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Designing a Phantom Option Plan for an NBFC
TL;DR
We sat down with Evelyn Tay, Head of Global Valuations at Qapita, in a live session hosted by Charlie O'Donnell – investor turned VC coach, and founder of NextNYC - a community built for first-time and repeat founders navigating the realities of building a company.
The conversation was built for founders who keep running into the same disconnect: the number on their term sheet and the number on their employees' option grants are never the same - and nobody has explained why in plain terms. That's what this session was for.
Here's what came out of it:
You can watch the full conversation here:
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Picture this: You just closed a round at a $20M valuation. You're excited, your investors are excited, and you're ready to hand out option grants to reward the team that got you here. Then your 409A report comes back - and it's a fraction of that number.
Founders see this as a contradiction. It isn't. It's a feature.
These are not the same asset priced differently. They are different assets, full stop. The 409A exists because the IRS requires you to price common stock independently - not as a proxy for whatever your last preferred round closed at.
"When an investor sets a price, they're buying preferred shares with preferred rights. Your employees are getting common stock. Same company. Different instrument. Different value."
The 409A valuation is a Section 409A Internal Revenue Code requirement. Its job isn't to match your round price. Its job is to establish a defensible fair market value for the common stock you're granting - independently, rigorously, and on the day the grant happens. Here’s a downloadable sample report.
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First-time founders almost always get this backwards. They assume a higher 409A is a good thing - after all, a higher number means the company is worth more, right? So employees should want that.
Not quite. The 409 sets your option strike price - the price an employee pays to convert their options into actual shares. The higher that price, the more cash they have to come up with out of pocket when they exercise. And in practice, that means many employees simply don't.
"Since they are paying that money out of pocket, they naturally don't want the exercise price to be too high."
High strike price, more skin in the game, harder to ever exercise. But the floor has its own problem.
This is a balance that has to come from a proper valuation methodology - not from asking your team what they'd prefer. The IRS doesn't care about employee preferences. They care about defensibility. If your 409A can't withstand scrutiny, the strike price doesn't matter.
The best 409A for your employees is one that's as low as the honest analysis allows - arrived at through a rigorous, independent exercise, with documentation that holds up if it's ever questioned.
Most founders treat the 409A as a tax on their time - something to knock out quickly, tick the box, and move on. That framing is expensive.
Section 409A of the Internal Revenue Code is specific: the exercise price of any option grant must be set at or above the fair market value of the underlying common stock on the date of the grant. Not approximate. At or above - backed by a defensible valuation report.
When that requirement isn't met, as Evelyn puts it: "It comes with penalties... fines for both the company and the employee. It's a very expensive payment."
There is no retroactive fix for a grant that was made with a stale or insufficient valuation. The obligation is locked in on the date the options are issued. Which means the only protection is doing it right the first time - with a proper report, from a qualified valuator, that can be defended if it's ever audited.
If the last 409A is more than 12 months old, or if anything material has changed - a new round, a significant customer, a shift in market conditions - the valuation is almost certainly stale. The IRS considers safe harbor to require a fresh 409A within that window.
Curious what a fast, audit-ready 409A looks like? Reach out to us or visit qapita.com/equity-management/409a-valuations for a no-pressure walkthrough.
Somewhere along the way, a shortcut spread through the startup ecosystem: the 409A should land somewhere between 30% and 60% of the last preferred price. Founders cite it. Lawyers reference it. Early employees expect it.
It came from real data, observed trends across actual valuation reports. But a trend and a rule are different things, and Evelyn is clear on the distinction:
"That number came from proper valuation reports. It's a real trend. But it's not a hard and fast rule."
The gap between common and preferred isn't a fixed ratio. It's a function of how many layers of preferred sit above the common, and what rights each layer carries.
Think of it this way: preferred shareholders sit higher in the capital stack. The more preferred layers stacked above common: seed, angel, Series A, each with its own liquidation preferences and terms - the more pressure those layers put on the value of what's left for common shareholders.
The practical implication: if you're trying to understand where your 409A will land, start by looking at your cap table, not at comparable companies' round announcements. The structure of what you've raised shapes the number as much as the amount.
This is the scenario that genuinely blindsides people. The round is announced. The price per share is up. Employees are excited. Then the new 409A valuation comes back lower than the previous one, and suddenly you're in an awkward conversation trying to explain how that's possible.
There are two distinct mechanisms at work here, and they often appear together:
Neither of these is a red flag. They're reflections of how valuations actually work - as a function of both internal capital structure and external market conditions simultaneously. Experienced investors understand this. What makes it painful is when it's unexpected.
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Getting the 409A right requires more than filing a report on schedule. It requires visibility into the cap table, an understanding of how each layer of preferred affects common, and a valuation partner who can explain the methodology - not just deliver a number.
At Qapita, this is exactly what we're built for: giving founders the tools and expertise to manage equity correctly, not just at the point of a raise, but through every grant, every round, and every cap table change that comes after.
Our Global Valuations team - led by Evelyn Tay, works directly with founders to produce defensible 409A reports, explain the methodology clearly, and help you communicate the results to your team without the anxiety of not knowing what you're talking about.
Learn more about Qapita →
The 409A is not a checkbox. It's not a number to minimize, maximize, or rush through. It's the mechanism by which your employees' equity becomes real, or doesn't - and it has legal, tax, and morale implications that compound over time.
The founders who get this right early don't just avoid IRS penalties. They run equity programs their teams can actually trust, because they can explain what the numbers mean and why they came out the way they did. That trust, in the long run, is worth more than most companies ever account for.
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What’s the Equity Matters newsletter? Created by the Qapita team, each issue breaks down one small but powerful insight on equity management, cap tables, and ownership strategy for growing companies.
About us: Qapita is an equity management platform that helps companies design, manage, and scale ownership structures with clarity and control. Manage cap tables, fundraising, share issuance, equity awards, 409A valuations, and liquidity globally - all in one unified platform. Qapita supports founders and finance teams automate employee equity workflows, stay compliant, and move faster with confidence from seed to IPO and beyond.
