409A Valuation
What is a 409A valuation?
A 409A valuation is an independent appraisal of a private company's common share fair market value (FMV), required under IRS Section 409A before granting stock options. The strike price of every option must be set at or above the FMV on the grant date. Options priced below FMV create immediate ordinary income tax liability for the recipient and 20% excise tax penalties under the same code section, on top of regular income tax.
When is a 409A valuation required?
- Before the first option grant to any employee, advisor, or contractor
- Within 12 months of the most recent 409A (annual refresh)
- After any material event: a funding round, a significant acquisition offer, or a material change in business outlook
What are the three 409A valuation methods?
| Method | When it is used |
|---|---|
| Option Pricing Model (OPM) | Most common at Seed and Series A. Uses Black-Scholes to allocate total equity value across share classes. |
| Probability-Weighted Expected Return (PWERM) | Used when a near-term liquidity event (acquisition or IPO) is anticipated within 12-18 months. |
| Hybrid OPM + PWERM | Later-stage companies with multiple plausible exit scenarios in the near term. |
What is the 409A safe harbour and why does it matter?
A 409A signed by a Qualified Independent Appraiser (QIA) creates a rebuttable presumption of reasonableness under IRS rules, known as the safe harbour. Under safe harbour, the IRS bears the burden of proving the valuation was unreasonable. Without a QIA-signed 409A, the company has no safe harbour, and the IRS can challenge the strike price, triggering penalties for both the company and option recipients.
What are the consequences of not having a current 409A valuation when granting options?
Under IRS Section 409A, stock options must be granted at or above fair market value to avoid classification as nonqualified deferred compensation. An option granted below FMV (because the company used an outdated or non-existent 409A) exposes the employee to immediate income tax on the full option value in the year of grant, a 20 percent additional tax penalty, and potential interest charges. The company is also exposed to withholding obligations and employer-side penalties. A single batch of options granted without a valid 409A can create six-figure tax liabilities for employees who may not have the cash to pay them. Boards should never authorise option grants without confirming a valid 409A is in place.
What triggers a 409A refresh requirement?
A 409A valuation has a 12-month safe harbour period, after which it must be refreshed. In addition to the time-based refresh, material events that significantly affect company value trigger an immediate refresh requirement before new grants can be made. Material events include: completing a priced equity financing round (Seed, Series A, etc.), a significant secondary share transaction at a materially different price from the existing 409A, a material adverse change in the business (loss of major customer, key patent invalidated), or a completed acquisition of another company. The most common trigger founders miss is the secondary share sale: if employees are selling shares on a secondary market at $8 per share and the current 409A FMV is $3 per share, the secondary transaction is a material event requiring a 409A refresh before new grants.
What do founders get wrong with 409A valuations?
The most common mistake is treating the 409A as a box-checking exercise rather than a meaningful financial analysis. Founders who shop for the lowest possible 409A to maximise the strike price benefit for employees are taking a real risk: if the IRS challenges the valuation, the burden of proof is on the company to demonstrate that the valuation was performed by a qualified appraiser using accepted methodology. An independent qualified appraiser (not the company's accountant, and not a template online tool) provides the legal safe harbour protection. Using unqualified appraisers or self-prepared valuations can eliminate the safe harbour entirely.
A second error is not timing option grants carefully around funding events. If a company is about to close a Series A that will materially increase the 409A FMV, authorising option grants before the round closes locks in the pre-round strike price for the employee. Waiting until after the round closes means the 409A must be refreshed at the higher post-round valuation, increasing the employee's strike price. Founders who want to reward early employees with low strike prices should grant before a material funding event, ensuring the existing 409A is still valid at grant date.
Third: not maintaining records of 409A valuation reports and board resolutions authorising each grant. In a Series A due diligence process, investors and their counsel will request evidence that every option grant was authorised at or above the then-current 409A FMV, with board minutes to confirm. Missing documentation for even a small number of grants can require retroactive legal remediation, which is expensive and can delay a round closing.
How it works in practice
Case example: Expired 409A, options granted at wrong strike price
A 20-person B2B SaaS company closed Series A in March. The company received a 409A report (FMV: $1.20/share common) from a QIA. Options were granted to 4 new hires in April at $1.20, within the 12-month validity window.
In November the same year, the company received a term sheet for Series B at a $45M post-money. This is a material event. The 409A should have been refreshed before any further option grants. The company's CEO, not realising this, granted options to two additional hires in December at the old $1.20 strike price, now significantly below the implied FMV of approximately $2.80/share given the Series B term sheet.
At Series B diligence, the investor's tax counsel identified the two December grants as likely non-compliant. The company needed a retroactive 409A to document FMV in December, and the two option holders potentially faced income tax and 20% excise tax on the $1.60 spread at grant. Total cost of the error: $40K in retroactive tax analysis and $30K in penalty exposure for the two affected employees. The 409A refresh would have cost $2,500.
Frequently asked questions
How much does a 409A valuation cost?
Typically $1,500 to $5,000 for a seed-stage startup from a qualified independent appraiser. Annual refresh valuations are usually 30-50% cheaper than the initial valuation. Later-stage companies with complex cap tables, significant IP, or multiple share classes pay $5,000 to $15,000.
How long is a 409A valuation valid?
12 months from the date of the report, or until a material event occurs, whichever comes first. Granting options after a material event on an expired 409A removes safe harbour protection entirely.
Can a startup do its own 409A valuation?
Technically yes, but it loses safe harbour protection. Without a QIA-signed 409A, the valuation is only presumed reasonable if it can demonstrate a "reasonable application of a reasonable valuation method", a high bar that shifts the burden of proof to the company rather than the IRS.
Why is common stock valued lower than preferred stock in a 409A?
Common stock carries the residual claim after all liquidation preferences are paid. Preferred stock has priority in any exit. The 409A discounts common relative to the most recent preferred round price using option pricing models that reflect this seniority difference. A company with $10M post-money preferred value will typically have common FMV of 20-40% of the preferred price at early stage.
How often should a startup get a 409A valuation?
At minimum, a 409A must be refreshed annually (the safe harbour period is 12 months). Additionally, a new 409A is required after any material event that could significantly affect fair market value: closing a new funding round, completing a significant secondary transaction, experiencing a material adverse change in business performance, or making a substantial acquisition. Many startups refresh their 409A every 6 to 9 months when growth is rapid, to ensure the strike price for new grants accurately reflects current value rather than stale data from up to 12 months prior.
Related glossary terms
- Option Pool, the equity pool from which options with 409A-compliant strike prices are granted
- Stock Options (Startup), how ISOs and NSOs are structured using the 409A FMV as the strike price floor
- Vesting Cliff, the vesting schedule within which 409A-priced options accrue to employees
Explore related Fintera content
- Fractional CFO for Startups: The 2026 Playbook, how a fractional CFO manages 409A scheduling, option plan compliance, and grant documentation
- When to Hire a CFO: 9 Signs It's Time, the equity administration complexity signals that indicate when senior finance oversight is needed
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