409A Valuation
Everything you need to know about 409A valuation
Most founders treat a 409A as a one-time checkbox. It's not. This guide covers what it actually measures, when it expires, and the mistakes that create legal exposure.
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The Basics
What is a 409A valuation?
What is a 409A valuation?
A 409A valuation is an independent appraisal that determines the fair market value(FMV) of a private company's common stock. Named after Section 409A of the U.S. Internal Revenue Code, it sets the legal strike price for every stock option you grant – and serves as your protection if the IRS ever questions your equity compensation.
Why was Section 409A introduced?
Before 2004, startups set option strike prices informally – often using rough multiples with no independent backing. Section 409A was introduced under the American Jobs Creation Act, partly in response to the Enron-era compensation scandals, to mandate an objective third-party valuation as the legal floor for every option grant. The intent was simple: no more informal pricing left employees exposed.
What is 409A safe harbor – and why does it matter?
When a qualified, independent appraiser performs your 409A valuation, the IRS presumes your FMV is correct. This is safe harbor status. The burden of disproving it shifts to the IRS – not you – in any audit. Without it, the IRS can challenge your strike price at any time, including years after the option grants were made, and your employees bear the tax consequences.
Does 409A apply to non-US companies?
Yes – the incorporation country doesn't determine the requirement. If your company grants options to employees who are US taxpayers, a 409A valuation is required regardless of where you're headquartered. This applies to companies with US hires, US subsidiaries, or any equity plan that covers US-based team members.
A Clarification Most Guides Skip
What a 409A valuation is not
Not your company's "real" valuation
A 409A is a tax compliance tool, not a statement of what your company is worth. It measures fair market value of common stock under IRS requirements – not investor sentiment, market momentum, or growth potential.
For that: your last priced round's post-money valuation is the market's view.
For that: your last priced round's post-money valuation is the market's view.
Not a substitute for your VC round price
Investors price preferred stock, which comes with liquidation preferences, anti-dilution rights, and board seats. Common stock carries none of these protections. A 409A values common stock only. The gap between the two numbers is structurally expected, not a red flag.
A lower 409A FMV actually benefits your employees – it means a lower strike price and more potential upside.
A lower 409A FMV actually benefits your employees – it means a lower strike price and more potential upside.
Not a one-time task
A 409A valuation expires after 12 months. Miss that window and every option grant after the expiry date falls outside safe harbor, regardless of how solid the original valuation was. Build the renewal into your equity calendar, not your legal to-do list.
12 months from approval date. Set the reminder now.
12 months from approval date. Set the reminder now.
"Lower" is not always better
An artificially low 409A is one of the first things flagged in an IRS audit. The goal isn't the lowest number – it's the lowest defensible FMV. A number that can't withstand scrutiny offers no protection, regardless of what it says.
Defensibility matters more than the number itself.
Defensibility matters more than the number itself.
Not valid the moment a material event occurs
A 409A material event – a new funding round, a significant revenue milestone, a change in capital structure – immediately invalidates your existing valuation for safe harbor purposes, even if it's only weeks old. The 409A valuation requirements are clear on this: a new event triggers a new valuation.
Don't issue options after a material event until you have a refreshed report.
Don't issue options after a material event until you have a refreshed report.
Not safe to DIY or automate
Only an independent, qualified appraiser – ABV or ASA certified – produces an audit-ready 409A valuation with safe harbor protection. DIY tools and automated platforms produce reports that carry no legal weight with the IRS.
Cheap here often costs multiples more in penalties.
Cheap here often costs multiples more in penalties.
Compliance Triggers
When do you need a 409A?
The short answer: more often than most founders expect.
Here are the five 409A valuation requirements that trigger a new or refreshed report.
Here are the five 409A valuation requirements that trigger a new or refreshed report.
Before your first option grant
Required first
No revenue threshold, no minimum grant size. The moment you issue options, you need a valid FMV baseline in place.
After every priced round
Mandatory
Every close – seed through series C+ is a material event that immediately invalidates your existing 409A. Don't issue options until you have a refreshed report.
Every 12 months
Annual
Reports expire annually regardless of business events. The worst time to realize your 409A is stale is the day before an offer letter goes out.
After material business events
Event-triggered
Major revenue milestones, significant new contracts, pivots, key executive changes, or M&A discussions can all invalidate your 409A before the 12-month mark.
Pre-IPO or M&A
Exit critical
Auditors and acquirers review your full grant history. Every option without a valid 409A at the time of issue is a potential liability.
Numbers to know
Additional excise tax for violations
20% federal + up to 5% state
Report validity period
12 months max
Typical early-stage cost
$1,000 – $6,000
Applies to foreign companies with US staff
Yes
Standard delivery time
7-10 business days
The Timing Nuance Nobody Talks About
Timing your grants around a fundraise
Ideal
Grant before a term sheet is signed
Using your current 409A before around closes is legitimate – provided no term sheet exists yet. It locks in a lower strike price before the new fair market value takes effect.
Caution
Granting while a term sheet is in negotiation
If a round is reasonably certain, the pending event may already affect your fair market value – even before it closes. Your existing 409A valuation may not hold. Consult your lawyer before issuing grants.
Avoid
Granting after a round closes without a new 409A
A priced round close is a 409A material event – your existing report is immediately voided. Any grants issued after fall outside safe harbor, regardless of what's in hand.
Best practice
Build your 409A refresh into your close checklist
Add "initiate new 409A" alongside cap table updates and board approvals. Meeting 409A valuation requirements at close is easier than fixing non-compliant grants during due diligence.
The Process
How a 409A valuation is conducted
The 409A valuation process typically takes 7–10 business days from data submission to signed report.
1
Data submission
Cap table, 12–24 months of financials, funding term sheets, and a business overview. The more complete your submission, the faster the process moves.
2
Methodology section
Your appraiser selects how your 409A valuation is calculated - OPM backsolve, PWERM, or asset approach - based on your capital structure and stage.
3
Draft review and 409A analysis
You receive the full draft with methodology documentation. Never accept a black-box report with no visibility into assumptions.
4
Final signed report
An audit-ready 409A valuation report. IRS safe harbor compliant, board-ready, and valid for 12 months from signing.
Valuation Methodology
How FMV is actually calculated
Market Approach
OPM Backsolve
Anchors to your most recent funding round price, then uses option pricing math to allocate value across all share classes. The most common method for post-seed companies.
Best for: Seed through Series B+ companies
Best for: Seed through Series B+ companies
Income Approach
Discounted Cash Flow (DCF)
Projects future cash flows and discounts them to present value. Requires credible revenue forecasts.
Best for: Revenue-stage, scalable businesses
Best for: Revenue-stage, scalable businesses
Asset Approach
Net Asset / Cost Method
Values the company based on underlying assets - net tangible book value and intellectual property. Conservative by nature.
Best for: Pre-revenue, IP-heavy companies
Best for: Pre-revenue, IP-heavy companies
Why your 409A will always be lower than your round price: Preferred stock includes liquidation preferences, anti-dilution protection, board control, and participation rights. Common stock has none of these. The resulting gap between preferred and common is not pessimism. It is arithmetic.
Sample 409A Valuation Report
See what an audit-ready 409A valuation report actually looks like
Most founders see their first 409A report the day they need to present it to the board. Download Qapita's sample 409a report and know exactly what you're getting.
- Executive summary — FMV per share and key findings
- Capital structure and funding history
- Methodology walkthrough — how FMV is calculated with full assumptions
- Comparable company selection and volatility derivation
Common Pitfalls
6 mistakes that create real legal exposure
Issuing options before a 409A exists
If your subsequent valuation comes in higher, employees had a retroactive taxable event - often with no liquidity to cover it. No 409A means no safe harbor from day one.
Using your round price as your 409A FMV
Your Series A preferred price is not your 409A fair market value. Preferred stock carries rights that common stock doesn't. They price different instruments entirely.
Continuing to grant after a material event
A round close, major revenue inflection, or secondary transaction is a 409A material event that immediately voids your report. Grants issued after fall outside safe harbor.
Hiring a low-quality appraiser
A cheap valuation that can't withstand an IRS audit is worse than none. Audit-ready 409A valuation reports require certified analysts and defensible assumptions - not just a number on a page.
Starting the process the week you need to grant
The 409A valuation process takes 7–10 business days. Initiating it the week an offer letter goes out creates pressure to rush - which is when errors happen.
Conflating board-approved and 409A valuations
A board may approve a valuation for investor communications that differs from your 409A FMV. Using one where the other is required is a compliance failure, not a grey area.
Clearing Up The Most Common Confusion
409A valuation vs. VC valuation
409A Valuation
VC / Fundraising Valuation
Purpose
Set a defensible legal strike price
Determine the price investors pay
Conducted by
Independent, certified appraiser (ABV/ASA)
Negotiated between founders & investors
What's valued
Common stock - no special rights
Preferred stock - with rights & protections
Typical result
Always lower
Always higher
Legally required?
Yes — IRS mandated
No - commercial negotiation
Expiry
12 months or material event
No expiry
The hard part was understanding it. The easy part is getting it done.
Qapita delivers a fully documented, audit-ready 409A valuation in 5 business days - so you can issue options with confidence.
FAQs
Frequently asked questions
What documents do I need to provide?
Cap table, 12–24 months of financial statements, term sheets from funding rounds, and a brief on your business model and major milestones.
We raised on SAFEs. Do we need a 409A?
SAFEs and convertible notes don't automatically trigger a new 409A. Once they convert into a priced round, that conversion is a material event and a new 409A is required.
We're incorporated outside the US. Do we still need a 409A?
Yes, if you grant equity to employees who are US taxpayers. The obligation follows the tax residency of the recipient.
My auditors are asking for a 409A. Is that normal?
Completely standard. Under ASC 718, auditors require a current, defensible 409A as part of annual financial statement audits.
Can I use the same 409A for multiple grants across the year?
Yes - as long as it's still within its 12-month validity window and no material event has occurred.
We granted options before getting a 409A. What do we do?
Address it immediately. Options granted without a valid 409A can be corrected through formal repricing or remediation. Consult a qualified equity attorney.
