?
- Understanding IRC Section 409A and its penalties
- What is 409A safe harbor?
- 409A penalties
- How is a 409A valuation calculated?
- 1. Market approach (OPM backsolve)
- 2. Income approach
- 3. Asset approach (cost approach)
- 4. Probability-weighted expected return method (PWERM)
- 5. Hybrid method
- Discount for lack of marketability (DLOM)
- The 409A valuation process
- How to read your 409A valuation report
- Enterprise value
- Equity allocation
- DLOM applied
- Final FMV per share
- Key assumptions
- How to choose a 409A provider
- How much does a 409A valuation cost?
- Common 409A myths and mistakes
- 409A valuation vs. fundraising valuation
- How Carta simplifies 409A valuations
- Frequently asked questions about 409A valuations
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. Its main purpose is to determine the minimum strike price for stock options, which is the price your employees will pay to purchase their shares. This appraisal is required for IRS Section 409A compliance whenever a company issues equity-based compensation.
If your company plans to issue equity to employees, advisors, or other service providers, you'll generally need a 409A valuation to remain in compliance with Section 409A of the U.S. Internal Revenue Code (IRC). Section 409A was enacted in 2005 to ensure equity-based compensation is appropriately valued and taxed. Companies that fail to obtain an independent 409A valuation risk triggering significant tax penalties.
Beyond preventing IRS penalties, having an audit-defensible 409A valuation can also help startups:
Attract and retain talent with competitive equity compensation
Build credibility with investors during fundraising
Streamline the due diligence process during a merger or acquisition
Why your startup needs a 409A valuation
Equity is one of your most powerful tools for attracting and retaining top talent. In H2 2025, the median size of initial equity grants for individual contributors is up nearly 11% over the past two years, while median salaries grew 6.4%. Grants are getting larger, which means accurate valuations matter more than ever. If you're going to offer meaningful equity, you need a defensible strike price behind it.
But equity only works if it's priced correctly. If you plan to offer stock options to your team from an employee option pool, a 409A valuation is a required first step. It allows you to confidently issue stock options to your team and protects your company and your employees from IRS penalties.
A history of defensible valuations also signals to investors that you are organized and take compliance seriously—which speeds up due diligence and removes one common source of friction in fundraising rounds.
When to get a 409A valuation
If you intend to offer equity to U.S. tax residents, get an independent 409A valuation before issuing your first common stock options. Working with a reputable, independent 409A valuation provider helps ensure safe harbor status with the IRS.
Here's when you will need a 409A valuation:
Before you issue your first stock options to employees or advisors.
After a material event occurs that could change your company's value.
At least once every 12 months to maintain compliance and continue issuing options.
What qualifies as a 409A material event?
A material event is any significant business change that could reasonably affect your company's stock price. It's a signal that your company's value has likely changed, making your previous 409A valuation outdated.
Common examples of material events include:
Closing a new financing round, whether it's a priced round, simple agreement for future equity (SAFE), or other convertible securities like a convertible note.
Receiving a credible term sheet offer to be acquired by another company.
A major change in your financial projections.
Entering a strategic partnership that opens up a new market or dramatically changes your business model.
If you aren't sure whether a recent event is considered material, reach out to a 409A valuation provider or consult your lawyer.
How long is a 409A valuation valid?
A 409A valuation is valid for a maximum of 12 months from its effective date. However, its validity ends sooner if a material event happens. Whichever comes first, that's when you'll need to get an updated valuation.
This updated appraisal is often called a "409A refresh." As your company grows, getting regular refreshes becomes a normal part of the process. It keeps your option grants compliant with tax law and positions you well for audits down the road.
Understanding IRC Section 409A and its penalties
Internal Revenue Code (IRC) Section 409A is the part of the U.S. tax code that sets the rules for stock options and other forms of deferred compensation. Its goal is to prevent companies from issuing stock options at an artificially low price, which was a way for executives to avoid taxes on capital gains.
Congress passed Section 409A as part of the American Jobs Creation Act of 2004 in response to the 2001 Enron scandal, as regulators were looking for ways to prevent executives from taking advantage of equity loopholes. The provision took effect in 2005, and a final version of the regulations went into effect in 2009.
The consequences of non-compliance fall heavily on your employees. If the IRS determines your strike price was too low, your team members could face immediate income taxes on their vested options, plus an additional federal penalty, interest, and potentially alternative minimum tax (AMT). This can turn a valuable incentive into a financial burden.
What is 409A safe harbor?
An independent 409A valuation establishes a "safe harbor" status with the IRS. Safe harbor provides a presumption of reasonableness for the valuation and protects companies from penalties related to stock option pricing, as long as the valuation is valid, follows acceptable methods, and is deemed and audit-defensible.
The IRS provides three safe harbor methods for setting the FMV of a private company's common stock:
Independent appraisal presumption: This is the most common way to obtain safe harbor status and means you have an independent valuation from a qualified, third-party appraiser.
Binding formula presumption: Uses a consistently applied formula that governs all equity transfers—compensatory and non-compensatory alike. Rarely used in practice because it requires the same formula to apply in every transaction, including third-party sales, which limits fundraising flexibility.
Illiquid startup presumption: Available to companies less than 10 years old with no publicly traded shares and no expected IPO within 180 days or acquisition within 90 days. A qualified internal appraiser with at least five years of relevant experience can perform the valuation, but the process must be documented in writing.
When you have a safe harbor valuation, the burden of proof shifts. Instead of you having to prove your valuation is correct, the IRS has to prove it is "grossly unreasonable."
409A penalties
When your 409A valuation isn't performed using one of the IRS-approved methods, it falls outside safe harbor. The penalties can be substantial for employees and shareholders:
All deferred compensation from the current and preceding years becomes taxable immediately
Accrued interest on the revised taxable amount
An additional tax of 20 percent on all deferred compensation
Most startups aren't likely to be audited by the IRS. However, as your company grows and you approach an exit (like a merger, acquisition, or IPO), you may face IRS audits. You'll save time and effort by working with a reputable valuation provider from the beginning.
How is a 409A valuation calculated?
There are several standard methodologies providers use during a 409A: market approach, income approach, asset approach, and, for later-stage companies, probability-weighted models. Appraisers consider factors such as a company's current assets, its cash flows, comparable public companies, and the implied valuation from any recent secondary transactions. The method they choose depends on your company's stage, industry, and financial health.
1. Market approach (OPM backsolve)
When your company raises a financing round, valuation providers typically use the option pricing model (OPM) backsolve method. The assumption is that new investors paid FMV for the equity, but investors typically receive preferred stock instead of common stock. This method makes adjustments to determine the FMV for common stock.
Other market-based approaches use financial information like revenue, net income, and EBITDA (earnings before interest, taxes, depreciation, and amortization) from comparable publicly traded companies to estimate the company's equity value.
2. Income approach
For businesses with sufficient revenue and positive cash flow, valuation providers often use the income approach. It values your company based on expected future cash flows, adjusted for risk, then discounted back to a present value. This approach is better suited for more mature companies with a predictable revenue stream.
3. Asset approach (cost approach)
This method calculates your company's value based on the FMV of its net assets. It's often used for very early-stage companies that have not yet raised money or generated revenue.
4. Probability-weighted expected return method (PWERM)
The probability-weighted expected return method (PWERM) is used when a company has multiple possible future outcomes, such as an acquisition, an IPO, or continued private operation. The appraiser assigns a probability to each scenario, estimates the equity value under each one, and then calculates a weighted average. PWERM is common for later-stage startups with a clearer view of potential exit paths.
5. Hybrid method
Some appraisers combine elements of OPM and PWERM into a hybrid approach. This is typical when a company has some near-term liquidity scenarios (like an acquisition offer) but also a realistic path to continued private growth. The hybrid method lets the appraiser weigh both perspectives in a single analysis.
Discount for lack of marketability (DLOM)
After determining the enterprise value and allocating it across share classes, appraisers apply a discount for lack of marketability (DLOM). Common stock in a private company can't be freely bought and sold the way public shares can. Employees who hold common stock face restrictions on when and how they can sell, so the shares are worth less than an equivalent stake in a publicly traded company.
The DLOM is typically 25%–35% for a standard holding period, depending on factors like the company's stage, how close it is to a liquidity event, and whether any secondary trading is available. This discount is one of the main reasons your 409A valuation will almost always be lower than your most recent fundraising valuation.
The 409A valuation process
The 409A valuation process is straightforward when you work with the right provider. It generally involves three steps.
Gather your documents: You'll need to provide key company documents, such as your articles of incorporation, your capitalization table, and your financial statements or projections, which should follow ASC 718 guidelines for expensing stock options. If your cap table is managed on Carta, it's always up-to-date and ready to go, which greatly simplifies this step.
Kick off with your provider: This is typically a call where you'll discuss your business with the valuation analyst. You'll share your business model, recent progress, and growth plans, giving the analyst the context they need to perform the valuation.
Review the draft report: Before the valuation is finalized, you'll receive a draft 409A valuation report. This is your opportunity to review it for factual accuracy and ensure the analyst has correctly understood your business.
Once you approve the final report, your board will need to formally approve the new FMV before you can begin granting options at the updated strike price. This board approval step is a requirement, not a formality.
To help you understand what an audit-defensible report includes, you can download a sample 409A valuation report and review a complete example.
How to read your 409A valuation report
Your board needs to approve the FMV before you can issue new options—so it's worth knowing what you're actually reviewing. The report has five sections that matter.
Enterprise value
The report will start with an estimate of your company's total enterprise value. This is the appraiser's assessment of what the entire business is worth, and it serves as the starting point for everything that follows. Compare it to your most recent fundraising valuation to gauge whether the gap is within a normal range.
Equity allocation
Next, the report allocates the enterprise value across all share classes: preferred stock, common stock, and any outstanding options or warrants. The specific method used (OPM, PWERM, or a hybrid) should be documented, along with the key assumptions behind it.
DLOM applied
Look for the DLOM percentage the appraiser used. In most cases, this will be between 25% and 35%. A higher discount typically reflects greater restrictions on selling your shares. If the number seems unusually high or low for your stage, ask your provider to explain the reasoning.
Final FMV per share
This is the number that matters most for day-to-day operations: the per-share FMV of your common stock. It becomes the minimum strike price for any new option grants. Your board will need to formally approve this value before you issue options.
Key assumptions
The report should list the assumptions behind the valuation, such as projected revenue growth, discount rates, and comparable companies used. Review these carefully. If any assumptions look outdated or inaccurate, flag them with your provider before the report is finalized.
How to choose a 409A provider
Choosing a provider of 409A valuation services is about finding a long-term partner who understands the startup journey. You want a firm that can provide an accurate, defensible valuation while making the process as smooth as possible.
To meet the IRS's 409A valuation requirements, a valuation provider should:
Be a qualified, independent third-party appraiser with at least five years of relevant experience in business valuations or appraisals, financial accounting, investment banking, private equity, secured lending, or other comparable experience
Have recent experience valuing similar private companies
Use generally accepted valuation methods such as market approach, income approach, or asset approach
Provide a detailed and comprehensive report
Comply with IRS Section 409A guidelines
Here are a few additional things to look for:
Experience and reputation: Look for a provider that is trusted by major audit firms and has valued thousands of companies at your stage and in your industry.
Integrated platform: A provider that also offers cap table management can save you time and reduce the risk of errors. When your valuation is connected to your cap table, data flows seamlessly, eliminating manual work.
Audit defensibility: Your provider should stand by their report. Confirm that they will support you if the IRS or an auditor ever questions your valuation.
How much does a 409A valuation cost?
Traditional valuation firms often charge a significant one-time fee for a standalone report. For standalone valuations, the cost ranges anywhere from $1,000 to over $10,000, depending on the size and complexity of your company.
Some platforms, like Carta, take a different approach. With Carta for cap table management, 409A valuations are included in your subscription. This model makes compliance a predictable and manageable part of your operating budget.
Common 409A myths and mistakes
Equity is full of old rules of thumb that can lead founders astray.
Myth: The lower the strike price, the better.
Reality: An artificially low strike price is a major red flag for auditors and the IRS. The goal is to set the lowest defensible price to protect your employees from tax penalties while still making the options an attractive incentive.
Myth: My 409A value should just be a fraction of my last round's price.
Reality: While your fundraising valuation is an important input, a 409A is a complex appraisal to determine the fair value of common stock, not a simple percentage. Relying on outdated formulas can lead to non-compliance and put your team at risk.
409A valuation vs. fundraising valuation
One of the most common points of confusion for founders is the difference between a 409A valuation and a fundraising valuation. Both put a price on your company, but they serve different purposes and almost always produce different numbers.
A fundraising valuation is what investors use to determine the price they'll pay for preferred stock. A 409A valuation determines the FMV of your common stock for tax purposes.
409A valuation | Fundraising valuation | |
Purpose | Sets the strike price for employee stock options for tax compliance. | Determines the price investors pay for a stake in your company. |
Stock type | Values the common shares held by founders and employees. | Values the preferred shares sold to investors, which have extra rights like liquidation preferences. |
Typical value | Usually lower, reflecting the lower value of common shares and the DLOM applied. | Usually higher, reflecting the premium paid for preferred shares. |
The DLOM is one of the key reasons the 409A value is typically much lower than the fundraising valuation. This gap is normal and expected.
→ Learn more about pre-money vs. post-money valuations
How Carta simplifies 409A valuations
Carta has integrated valuations directly into its equity management platform to make the process simple, accurate, and professional.
A single source of truth: Your valuation is connected directly to your cap table on Carta. This ensures accuracy and saves you from the headache of chasing down spreadsheets and manually entering data.
Expertise you can trust: Carta’s in-house team of experienced valuation analysts delivers thousands of audit-defensible 409A valuations every year, with deep understanding of the nuances of startups.
A platform that grows with you: From your very first 409A to preparing for an exit, Carta's platform scales with your company.
"The requirements were very manageable, as streamlined as it could be when it came to pulling data. We passed that segment of the audit with flying colors. Carta helped us conquer it."
- Bary Dunn, CFO and head of strategy, ButterflyMX
Carta is the country's leading cap table management and 409A valuation provider, trusted with over 16,000 audit-defensible 409A valuations each year. Carta delivers valuations faster and for less than traditional providers.
To see how our platform can streamline your next valuation, request a demo.
Frequently asked questions about 409A valuations
Is a lower 409A valuation always better?
No. An accurate and defensible valuation is what you want. An artificially low valuation can expose your employees to significant tax penalties, which defeats the purpose of offering equity in the first place.
Can I do my own 409A valuation?
To get safe harbor protection from the IRS, your valuation must be performed by a qualified, independent appraiser. Doing it yourself will not provide the legal protection you and your team need.
What happens if my 409A valuation is too high or too low?
A valuation that is too low can trigger tax penalties for your employees. Too high, and your equity grants become less attractive to new hires because the cost to purchase shares is steep. The right outcome is an accurate valuation that reflects your company's actual FMV.
What financial and company information do I need to provide for a 409A valuation?
You'll need to provide your cap table, financial statements, financial projections, fundraising documents, corporate charter, details of outstanding debt, and any relevant board approvals or consents.
How long does a 409A valuation take?
It typically takes one to three weeks, depending on your company's complexity and how quickly you provide the required information. Providers like Carta can deliver faster turnaround for straightforward valuations.
How does a changing 409A valuation affect the strike price?
A changing 409A valuation directly affects the strike price, also known as the exercise price. New option grants must be priced at or above the updated FMV determined by the most recent 409A valuation.
Why are 409A valuations important when issuing stock options to early employees?
Setting an accurate FMV lets your first employees receive stock options at the lowest defensible strike price. This maximizes their potential upside while keeping the company in tax compliance and reducing legal risk for everyone involved.
How does a 409A valuation work for a company that's still pre-revenue?
For a pre-revenue company, a 409A valuation relies on factors like recent funding rounds, the business plan, market potential, intellectual property, and comparable companies rather than revenue. Firms typically use the backsolve or OPM method to determine FMV.
How should founders explain a lower 409A FMV to employees or investors?
409A valuations reflect a specific point in time and account for market conditions, company performance, and risk factors that investors don't face with preferred stock. A lower FMV doesn't mean the company is underperforming. It may result from updated financials, broader market downturns, or increased uncertainty. The key message: a lower 409A price actually benefits employees by lowering the cost of their options.
Do I need to include SAFE notes or priced round details when getting a 409A valuation?
Yes. SAFE notes and priced rounds directly impact your company's capital structure and are important factors in determining FMV. Your valuation provider will need these details.
Are 409A valuations public?
No. 409A valuations are private internal documents. They are not filed with the IRS or made public. Your valuation report is typically shared only with your board, auditors, and relevant advisors.
Which software can help generate a compliant 409A report?
Carta can help generate a compliant 409A valuation report by streamlining data collection, leveraging expert valuation teams, and ensuring reports meet IRS regulations and standards.
DISCLOSURE: This communication is on behalf of eShares, Inc. dba 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. ©2026 Carta. All rights reserved. Reproduction prohibited.
