The 409a Valuation
409A Valuations are an essential tool for startups seeking to raise capital, go public, or get acquired. It helps them determine the fair market value of their common stock, enabling them to comply with the Internal Revenue Service (IRS) rules and regulations.
In this article, we explore the basics of a 409A Valuation: why startups need to get one, how to prepare for one, how to interpret the results, and the set of common mistakes to avoid. We also cover a list of the top providers you can use to get a 409A Valuation for your startup.
What is a 409A Valuation?
The term ‘409A Valuation’ refers to the process that startups undergo to determine the fair market value of their common stock. This process is often conducted by a valuation professional or a Certified Public Accountant (CPA) using a variety of methods and techniques including: discounted cash flow analysis, trading multiples, and the guideline public company method.
The ultimate fair market value is used to issue stock options, restricted stock units (RSUs), and other forms of equity compensation to employees and executives, which is required by the IRS.
What are 409A valuations used for?
As described above, a startup’s 409A Valuation for a variety of things including:
- Determining the fair market value of common stock for issuing stock options, RSUs, and other forms of equity compensation
- Maintaining compliance with IRS regulations
- Mitigating the risks of overvaluing common stock
- Providing investors with greater assurance of the value of the company
- Providing a benchmark for future 409A Valuations
Impact of 409A Valuations on strike price?
The 409A Valuation is used to determine the fair market value of the company’s stock, which is then used to set the strike price for employee stock options. The strike price is the price at which employees can purchase the company’s stock.
Why do startups need to do to get a 409A valuation?
A 409A Valuation is an important step for startups to take when issuing stock options or RSUs to their employees and executives. It helps startups comply with IRS regulations, provides investors with greater assurance of the value of the company, and provides a benchmark for future valuations. In addition, it can help startups mitigate the risk of overvaluing their common stock, which can prevent the liability of penalties and taxes for excess values.
When should startups get their first 409A valuation?
Startups should get their first 409A Valuation when they are preparing to issue stock options or RSUs to employees and executives, as the IRS requires companies to use the fair market value.
How often to get a 409A valuation refresh?
Startups need to get a 409A Valuation refresh every 12 months. This is because the IRS requires companies to use the stock's fair market value when issuing stock options or RSUs, and a 409A Valuation is only valid for 12 months. In addition, startups should get a refresh any time there is a material event that could affect the value of the common stock.
What is a 409A Valuation material event?
A 409A Valuation material event is any event that has a significant impact on the value of the company’s stock. This includes events such as significant changes in the company’s financial performance, a change in the company’s business model, a change in the industry, or any other event that could impact the value of the company’s stock.
How to prepare for a 409A Valuation?
Before beginning the 409A Valuation process, startups should gather the necessary documents and records. This includes financial statements, and income tax returns. It also includes detailed lists of all shareholders, employment agreements, stock option agreements, and RSU agreements.
Startups should also provide a detailed description of the company’s business plan and operations to the valuation firm. This includes information on the company’s products and services, the size of the market, the competitive landscape, and any other pertinent information.
How to Interpret Your 409A Valuation Report
Once your 409A Valuation process is complete, the valuation firm will provide you with a report.
The report will outline the various methods and techniques used to determine the fair market value of your common stock, as well as the results. Review the report thoroughly to ensure that the results are in line with your expectations.
Also, ensure that you review the report for any errors or inconsistencies. If you find any errors or inconsistencies, address them with the firm before using the results of the report.
Common Mistakes to Avoid with a 409A Valuation?
When getting a 409A Valuation, it is essential to avoid some common mistakes which include:
- Not providing the valuation firm with all of the necessary financial documents and records
- Not providing the valuation firm with a detailed description of your business plan and operations
- Not providing the valuation firm with a list of all shareholders
- Not reviewing the report thoroughly
- Not addressing any errors or inconsistencies in the report
Common myths associated with 409A valuations?
There are several common myths associated with 409A Valuations. One of the most common is that it is expensive and time-consuming. While the cost can vary depending on the complexity of the company’s stock options and the size of the company, the cost is generally well worth it for the accuracy and peace of mind it provides. Additionally, the process can be relatively quick and efficient if the company is prepared with the necessary documents and information.
Another common myth is that the 409A Valuation is only necessary for large, publicly-traded companies. This is not true – all companies, regardless of size or stage of growth, must comply with Internal Revenue Codes and must conduct one to set the strike price for employee stock options.
Finally, some people believe that the 409A Valuation is only necessary when issuing stock options. While it is important for setting the strike price of stock options, it is also important for other reasons, such as tax planning, compliance with Internal Revenue Codes, and accurately valuing the company’s stock.
Should startups determine their 409A valuation or hire a firm to do it?
Startups should hire an independent firm to conduct their 409A Valuation to ensure that the valuation is accurate and compliant with Internal Revenue Codes.
What is the cost of getting a 409A Valuation?
The cost of getting a 409A Valuation varies based on the complexity of the company’s stock options and the size of the company. Generally speaking, it can range from a few thousand dollars to tens of thousands of dollars.
What are the providers of 409A Valuations for startups?
When looking for a provider of 409A Valuations for startups, it is important to find one that is experienced and knowledgeable in the field. Here are some of the top providers for startups:
Final thoughts on 409A Valuations
409A Valuations are essential for startups seeking to raise capital, go public, or get acquired. It helps them determine the fair market value of their common stock, enabling them to comply with Internal Revenue Service (IRS) rules and regulations, and issue stock to their employees. If you’re in any of the above situations, consider leveraging one of the providers we’ve outlined to maximize your next raise.